EUROPE - The European Commission's long awaited Solvency II proposal to upgrade legislation for the insurance industry would have insurers assessing their own capital needs in light of all risks by means of a so-called 'own risk and solvency assessment' (ORSA).

This refinement to assessments of capital backing by the insurers  is expected to release vast funds, in the order of billions of euros, on to the investment market, largely from the life side of insurance.

A  'supervisory review process' (SRP) would shift supervisors' focus from compliance monitoring and capital to evaluating insurers' risk profiles and the quality of their risk management and governance systems. In addition, the new system would enable insurance groups to be supervised through a 'group supervisor' in the home country.

The introduction of group supervisors would ensure that group-wide risks are not overlooked and would enable groups to operate more efficiently, while providing policyholders with a high level of protection. Groups that are sufficiently diversified may also be allowed to lower their capital requirements under certain conditions.

The new Solvency II draft directive will now be subject to the Brussels processing machinery - involving the European Parliament, various other groups including lobbies, and the Council of national government ministers - before coming into effect in national rules. Guesses at the likely date for final implementation hover around 2012.

The Commission notes that the current EU solvency system is over 30 years old. As a result of lack of a lead position on regulation, many EU member nations have introduced their own additional rules at national level, leading to a range of different regulatory requirements.

Solvency II would replace this patchwork of different rules, ensuring a level playing field and a uniform level of consumer protection. It is in line with international discussions within the International Association of Insurance Supervisors (IAIS), which may take on board some of the principles involved, for the eventual upgrading other financial legislation.

However, the proposed directive does not apply directly to pension funds. These are covered by the Occupational Pensions Funds Directive (IORPs) directive of 2003, which is due for review in 2008.

Solvency II takes its place alongside its equivalent for the banking industry, Basel II, and the MiFID directive covering the sales of securities across the EU, as one of the majors in the European Union's Financial Services Action Plan. This plan is on the way to breaking down the fragmented nature of financial services legislation across Europe. The aim is to improve capital markets to stimulated economic growth.