Basic architecture

Solvency II is based on a three pillar approach which is similar to the banking sector (Basle 2) but adapted for insurance.

The first pillar contains the quantitative requirements. There are two capital requirements, the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR), which represent different levels of supervisory intervention. The SCR is a risk-based requirement and the key solvency control level. Solvency II sets out two methods for the calculation of the SCR: the European Standard Formula or firms' own internal models. The SCR will cover all the quantifiable risks an insurer or reinsurer faces and takes into account of any risk mitigation techniques. The MCR is a lower requirement and its breach triggers the ultimate supervisory intervention: the withdrawal of authorisation.

The second pillar contains qualitative requirements on undertakings such as risk management as well as supervisory activities.

The third pillar covers supervisory reporting and disclosure. Firms will need to disclose certain information publicly, which will bring in market discipline and help to ensure the stability of insurers and reinsurers (disclosure). In addition, firms will be required to report greater amount of information to their supervisors (supervisory reporting).

Solvency II will also streamline the way that insurance groups are supervised and recognises the economic reality of how groups operate. The new regime will strengthen the powers of the group supervisor, ensuring that group-wide risks are not overlooked, and demand greater cooperation between supervisors. Groups will be able to use group-wide models and take advantage of group diversification benefits.