The Implications of Solvency II for U.S. Insurance Regulation

Much work has been done in recent years on the subject of insurance regulation and capital requirements, and the process of regulatory reform will continue. It behooves insurance supervisors to take a step back, revisit the underlying assumptions that have driven supervisory reform in the various sectors, and assess what implications, if any, their conclusions have for future work. The use of internal models to establish regulatory capital requirements cannot and should not disappear. However, they must be used appropriately, with recognition of their significant limitations. The optimal structure of insurance supervision is likely to be a combination of a rules-based and a principles-based approach. That is, internal models should be an adjunct to a rules-based capital requirement that establishes a floor for regulatory capital. Capital regulation is a necessary, but not sufficient, additional requirement for effective financial regulation. On-site examinations, offsite analysis of financial performance and trends, and frequent interaction with the regulated entity are equally important. Finally, current developments have demonstrated that market discipline cannot be relied on as a substitute for regulation and supervision. The optimal regulatory structure is one that encourages supervisors to take action when it is appropriate, and a system that incorporates duplicative regulatory oversight may advance that objective.