Most insurers across Europe will meet the long-awaited Solvency II risk-based capital requirements that come into force this month but it's still unclear whether the rules will change their long-term strategies.

Smaller and midsize insurers may be forced to merge to survive under the new regime or pull out of some lines of business, some industry experts say.

The rules are designed to protect insurance buyers and reduce the risk of insurers and reinsurers going bust.

Solvency II has “the end goal of protecting the interests of policyholders” and the “long-term solvability” of insurance companies, said Alberto Minali, chief financial officer of Trieste, Italy-based Assicurazioni Generali S.p.A.

Solvency II “is intended to ensure a uniform and high level of policyholder protection, giving customers confidence in insurance products,” said Hugh Savill, director of regulation at the London-based Association of British Insurers. “Solvency II will also modernize supervision across the European Union, shifting focus from solely compliance and capital to include the evaluation of insurers' risk profiles, risk management and improved reporting and transparency,” he said.

The new European Union capital rules, which were initially framed in 2009, replace solvency rules that had been in place since 1973. The Solvency II Directive, which has been delayed and criticized over the past seven years, marks a major change in the way insurers will assess their capital needs.

Beginning this month, insurers and reinsurers in all 28 E.U. member states will be subject to harmonized regulation that will focus on their risk profiles, risk management and governance.

Solvency II has three so-called pillars that cover risk-based capital, governance and reporting.

Large captives that handle risks of their parent companies — and not compulsory third-party insurance coverages — will adopt Solvency II under the so-called principle of proportionality, which will mean certain sections of the rules are simplified.

The Brussels-based Federation of European Risk Management Associations said that discussions between the captive industry and European regulators would continue even after the implementation of Solvency II to ensure that the rules are not too onerous for captives.

While many local country regulators have imposed the rules to their most stringent extent — so called gold-plating — many insurers believe the new code has led to improvements in governance, risk monitoring and data quality.

Sources said some national regulators are expected to use lower levels of interest rates for insurers to calculate their liabilities than required by the Solvency II rules, which may make liabilities appear larger, while other regulators are expected to require more disclosure than required by the rules.

According to a survey by Insurance Europe, the Brussels-based association of European insurance companies, many insurers and reinsurers believe that they are ready for the new rules that cover risk-based capital, governance and reporting.

During November, Insurance Europe surveyed insurers and reinsurers representing about 92% of premium volume in Europe about their readiness for Solvency II. A spokesman for the organization declined to give many details but said a “very large percentage” of insurers and reinsurers feel completely confident they are ready.

More than two-thirds — 68% — of respondents to the survey said they believe that their principal regulator had gold-plated the rules and that many had imposed last-minute additional requirements.

“I would like to stress that Solvency II is already an extremely conservative and extensive regime. It is, therefore, important — especially at this late point — to limit additional requirements and conservative interpretations,” said Igotz Aubin, head of prudential regulation at Insurance Europe, in a statement.

Any additional regulations will have time to evolve, however. The European insurance regulator, the Frankfurt, Germany-based European Insurance and Occupational Pensions Authority, said in early December that “in light of current differences of supervisory cultures and practices,” insurance regulators would have a further five years to fully harmonize practices across the European Union.

Meanwhile, rating agency A.M. Best Co. Inc. said it does not expect to take any rating actions as a direct result of the introduction of Solvency II, despite the tougher capital requirements.

Catherine Thomas, an analyst at Best in London, said it was highly unlikely that any European insurers and reinsurers that the agency rates will be in breach of the rules' minimum capital requirement when Solvency II comes into force in January.

Under Solvency II, insurers and reinsurers also must comply with a solvency capital requirement, which is of a higher level than the minimum capital requirement.

Breach of the solvency capital requirement would result in intervention by the regulator and the insurer in question being required to boost its funds or reduce its risk profile, while breach of the minimum capital requirement would likely lead to the insurer losing its license, Best said in a report.

During the past few months, regulators across Europe have been granting approval to many of the internal models that most larger insurers and reinsurers will use for their Solvency II capital calculations.

Those insurers and reinsurers that do not apply to have an internal model approved, or whose model is not approved, will be required to use a standard formula. The standard formula comprises models for market risk, health insurance, default risk, life insurance, nonlife insurance and intangible risks, and is calculated to a 99.5% confidence level over a one-year period.

“The ability to use an internal model to calculate the solvency capital requirement is particularly important to companies for which the standard formula does not appropriately reflect their risk profile,” Best said.

According to Jim Richard, U.K. Solvency II leader at PricewaterhouseCoopers L.L.P. in London, internal model approval gives insurers and reinsurers not only “the certainty of optimal capital requirements” but also reputational benefits.

Internal model approval demonstrates that regulators are satisfied with a company's own risk-based capital management, experts say.

Once firms have their model approved, insurers and reinsurers will need to update those models regularly, he said.

The announcement earlier this month by the London-based Prudential Regulation Authority that 19 U.K. insurers had had their internal models approved is a “major step towards clarity of those insurers' capital positions,” Fitch Ratings Ltd. said in a statement.

“As Solvency II positions become clear, insurers will have their regulatory capital strength — or weakness — confirmed,” Fitch said.

“We believe this clarity will trigger some M&A, as stronger insurers acquire or merge with weaker ones facing capital shortfalls,” the rating agency said.

According to Yannis Samothrakis, a partner at law firm Clyde & Co. L.L.P. in Paris, the introduction of Solvency II may result in an increase in runoff deals in Europe.

Many smaller or midsize insurers and reinsurers likely will reassess their business models in the light of the new rules, which may result in some selling off certain books of legacy business, he said.