Solvency I to Solvency II

Two insurers collect the same premiums. One invests in government bonds, the other in shares. Under the EU's old rules they needed exactly the same capital. Solvency II was built to tell them apart.

L1.8.04: An insurer’s balance sheet showed an insurer's balance sheet: investments on one side, technical provisions and own funds on the other. Solvency rules ask how much of that cushion is enough.

Solvency I: a rule of thumb

EU insurance law first set a required solvency marginUnder Solvency I, the required solvency margin: capital set as a fixed share of premiums, claims or provisions. in the 1970s, for non-life insurers in 1973 and for life insurers in 1979. A 2002 update became known as Solvency I. The margin was a fixed share of the business written: for non-life insurers, roughly 16% to 18% of annual premiums or 23% to 26% of claims, whichever gave more; for life insurers, mainly a share of technical provisions. It was simple and cheap to run. But it looked only at the size of the business, not at its risks. Investment risk, the biggest risk for many insurers, was hardly in it, and neither was reinsurance quality, interest rate risk or concentration.

Solvency II: three pillars, like Basel II

The Solvency II Directive (2009/138/EC) was adopted in November 2009 and, after a long delay to settle the treatment of long-term guarantees, applied from 1 January 2016. It borrows Basel II's structure (L2.7.03: Basel II: three pillars).

The balance sheet. Everything is valued in a market-consistentValuing assets at market prices and liabilities at what it would cost to transfer them to another insurer. way. Technical provisions are a best estimateBest estimate: the probability-weighted average of future cash flows to policyholders, discounted with a risk-free curve. plus a risk marginRisk margin: an amount added to the best estimate so that another insurer would take over the obligations.. What is left after all liabilities is own fundsAssets minus liabilities on the Solvency II balance sheet, plus qualifying subordinated debt, sorted into three tiers., the insurer's loss-absorbing capital.

Two capital thresholds. The Solvency Capital RequirementSolvency Capital Requirement: own funds needed to survive a one-year loss that would be exceeded only once in 200 years. (SCR) is the own funds needed to survive a one-year loss that would be exceeded only once in 200 years: a 99.5% value at risk (L2.5.06: Value at risk: the idea). Insurers calculate it with the standard formulaThe SCR calculation set out in the rules: stresses for each risk, combined with set correlations. or, with approval, an internal modelAn insurer's own model of its risks, used for the SCR once the supervisor has approved it.. The Minimum Capital RequirementMinimum Capital Requirement: a lower threshold (an 85% one-year level), between 25% and 45% of the SCR. Below it, the insurer can lose its licence. (MCR) is a lower floor, kept between 25% and 45% of the SCR. The gap between them is the ladder of intervention.

Three lines carry the whole of Pillar 1:

Shown in full: the same assets-minus-liabilities logic as L1.8.04: An insurer’s balance sheet. How the standard formula combines its risk charges belongs to M4.6: Solvency II and insurance regulation.

Start from Northwind Life. Press “Shares fall” twice. Then raise the best estimate, as if interest rates had fallen or customers were living longer. When do you cross the SCR? The MCR?

Northwind Life, a made-up EU insurer, holds €8,500m of bonds, €1,000m of listed shares and €500m of other assets. Its best estimate is €8,200m, its risk margin €350m, other liabilities €250m, and its standard formula SCR €750m.

Solvency II applies across the EU and, through the EEA agreement, in Norway, Iceland and Liechtenstein. EIOPA writes much of the detailed technical rulebook and promotes consistent supervision, while national supervisors such as BaFin in Germany or the ACPR in France supervise insurers day to day (L2.7.07: The EU, UK and US landscape). The EU adopted a review of the Directive in late 2024 (Directive (EU) 2025/2), which applies from 30 January 2027.

Elsewhere, the same goals are met in different ways:

• UK: kept Solvency II after leaving the EU and has since reformed it as Solvency UK, supervised by the PRA.
• US: each state regulates its insurers, using the NAIC's risk-based capital (RBC) formula; there is no single federal insurance supervisor.
• Asia-Pacific: risk-based regimes such as China's C-ROSS and the frameworks of APRA in Australia and the Monetary Authority of Singapore.
• Global: the IAIS has agreed an Insurance Capital Standard for internationally active insurance groups.

• Solvency I set a margin as a share of premiums, claims or provisions, so it ignored investment and most other risks.
• Solvency II (Directive 2009/138/EC, applying from 1 January 2016) has three pillars: quantitative rules, governance and supervision, reporting and disclosure.
• Own funds = market-consistent assets − (best estimate + risk margin) − other liabilities.
• The SCR is a 1-in-200-year, one-year loss; the MCR is a lower floor of 25% to 45% of the SCR.
• Below the SCR: a recovery plan within two months. Below the MCR: a finance scheme within one month, then loss of authorisation.

Solvency margin

Under Solvency I, the required solvency margin: capital set as a fixed share of premiums, claims or provisions.

Market-consistent

Valuing assets at market prices and liabilities at what it would cost to transfer them to another insurer.

Best estimate

Best estimate: the probability-weighted average of future cash flows to policyholders, discounted with a risk-free curve.

Risk margin

Risk margin: an amount added to the best estimate so that another insurer would take over the obligations.

Own funds

Assets minus liabilities on the Solvency II balance sheet, plus qualifying subordinated debt, sorted into three tiers.

SCR

Solvency Capital Requirement: own funds needed to survive a one-year loss that would be exceeded only once in 200 years.

MCR

Minimum Capital Requirement: a lower threshold (an 85% one-year level), between 25% and 45% of the SCR. Below it, the insurer can lose its licence.

Standard formula

The SCR calculation set out in the rules: stresses for each risk, combined with set correlations.

Internal model

An insurer's own model of its risks, used for the SCR once the supervisor has approved it.

ORSA

Own Risk and Solvency Assessment: the insurer's own view of its risks and the capital it needs, owned by its board.

SFCR

Solvency and Financial Condition Report: the public annual report each insurer publishes under Pillar 3.