“In the light of the recent banking crisis, the new Solvency II regulatory measures should be re-appraised”. Critically consider this statement | |
| INSURANCE |
I) The banking crisis
II) The main principles of Solvency II
1) Three Pillars
2) Risk assessment : differencewith Solvency I
III) Solvency II : Advantages and disadvantages
2) Criticisms and points to review
Solvency is the ability for an insurer to meet the long-term commitments that it takes with its customers. It depends on the size of these commitments and resources available to the insurance company to deal with, especially inthe form of equity or asset it holds. Insolvency is the main financial risk faced by insurance companies (T.Pentikäien).
In Europe the first solvency margin requirements were established in 1973 for non-life insurance and in 1979 for life insurance, but since the end of the century the Müller’s report recommended changes because these requirements became obsolete and the market had change: allconditions were met to review the old guidelines, so Solvency I was born in March 2002. However Solvency I couldn’t take into account the economic risks they are exposed (Lloyds’. Solvency I).
Nowadays, in the movement of redefinition the margin of solvency in risk for all financial risks, and after the banks and the implementation of Basel II, it is the turn of the insurance. With the newregulatory Solvency II, now insurance companies take risks into account. The directive was passed April 22, 2009 and will be enters into force at the end of 2012. The directive is divided in three pillars and the objectives of Solvency II are to create a harmonized system, with better consideration of the risks faced by insurance organizations and more consistent with the prudential banking system.
Thebanking crisis and all the risks in 2009 have accelerated the adoption of the directive Solvency II. Yet we can ask what are the advantages and disadvantages of this reform and therefore the points to review.
I) The banking crisis
The financial crisis that began in 2007 and is still ongoing in 2010 is a market financial crisis by a crisis in interbank liquidity and credit. Initiated in July2007, it results from significant losses of financial institutions that caused the subprime crisis.
Origins: Subprime credit and securitization
The subprime is at this time a subprime mortgage widespread in the United States. This is a type of variable-rate credit secured on the housing of the borrower. The success of this loan comes from its strong profitability and little apparent risk beingtaken by the lender, the latter becoming the owner of the property if the borrower couldn’t pay. But between 2004 and 2007, the FED raised its main rate going from 1% to 5%. U.S. households had to pay more and more each month. So, banks became owners of many homes in the country. However the real estate market has declined over the same period, lending institutions have recognized the loss ofvalue of their claims.
The main problem is that these subprime loans didn’t stay in US banks, they have been transferred in the form of debt securities, like bonds to other banks and institutional investor through financial markets: this is called securitization. With this process, the subprime debts have become “rotten” because borrowers couldn’t repay. That’s how the virus has spread through thestock market to regain the balance sheet of some banks around the world.
Effects: falling of stock markets, credit crisis and recession risk
Thus banks were left with risk investment in assets whose value has fallen sharply. This impairment must be incorporated in accounts on the Mark-to-Market principle (advocated by the International Accounting Standards: IFRS), which reduces the capital of...
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