Diversification reduces capital requirements

Solvency II will also strengthen the use of the appropriate performance yardstick. Success will not be measured in terms of generating a high premium volume but according to whether a high return on risk capital is achieved. This is all the more likely in view of the fact that the insurance industry's overall regulatory capital requirements will rise. However, an individual company's capital requirement will be reduced through the use of diversification effects. These can be systematically influenced by means of risk transfer, which will increase the importance of individually tailored reinsurance. In addition, under Solvency II reinsurance will be considered in full in the alculation of the solvency margin. Reinsurance is therefore an effective risk-management measure which can provide substantial capital relief.

The new rules will increasingly focus the attention of clients and investors on capitalisation. Given the risk-return requirements, primary insurers face the challenge of optimising their risk capital in terms of the business to be written, i.e. of not measuring risk capital too conservatively or too generously. In the event of shortages, insurers can either turn to the capital markets and increase the available capital or reduce their required risk capital, for example through reinsurance or by shedding business.

Risk management — The decisive parameter

Solvency II will especially benefit those companies that, despite existing uncertainties, are already looking into the subject and creating a better basis for future operational and strategic decisions. This effort will be rewarded as it will facilitate preparation for future requirements in supervision and risk management and will thus make it easier to implement Solvency II when the time comes. It will also improve steering and control mechanisms throughout the company.

The requirement of greater transparency will permit more accurate analysis of risk management and will strengthen the economic need to adjust capitalisation to requirements. In future, reinsurance programmes will also be subject to altered criteria and individual solutions will be more sought after. Risk management will therefore become the decisive parameter in the structure and negotiation of reinsurance cover and the requirements insurers demand of their reinsurers will also increase as a result. Thanks to its active involvement in committees engaged in structuring Solvency II and the development of its own risk model at an early stage, Munich Re has acquired extensive knowledge of the design process and potential implications of Solvency II. It is therefore ideally placed to offer all-round solutions and can demonstrate its value as an attractive partner in risk.

In its partnerships with clients, Munich Re is looking to step up dialogue with clients on the subject of Solvency II, so that we can tackle the changes together. One of the challenges we face is to integrate the data needed to manage a company on an exposure-oriented basis into the existing core administration systems or to represent the data with sufficient precision in supplementary systems that will enable us to model and evaluate this data. Even for companies in the vanguard of Solvency II, there still remains much to do in the years to come, not just in anticipation of the changed supervisory requirements, but above all in the companies' own interest with the view to improving riskreturn management.

Kathleen Ehrlich and Dr. Clemens Frey (both DAV actuaries) work in Munich Re's Integrated Risk Management Division. They are concerned with the quantification of risks in the internal capital model, focusing principally on Solvency II and insurance supervision.
Bernd Horsch works in Munich Re's SFR Innovation Team. His tasks include analysing the implications of Solvency II for client companies. His main field of activity is product development for operational risks in the context of Basel II and Solvency II.
Ralf Kürzdörfer (DAV actuary) works in Munich Re's Life Divisional Unit, where his responsibilities include investigating the implications of Solvency II for life insurers and reinsurers.