UK regulatory approval of insurers' internal models is a major step towards clarity on their capital position under Solvency II (SII), and a precursor to announcements of strong solvency ratios, according to a report Fitch Ratings.

On Saturday, the Prudential Regulation Authority announced its approval of 19 UK insurers' models, meaning that they will be able to determine their SII capital position based on their own risk calibration when the regime takes effect in January.

Model approval removes the biggest remaining SII uncertainty for these insurers. Without approval, they would have to use the standard formula approach, leading to potentially much higher capital requirements. Dutch insurer Delta Lloyd is the most notable public example to date of a major insurer facing serious difficulties under SII. Until recently it was planning to use an internal model, but in light of uncertainties over its model, the company said last week that it will now use the standard formula and announced plans to raise EUR1bn to strengthen its SII capital position.

As SII positions become clear, insurers will have their regulatory capital strength – or weakness – confirmed. Fitch says this clarity may trigger some M&A, as stronger insurers acquire or merge with weaker ones facing capital shortfalls.

Some UK insurers, including Old Mutual, have decided not to use an internal model. The models are costly and time-consuming to implement and maintain, so insurers will typically only use them if they might produce significantly different results from the standard formula. We believe annuity and catastrophe business give the most scope for insurers to calculate lower capital requirements using an internal model.

Outside the UK, many insurers are still waiting for approval decisions. However, some insurers' models have been approved, notably Allianz, Munich Re and Hannover Re in Germany, and Axa and Scor in France.

Fitch says end-2015 will not mark the end of SII model developments. More insurers are planning to apply for approval in 2016, and those already using approved models will make changes. UK insurers in particular are expected to continue restructuring certain asset portfolios, such as equity release mortgages, to make more of their balance sheet eligible for the matching adjustment, strengthening their SII metrics.

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