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Lloyd's prepares for Solvency II

Readiness assessment for managing agents scheduled for this fall

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Lloyd's prepares for Solvency II

LONDON—Lloyd's of London is confident that its internal model for Solvency II will be endorsed by regulators and is making sure the models of its managing agents also meet Europe's new rules governing insurer capital.

Lloyd's will be treated on a marketwide basis by European regulators once Solvency II goes in effect, which is scheduled for Jan. 1, 2013. In preparation, individual managing agencies must provide Lloyd's with information about how they are managing risks in accordance with Solvency II.

Lloyd's, like many other insurers and reinsurers, is seeking approval of its internal model from the U.K. Financial Services Authority. But that model also will be calibrated against the models of the 55 managing agents working in the market, said Luke Savage, director of finance, risk management and operations at Lloyd's.

“We need to be comfortable that all of those 55 models are up to a standard—including their corporate governance—that would gain them approval (from regulators) on an individual basis,” Mr. Savage said.

The need to aggregate the models of 55 managing agencies is a costly challenge and one on which Lloyd's is hard at work, said Andy Tromans, a partner at London-based law firm Clyde & Co. L.L.P.

Under Solvency II, internal models must pass what is known as the “use test,” which requires insurers to demonstrate that their internal model plays an important role in the company's system of governance, risk management and decisionmaking, Mr. Tromans said.

To ensure the market is well-prepared for Solvency II, Mr. Savage recently informed managing agents that Lloyd's will assess their readiness this fall.

In a letter, Mr. Savage explained that by November, when Lloyd's businesses must put up their capital for the coming year, if there are concerns about a managing agency's preparedness for Solvency II, Lloyd's may take several sanctions.

He said Lloyd's may increase the capital that managing agents must have in place for 2012, restrict business that managing agencies' syndicates can underwrite or charge managing agencies higher contributions to the market's central fund—its fund of last resort.

Solvency II would allow “partial approval” of an insurer's internal model, whereby an insurer may be allowed to use it for certain areas of its business but also be required to use the standard model, which likely will impose higher capital requirements, for other areas.

Lloyd's also may adopt a similar approach for some managing agencies in the market, Mr. Savage said.

While Lloyd's is confident regulators will improve its internal model, Mr. Savage said Lloyd's is working hard to ensure that all 55 managing agencies are ready for Solvency II. Still, it is possible that some will not be fully ready for the new rules when they come into force, he said.

In that case, any managing agencies that are not deemed ready to be included in Lloyd's internal model would have to use the standard formula “until they are up to speed,” he said.

Applying the standard model to determine an insurer's solvency requirements would vastly increase the amount of capital that Lloyd's would have to hold to underwrite its business, said Clyde & Co.'s Mr. Tromans.

The entire Lloyd's market will spend about £300 million ($484 million) to prepare for Solvency II, outgoing Chairman Lord Peter Levene has said.

The Corp. of Lloyd's has about 100 people—of a worldwide staff of about 900—working on preparations for Solvency II, Mr. Savage said. In addition to a team developing Lloyd's internal model, a team also is working with managing agencies to ensure that they are progressing in their preparations.

It is essential for Lloyd's to receive approval of internal model, said Catherine Thomas, a director of analytics at A.M. Best Co. Inc. in London.

There are several areas where the standard model calculation is disadvantageous to Lloyd's, notably the amount of capital that companies underwriting catastrophe risks outside the European Economic Area must hold, Ms. Thomas said.

International catastrophe business is one of Lloyd's largest sources on premium volume.

Martin Bride, group finance director of Beazley P.L.C., said his company, which operates five syndicates at Lloyd's and is domiciled in Dublin, will spend about £4.6 million ($7.4 million) and devote about 4,000 working days to prepare for Solvency II.

As well as developing internal models, Solvency II requires insurers to undergo extensive reporting and documentation of governance controls, noted Clyde & Co.'s Mr. Tromans.

Solvency II is “a significant program of work made more intensive by the reporting and documentation requirements,” Beazley's Mr. Bride said.

Beazley has a capital model team, a risk team and a compliance team working to prepare for Solvency II. It also has a team of information technology specialists and consultants who will work with the company on Solvency II for the next 18 months, he said.

Beazley has to report its Solvency II readiness to three regulators, Mr. Bride noted—Lloyd's, the FSA and the Central Bank of Ireland, the Irish regulator.

For companies that operate outside of Lloyd's but also run syndicates within the market, models of those differing businesses need to be dovetailed, Mr. Tromans said.

Developing models, plus the Solvency II reporting and documentation requirements, could prompt mergers and acquisitions among some smaller Lloyd's agencies, he said.

While the burden of Solvency II compliance is a heavy one for small Lloyd's entities, they benefit from the support and information provided by Lloyd's in a way that smaller stand-alone companies outside the market would not, said Best's Ms. Thomas.

However, the reporting and governance requirements of Solvency II—or what are know as Pillars II and III of the regime—may prove onerous for smaller Lloyd's entities, she said. After requirements are fully known, some M&As may take place among smaller players that find the burden too great, she said.