I am conscious of the time limitations and will not repeat what other contributors have said. I will cover four aspects of the proposal: the general structure of the Solvency II directive, which has already been mentioned; the Financial Regulator's involvement with the Solvency II project; the key regulatory issues; and challenges for stakeholders, which include industry supervisors and market participants.
Other speakers have outlined the purpose of the Solvency II directive. Essentially, it introduces a market-consistent, risk-based approach to the assessment of solvency. From a consumer protection perspective, a robust supervisory regime, particularly in regard to solvency, is the main protection for consumers in terms of the industry fulfilling its policy obligations. The main drivers have already been mentioned. One interesting driver is the desire for harmonisation and convergence of supervisory practices and, more importantly, regulatory regimes in Europe. Mr. Kemp mentioned the attractiveness of Ireland as a location because of the way we regulate. However, increasing harmonisation and convergence across Europe will lessen that attractiveness, which poses a challenge for us. In addition, changes are being considered by the International Association of Insurance Supervisors and, perhaps more importantly, the International Accounting Standards Board. The idea is that whatever we introduce in the solvency regime will be consistent with new accounting practices that are already being discussed at international level. The current regime does not address any of these concerns, based as it is on 13 directives in the insurance area.
The three pillars have already been mentioned. What is important about them is that they interact in the sense that each pillar cannot be considered independently. It is important to point out that the first pillar is entirely quantitative. It deals not only with technical provisions for known liabilities of insurers, but also the questions of what capital is for and what solvency is all about. In essence, solvency is concerned with unseen losses. This is sometimes forgotten in the debate; it is a question of unknown rather than known challenges. Institutions must have sufficient capital to get through those times.
Interestingly, there are two levels of capital, the MCR and SCR. The idea is that there be different elements of supervisory intervention if capital falls below the SCR. If the MCR is broken, we have what the directive describes as "ultimate supervisory action", which is the withdrawal of authorisation. This structure of an MCR and SCR is consistent with what we already have in our regulatory process in that we have a requirement above the absolute minimum set by the directives.
The second pillar, which focusses on corporate governance, internal control and risk management, will present a challenge for many supervisors in Europe but, fortunately, not so much in Ireland. It requires institutions to have their own risk and solvency assessment carried out on at least an annual basis. The Financial Regulator already focuses very much on corporate governance and risk management in companies.
The provision regarding disclosures will have significant implications for the industry across Europe. Institutions will be required on an annual basis to publish a financial condition report as well as details of how they have complied with their solvency requirement for the year in question. This applies equally for groups, subsidiaries and solo entities.
Since 2004, the Financial Regulator has committed significant resources in terms of person days to the Solvency II process. We have partaken in all the working groups of the Committee of European Insurance and Occupational Pensions Supervisors, CEIOPS, and we chair the Insurance Groups Supervision Committee, IGSC. We have also participated in the work of the Financial Stability Committee, FSC, for the last three years. We were involved in the drafting of advice requested by the European Commission from CEIOPS. The latter drafted advice, put it out to public consultation and, having considered the findings of that consultation, sent formal advice to the Commission. Slide No. 24 outlines this formal advice. I use the word "formal" because CEIOPS responded to official calls for advice. Mr. Carrigan mentioned that the Commission has called for further advice on groups issues. The advice was given prior to the publication of the directive earlier this year. I do not claim that all the advice was taken on board but a large part of it was.
As members know, the Commission is responsible for drafting EU legislation. It was involved with member states at Finance Ministry level, or Level 2 under the Lamfalussy process, in the context of Council working party negotiations. Since the proposal was put forward under the Portuguese Presidency, as Mr. Carrigan mentioned, several meetings have taken place and various regulatory issued were notified. One of these is group supervision. Another relates to diversification effects and what is called group support. Other regulatory issues include harmonisation and supervisory co-operation. Finally, there is the issue of "one size fits all".
Although it is not proposed to have a "one size fits all" regime, the proposal is based on a risk-sensitive regime and is, as Mr. Kemp noted, highly technical. It is not obvious that all companies will be able to comply with it. This certainly has implications in an Irish context and in respect of offering competition to consumers in a European context. This is because while there are almost 5,000 insurers throughout Europe, there only are 122 insurance groups. Members will find that the regime is designed largely for the more complex and dominant insurers in the market, as distinct from the large numbers of insurers that exist. Our statistics show the presence of 229 insurance undertakings in Ireland. This figure excludes 120 reinsurers that were deemed authorised from last Monday of this week. In addition, 42 branches of other jurisdictions operate directly in this jurisdiction. Significantly, however, as companies are allowed to operate here on what is called a freedom of service basis, they are not obliged to locate here and we have received 711 notifications of companies who can do business in Ireland on a freedom of service basis.
As for group supervision, the initial advice provided to the Commission essentially was to effect an incremental change to the current regime. Supervisors in Europe already had done much work in this regard and a fairly detailed paper was published last December on a lead supervisor concept for insurance groups. Mr. Carrigan mentioned colleges of supervisors. Co-ordination committees, which amount to the same thing, have operated for a number of years in the field of insurance supervision. Consequently, for most of the 122 insurance groups in Europe, a lead supervisor already has been appointed.
Under the proposal, greater responsibility will be vested in the group supervisor and most supervisors have no major difficulty in that regard. Essentially, the directive will put into law what supervisors had already proposed on their own initiative last December. Supervisors throughout Europe have concerns relating to the diversification benefits from which groups may benefit and what is called the group support regime, which constitute two different issues. In any group that seeks to benefit from the group support regime, the group supervisor will have a vastly increased role and responsibilities and, consequently, the local supervisor will have significantly less responsibility in this regard. Essentially, local supervisors only will oversee the minimum capital requirement, whereas the group supervisor will oversee, even in respect of a subsidiary, the solvency capital requirement, which is the higher level of capital that the solo entities will be required to hold. Moreover, it is not clear where the capital in excess of the minimum capital requirement can be, or will be, held in a group context.
Hence, reservations exist among supervisors in Europe on these issues. As Mr. Kemp pointed out, this is because the proposal assumes a willingness on the part of both the group and the group supervisor to act promptly if a subsidiary is under financial stress. As Mr. Carrigan mentioned, it also looks to the economic form of supervision and the economic manner in which groups are established, instead of the legal way that groups have set up, which largely involves using subsidiaries rather than branches. Clearly, the only obligation on groups that wanted to benefit from having centralised capital would be to set up branches in all the jurisdictions in Europe as such a benefit would then arise automatically. The worrying question then arises whether capital could be moved from one jurisdiction to another when either the group or the individual company is in stress. Clearly, there is a potential conflict with the existing reorganisation and winding up directive, which specifically exists to protect policyholders in a winding-up situation. Moreover, what can be regarded by large groups as small subsidiaries may in fact be fairly large subsidiaries in a domestic context.
I will not mention the additional work on groups that is being carried out because Mr. Carrigan has already done so. However, CEIOPS and the European Commission will examine these issues over the coming months and, hopefully, advice will be given to the Commission by next May on how to deal with them. As Mr. Kemp noted, the fourth quantitative impact study will take place next April, which should identify other issues on the group support regime.
On harmonisation, while there are common directives, the member states' regulatory regimes are entirely different and member states have exercised different options in respect of such directives throughout the Union. Some member states have what is called gold-plating or super equivalence when compared to a directive's contents. Supervisory approaches diverge and the legal frameworks that operate across the Union also differ. However, harmonisation is one of the key objectives of Solvency II. If successful, it will create a truly single market in insurance and, consequently, an institution really should experience the same regulation irrespective of its location.
Everything that has emerged from the ECOFIN Council, the Commission, the European Parliament and the inter-institutional monitoring group on the Lamfalussy process in particular has stressed the desirability of convergence in supervisory practice in both insurance and across all financial services legislation and practices in Europe. This objective faces several challenges including differences between the conservative regulators in Europe and those that are progressive, rules-based regulators as opposed principles-based regulation and expedient measures to reach agreement during the negotiation of directives. An example of the latter is that the directive already calls for a five-year review of the group support regime although the directive has not yet been agreed. Other challenges to harmonisation include its local implementation, as well as failure to consider all relevant situations. Clearly, the legislation focuses on the larger companies and issues and it is not always possible to address all institutions in all circumstances in a directive.
Mr. Kemp has already mentioned an issue in respect of the "one size fits all" approach. Although the work on the directive focuses clearly on large market participants, particularly in the non-life sector, Ireland has many cross-border companies, that is, companies that are located here specifically to write business in other jurisdictions. In addition, Ireland has a very large captive sector, which essentially comprises insurers that have been set up to cover the own risk of their parent entities rather than selling it to third parties. Ireland also of course has a significant reinsurance business. It is the third largest in Europe and holds approximately 7% of the global insurance premiums in reinsurance. Our concern is that, given the broad nature of the directive's framework, significant attention will not be paid to such issues and I agree with Mr. Kemp's comments in this regard.
The key message for stakeholders is to start early. Although Mr. Carrigan mentioned that it will not be implemented until 2012, we have learned significantly from developments in the banking sectors. I refer to the Basel II rules and the negotiations leading up to the capital requirements directives. In that instance, banking institutions in particular are playing catch-up although they had a good few years' notice of what was coming down the tracks. Another lesson is to avoid underestimating the complexity of the project and, undoubtedly, as Mr. Kemp has mentioned, it is complex. The current insurance regime is very straightforward and simple. Essentially, solvency is calculated on the basis of either premium income or claims. However, the new regime will have capital requirements for credit risk, liquidity risk, interest rate risk, equity risk, property risk and operational risk. Hence, as all these risks apart from insurance underwriting must be taken into account, it will be complex. A further lesson pertains to the importance of securing the involvement of the Irish industry in particular in the quantitative impact surveys. I compliment the industry in this regard as 39 companies became involved in the third survey, which has provided us with a good idea of the potential impact on Irish insurers.
This will have major implications across Europe from a supervisory perspective. However, for the Irish regulator, the implications initially may not be so great in terms of the supervisor review process. Nevertheless, as Mr. Kemp has noted, the attraction to Ireland of the complex institutions would involve major information technology demands and the validation of internal models might require significantly greater actuarial expertise within the regulator. I refer to level three, which has not been mentioned. It constitutes the third level of the Lamfalussy process, whereby, in essence, supervisors will agree on proposals and convergence in supervisory practice without needing legislation to so do. This certainly will happen and, ultimately, there also will be greater transparency and accountability for supervisors.
In conclusion, although this is a prudential directive that is significantly, if not entirely, focused on technical and governance aspects of supervisors, as I noted at the outset a sound robust prudential regime constitutes the bedrock of prudential supervision. This is a consumer protection directive because although it only focuses on industry, consumers will be better protected by it. The Financial Regulator is the institution charged with the protection of consumers in respect of financial services and my colleague, Ms Colette Drinan, who is from our consumer protection department, will answer any questions in that regard.
