Actuarial Notes

Solvency II

Study guides: Exam 6C, Exam GI-201

Solvency II is the European Union's risk-based solvency regime for insurers, in force since 2016. Canadian candidates study it as the international benchmark against which the Canadian framework is compared: it is more explicitly principles-based, uses a market-consistent balance sheet, and permits approved internal models in place of the standard formula.

\text{Solvency ratio} = \frac{\text{Own funds}}{\text{SCR}}

  • The three pillars: Pillar 1 — quantitative requirements (technical provisions, the Solvency Capital Requirement and the Minimum Capital Requirement); Pillar 2 — governance and supervisory review, including the ORSA (which Canada adopted); Pillar 3 — disclosure and reporting.
  • The SCR is calibrated to a 99.5\% VaR over one year — the capital needed so that the probability of ruin in a year is 0.5\%. The MCR is a lower floor, breach of which triggers the most severe intervention. The explicit probabilistic calibration is a clear contrast with the MCT, whose factors are calibrated but whose overall confidence level is not stated as a single figure.
  • Technical provisions are a best estimate plus a risk margin, the risk margin computed by a prescribed cost of capital method at a specified rate. Compare IFRS 17's risk adjustment, which is entity-specific with a disclosed confidence level and no prescribed method.
  • Internal models may replace the standard formula for all or part of the SCR, subject to supervisory approval and stringent use, validation and documentation tests. Canada's MCT does not permit a general internal model for P&C insurers, which is the largest structural difference between the regimes.
  • Comparison points to be able to make:
    • Both are risk-based, three-pillar frameworks with an ORSA and public disclosure.
    • Solvency II is market-consistent throughout and states its calibration; the MCT is factor-based with a 1.5 buffer multiplier and target ratios.
    • Solvency II permits internal models; the MCT does not.
    • Canada supervises through a federal-provincial split (Federal-Provincial Jurisdiction); the EU through national supervisors coordinated by EIOPA.
  • Both descend from the same international work — the IAIS Insurance Core Principles and the emerging global capital standard — so convergence rather than divergence is the direction.

Comparing the Two Regimes An insurer operating in both Canada and the EU reports an MCT ratio of 195\% and a Solvency II ratio of 148\%. Management asks which regulator is being tougher.

Answer Neither ratio can be read against the other, and saying why is the substance of the answer.

The denominators measure different things.

  • The SCR is calibrated to a 99.5\% one-year VaR — an explicit probability statement.
  • The Base Solvency Buffer is 1.5 times factor-based Capital Required, with no single stated confidence level. So a 148\% Solvency II ratio means own funds are 1.48 times a 99.5\% VaR; a 195\% MCT ratio means capital available is 1.95 \times 1.5 = 2.9 times capital required. The multipliers are not comparable.

The numerators differ too. Own funds under Solvency II are computed on a market-consistent balance sheet with technical provisions at best estimate plus a prescribed cost-of-capital risk margin; Capital Available starts from IFRS equity with regulatory deductions. Different liability measurement produces different capital.

What can legitimately be said:

  • Against each regime's own thresholds: 195\% against a 150\% supervisory target is comfortable; 148\% against a 100\% SCR requirement is adequate but with less headroom than the Canadian figure suggests, since a fall to 100\% is a regulatory event in both.
  • Against peers in each jurisdiction, which is the only genuinely comparable benchmark.

The management answer: the two ratios are not evidence about relative toughness; they are two different measurements of the same company. If a single view is needed, the honest route is an economic capital model — which is exactly what ORSA asks the insurer to build, and why ORSA exists in both regimes.