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Fitch Ratings: Implementation of Solvency II in LATAM Maintains

Fitch Ratings are one of our Silver Sponsors for the 6th Annual Latin American Insurance & Reinsurance Forum, taking place on May 4th & 5th. Full information can be found on our website here, or you can secure your place here.



Fitch: Implementation of Solvency II in LATAM Maintains Challenges, Although With Minor Impacts


Fitch Ratings predicts widespread industry implications from the implementation of Solvency II. The main drivers behind this are the adjusted capital requirements, the implementation costs, the change from a nonrisk-based capital framework to a more risk-sensitive regime, and managing the volatility of a mark-to-market balance sheet. Furthermore, the adoption of Solvency II type regulations could transform the insurance landscape in Latin America with some fundamental shifts to a lower risk product mix; a more cautious investment strategy; and, for certain products, higher premiums.

The solvency regulation in Latin America, with the exception of Mexico, is broadly based on the former European Solvency I approach, with certain adjustments to meet international standards. Thus, solvency margin requirements for the insurance industry in LatAm countries are based on the following two components: minimum capital solvency requirements, which are generally based on premiums and reserves; and, resources available to cover those requirements, which are defined as capital plus certain permissible assets. Some countries have amended the minimum requirements to include additional components beyond premiums and reserves to better reflect the increasingly complex insurance and financial environment such as operational risk, credit risk and market risk.

In this sense, Mexico is recognized as the first country in Latin America to implement at the end of 2016, in an integral way, the standards embodied in the three pillars that make up the European Community Solvency II regulatory framework. In the region, countries such as Chile, Brazil, Peru, Colombia and even smaller markets such as Uruguay and Costa Rica are gradually working to implement a risk-based capital scheme, in some countries the implementation will be partial, whether due to discrimination of some pillar (generally transparency and divulgation of information), because of the adaptation of some component (accounting guidelines, periodic self-assessment, etc.) or by the exclusion of some type of risk

(counterparty, operational, etc.). In the Central American region, implementation remains as a project, so the final scope is not yet defined. In Panama and Venezuela, a Solvency II introduction is not in the agenda.

Excluding Mexico, a country that incorporated all the different risks described in the original scheme (market, credit, liquidity, counterparty, operational and concentration) mostly through value-at-risk models; the Risk Based Capital Requirement model contemplates the gradual inclusion of risks to models, such as Colombia where regulators will work to incorporate operational risk, or Chile and Brazil that will employ a methodology that incorporates a technical component similar to the formula used for Solvency II. The Risk Based Capital models in other countries of the region are parametric, and the element that varies in the schemes is the cost of capital by the relation between the types of risk. In Mexico, the system considers models of copula while in other countries the tendency is to calculate the correlation between type of risks and business lines.

In terms of corporate governance, Fitch considers that LatAm countries have gradually adopted the best international practices, and that most of them already have documented guidelines and procedures, either because of institutional policies or jurisdiction regulations. However, only Mexico and Brazil Corporate Governance is included into a solvency model called Own Risk and Solvency Assessment (ORSA), which states the guidelines for the periodic self-assessment of risks and solvency of companies, that is, the document that defines the integral system within the company, and comprises all processes and procedures to identify, evaluate, monitor, manage and report the different risks.

In Mexico, although the latest figures are interim and non-official, Fitch expects an adjustment in the leverage metrics as a result of the increase in stockholders’ equity resulting from negative adjustments in reserves that drive an increase in net income. Also, assets revalued at market value impacted the balance sheet while the effect of annualized premiums (mainly of Life) influenced the income statement.

Fitch believes that, for countries in the course of a RBC inclusion, the implementation effects of a new solvency regulatory framework will vary individually but will not significantly change the historical performance observed. In Chile, the different quantitative impact studies lead to a smaller and more gradual impact on companies’ capital. In some cases, diversification effects and the transfer of risk through reinsurance will help mitigate the impact of additional capital charges. Although not significantly observed in Mexico, smaller and less diversified insurance companies (geographically or by lines of business) may find themselves at a disadvantage which may favor mergers and acquisitions.

This content is provided by Euromoney Seminars for informational purposes only, and it reflects the market and industry conditions and presenter’s opinions and affiliations available at the time of the presentation.