Groups and Diversification

Diversification of risk is the fundamental principle upon which an insurance business is built. On the vast majority of occasions, only some of the things that could go wrong will go wrong at a given point in time. Large groups are typically able to diversify their business across a large range of risks in different markets, which provides a very important 'averaging-out' effect. This allows a bad result in one market or one line of business to be compensated by a better result somewhere else, providing a substantial degree of resilience to bad events or out-turns in any one area. However, to achieve the maximum benefit, capital must be free to be deployed as and where needed across the group, rather than being held in separate reserves for each individual line of business or in each individual legal entity.   

As set out in the HMT/FSA discussion papers on groups, ("Supervising insurance groups under Solvency II", Enhancing group supervision") group diversification effects should be fully taken into account provided that the group can demonstrate it has the freedom to move capital around according to need in the different legal entities.  

In contrast, the current structure of supervision is founded on requirements based at individual legal entity level. For groups operating across Europe this can result in a significant degree of duplication in the regulatory process and constrains the efficient use of capital across the group.  

Solvency II presents an opportunity to develop a new approach to supervision for these large cross-border groups, which recognises them as a single economic entity managing a diverse range of risks across many different EU markets. With a single lead supervisor for prudential regulation this would allow the entire group to be assessed and regulated against common criteria, ensuring a consistent approach to capital assessment and supervision across the group and the proper recognition of diversification effects.

Links to CEA papers on Group Issues

FAQs on Group supervision and Group support (March 2008)

Group Support Regime Case Studies (March 2008)

FAQs on the legal aspects of the Group Support Regime (August 2008)

Solvency II Briefing Note 1: Diversification and Specialisation (June 2007)

Solvency II Briefing Note 2: The Insurance Groups and Solvency II (June 2007)