Europe's insurance industry looked ready to enjoy lower regulatory capital requirements under Solvency II, but that all changed with the financial turmoil that took hold in 2008 and spread worldwide.

Today, insurance buyers are concerned that they will face higher prices and reduced availability of some commercial insurance and reinsurance when the new regulations go into effect on Dec. 31, 2012.

The financial crisis forced European regulators to rethink the calibration of the proposed Solvency II capital regime, resulting in proposals for substantially higher capital requirements, said Rob Jones, managing director in London at Standard & Poor's Corp.

Last year's proposal from the Frankfurt-based Committee of European Insurance and Occupational Pensions Supervisors would have resulted in capital levels 70% higher than recommended by a 2008 quantitative impact study known as QIS 4. Capital requirements under the next impact study, QIS 5, are likely to be much lower, but still well above QIS 4, Mr. Jones said.

Although the final calibration of Solvency II will not be known until 2011, capital levels generally are expected to increase for European insurers, said Clara Hughes, associate director at Fitch Ratings Ltd. in London.

“Under QIS 4, reinsurers, captives and nonlife players showed the greatest deterioration in solvency ratios when compared to Solvency I,” Ms. Hughes said. “All other things being equal, Fitch considers it likely that this would remain the case under QIS 5.”

Last week, Karel van Hulle, head of the European Commission's internal market and services unit, raised the possibility of a sixth study, depending on the results of QIS 5. During a Madrid meeting of the International Insurance Society, he said QIS 6, if needed, would focus on “targeted issues” to allow a final decision “on the basis of facts, not dreams or theories.”

Higher capital levels could lead insurers to increase their hedging of asset and liability risks—potentially buying more reinsurance—and changing their business mix in favor of less capital-intensive lines of business, Ms. Hughes said. There also is the potential for consolidation among smaller insurers struggling with the cost of compliance and the need to raise capital to meet potentially higher solvency requirements, she said.

In the absence of equivalent supervisory agreements between the United States and Europe, European insurers could reconsider the viability of U.S. operations, should they be subject to significantly higher capital charges under Solvency II than domestic U.S. carriers, Ms. Hughes said.

The Brussels-based Federation of European Risk Management Assns. is concerned that commercial insurance and reinsurance buyers would have to pay significantly more for their coverage if insurers' regulatory capital requirements increase as signaled by CEIOPS' recent advice to the European Commission on Solvency II.

A March Comité Européen des Assurances report, “Why Excessive Capital Requirements Harm Consumers, Insurers and the Economy,” suggested that “the price of more capital-intensive general insurance could increase by some 20% on average with a potential reduction in capacity, especially for more capital-intensive long-tail exposures and catastrophe risks,” said Peter den Dekker, FERMA's president and corporate insurance risk manager at Naarden, Netherlands-based aerospace company Stork B.V.

The new regulations also will apply to non-European Union exposures written by European insurers, Mr. den Dekker said. “Solvency II will affect the U.S. and Asian risks covered by multinational companies' global insurance programs written by European insurers,” he said.

Global programs with European exposures written by U.S. insurers also will be affected by Solvency II because European fronting insurers may have to apply capital charges to business reinsured to domiciles that do not have equivalent supervisory status, he added.

FERMA members also are concerned about the threat of reduced availability of coverage and insurers' commitment to volatile lines of business.

“While it is still speculation on how Solvency II will turn out, the main concern of risk managers is the availability of coverage in the long term. Many of our companies rely on the insurability of certain risks and the commitment of insurers when deciding whether to invest and develop new products or business opportunities,” Mr. den Dekker said. “There is already competition between underwriters for capital within an individual insurer, and this could increase under Solvency II.”

“There is no guarantee that our insurance partners will still be active in the industrial insurance market in 10 years time, or whether they will have run away from the more capital-intensive lines,” Mr. den Dekker said.

Some insurers may find the bar too high due to the capital required or costs associated with higher standards of risk management systems and disclosure, said John Hume, London-based executive vp and chief financial officer of XL Capital Ltd.'s reinsurance operations.

“Some companies will face greater pressures to merge, be acquired or perhaps, in more extreme circumstances, even cease operations. Similarly, some companies may find that the capital they are carrying will need to be raised significantly under Solvency II and will overcome this by either writing less business or passing on more or raising more capital,” Mr. Hume said.

FERMA's concerns are valid, said S&P's Mr. Jones.

“Higher capital requirements could lead to an increased cost of transferring risk to insurance markets, and this may be an issue for the price and availability of capacity on offer from European insurers. This could work in favor of U.S. insurers operating in Europe,” Mr. Jones said.

A year ago, U.S. insurers were concerned that E.U. capital requirements under Solvency II would be too low and give a competitive advantage to European insurers in the U.S. market, said Therese M. Vaughan, Washington-based CEO at the National Assn. of Insurance Commissioners. “Now it is the other way around,” she said.

Even if required capital levels do increase, it is too early to assess what effect, if any, Solvency II will have on the availability of reinsurance, said Frank Achtert, Munich-based managing director at Guy Carpenter & Co. L.L.C. Global reinsurers already use internal capital models similar to those they are likely to seek authorization for under Solvency II, he said.

To establish capital requirements under Solvency II, insurers have the option to apply for internal model approval or use the standard formula, said Andrew Pryde, group actuary at Beazley Group.

It is anticipated that insurers that achieve internal model approval, which Beazley is aiming for, may require lower levels of capital than under the standard formula. This is because the standard formula under Solvency II will be calibrated to fit the range of European insurers, whereas an internal model should better reflect an individual insurer's risk profile, he said.

The impact of Solvency II on groups, particularly with significant U.S. operations, still is being explored. Beazley applies one risk management standard across the group and already allocates capital to classes of business as part of the business planning process, Mr. Pryde said. At this stage of the implementation process, “we believe that the classes of business we underwrite across the whole group will remain viable in a Solvency II environment,” he said.

If Solvency II requires European insurers to hold significantly higher levels of capital than currently, the additional demand for reinsurance could put pressure on global reinsurance capacity and pricing, Mr. Achtert said.

Provisions for group solvency under Solvency II also could have a “kickback” for U.S. cedents, he added. While the scope of Solvency II does not extend to the supervision of U.S. legal entities, European reinsurance groups will be required to put aside risk capital for non-E.U. exposures at a group level, Mr. Achtert said.

“Reinsurers may need more capital (under Solvency II), but whether this will be significant for U.S. exposures or whether it will have a major impact on price and capacity, it is too early to tell,” he said.

There are other potential implications of Solvency II for U.S. cedents, Mr. Achtert said.

The risk management and internal controls required by Solvency II could further enhance reinsurers' early warning systems which, in turn, could affect reinsurance catastrophe capacity for the United States as reinsurers seek to control their aggregate exposures, he said.

Solvency II also will raise the bar in the quality of data that reinsurers will require of cedents, he said. The higher levels of transparency and disclosure required by Solvency II and the demands of reinsurers' internal models will increase pressure on primary insurers to provide more accurate data, he said.