Captive Insurance
An insurer owned by the businesses it covers, the forms it takes, and what separates a captive from simply retaining the risk.
Glossary
Solvency II
The EU prudential regime in three pillars, the two capital thresholds that trigger different supervisory responses, and what changes in 2027.
Solvency II is the European Union’s prudential framework for insurance and reinsurance companies. It sets requirements for the financial resources insurers hold, the way they manage risk, and the information they report to supervisors and the public.
Its purpose is to help protect policyholders by connecting an insurer’s financial strength to the risks it takes. The framework has applied since January 2016. EIOPA’s overview of Solvency II.
An insurer can collect premiums today while remaining responsible for claims many years later. Solvency II asks whether it can meet those obligations and withstand adverse developments, rather than judging its position only by current cash receipts or accounting profit.
The three pillars of Solvency II
The framework combines numerical requirements with management responsibilities and reporting.
| Pillar | Main focus | What it addresses |
|---|---|---|
| Pillar I | Valuation and capital | How obligations are valued, what capital is required, and which financial resources qualify to cover it |
| Pillar II | Governance and risk management | How the insurer identifies, controls, and assesses its risks, including its own future solvency needs |
| Pillar III | Reporting and disclosure | What the insurer provides to supervisors and makes publicly available |
The pillars support one another. A calculated capital surplus is more meaningful when it rests on reliable valuations, effective management, and reporting that explains material risks.
Technical provisions and the solvency balance sheet
Solvency II uses a valuation framework for assets and liabilities that can differ from the values in an insurer’s financial statements.
The amounts recognized for insurance obligations are called technical provisions. Generally, these consist of a best estimate plus a risk margin. The best estimate is a probability-weighted estimate of future cash flows, allowing for their timing through discounting. The risk margin reflects the additional amount associated with another insurer taking over and meeting the obligations. EIOPA’s rulebook on calculating technical provisions.
Relevant cash flows can include future claims, benefits, expenses, and premiums within the applicable contract boundaries. They require assumptions about matters such as claim severity, settlement timing, and policyholder behavior.
Technical provisions and capital serve different purposes. Provisions recognize the value of obligations. Capital provides resources to absorb adverse outcomes beyond the amounts already recognized. An insurer therefore needs both an appropriate estimate of what it owes and sufficient financial resilience if experience is worse than expected.
SCR and MCR: two capital thresholds
The Solvency Capital Requirement, or SCR, is the principal risk-based capital requirement. It is calibrated to a 99.5% value-at-risk confidence level over one year for adverse changes in basic own funds.
This calibration concerns the modeled distribution of adverse changes in financial resources. It does not mean that every insurer has a known, fixed 0.5% annual probability of bankruptcy.
The SCR addresses risks such as insurance losses, market movements, counterparty credit exposure, and operational failures. It can be calculated using the standard formula or an approved internal model. EIOPA’s rulebook on the SCR.
The Minimum Capital Requirement, or MCR, is a lower intervention threshold. Breaching it indicates a more serious solvency problem. Its calculation generally uses a band of 25% to 45% of the SCR, subject to an absolute minimum that can affect the final amount. EIOPA’s rulebook on the combined MCR calculation.
The SCR and MCR are requirements, not funds sitting in separate bank accounts. The insurer must demonstrate that qualifying resources cover each requirement under the applicable rules.
Own funds and the solvency ratio
Own funds are the financial resources recognized under the solvency framework. Basic own funds comprise the excess of assets over liabilities, with the required adjustments, together with subordinated liabilities. Subordinated debt ranks behind other specified claims if the insurer fails. EIOPA’s definition of basic own funds.
Quality and availability matter, so own funds are classified into tiers and subject to eligibility limits. The amount eligible to cover the SCR need not equal accounting equity or the amount eligible to cover the MCR. EIOPA’s capital management disclosure requirements.
The SCR coverage ratio, often called the solvency ratio, is:
SCR coverage ratio = Eligible own funds to cover the SCR ÷ SCR × 100
The numerator and denominator must refer to the same entity or group and reporting date. The EU reporting instructions defining the ratio.
Consider a fictional insurer with €15 million of eligible own funds and an SCR of €10 million. Its ratio is 150%.
Now suppose adverse experience reduces eligible own funds to €12 million, while a change in the risk profile increases the SCR to €11 million:
| Position | Eligible own funds | SCR | SCR coverage ratio |
|---|---|---|---|
| Before the change | €15 million | €10 million | 150% |
| After the change | €12 million | €11 million | Approximately 109.1% |
The ratio falls because resources decrease and the requirement increases. Looking only at the capital amount would miss part of the deterioration.
A ratio above 100% indicates coverage of the calculated SCR at that point. It does not establish that the insurer is risk-free or that all resources are immediately available as cash.
Governance and the ORSA
Pillar II addresses how the insurer runs its business, including risk management, responsibilities, controls, and oversight.
An important element is the Own Risk and Solvency Assessment, or ORSA. It connects the insurer’s specific risk profile and business strategy with its assessment of solvency needs. It also considers continued compliance and whether its risks differ significantly from the assumptions underlying its SCR calculation. EIOPA’s rulebook on the ORSA.
For example, an insurer planning rapid growth in a new liability class needs to consider the uncertainty of claims that may take years to settle. Its assessment can examine baseline projections, adverse scenarios, available capital, and possible management actions. A satisfactory ratio today does not answer every question about that future business plan.
The ORSA is performed at least annually and also without delay following a significant change in the risk profile. It should inform decisions rather than exist only as a reporting exercise. EIOPA’s explanation of ORSA frequency.
Reporting to supervisors and the public
The Solvency and Financial Condition Report, or SFCR, is an annual public report. It explains the insurer’s business, governance, risks, valuation, and capital position. It gives readers context for figures such as the solvency ratio. The Solvency II Directive’s public disclosure requirements.
Supervisors also receive the Regular Supervisory Report, the ORSA supervisory report, and quantitative reporting templates. The templates include annual and quarterly information, with differences in scope and applicable exemptions. These are separate reporting obligations; not every report has the same frequency or audience. EIOPA’s rules on regular supervisory reporting.
What data does Solvency II require?
The calculations draw on several connected sources:
- Policy terms, premiums, coverage periods, and insurance exposures.
- Claims payments, outstanding claims estimates, and settlement patterns.
- Reinsurance terms, recoverables, and counterparty information.
- Asset holdings, valuations, currencies, and investment exposures.
- Expense assumptions, valuation assumptions, and own-funds records.
A policy administration system supplies part of this information. Claims, finance, investment, and actuarial processes supply other parts.
Consistency matters across those sources. If a claim estimate changes after a reporting cut-off, the insurer needs to know which valuation used the previous amount and how the adjustment affects later results. Traceable dates, reconciliations, and documented assumptions make reported figures easier to explain and review.
Solvency II, IFRS 17, and jurisdiction
Solvency II concerns prudential supervision and financial resilience. IFRS 17 concerns accounting for insurance contracts and reporting financial performance. Shared policy and claims data can support both processes, but their objectives and measurement rules differ.
Jurisdiction also matters. EU Solvency II requirements should not automatically be treated as identical to the United Kingdom’s framework. The Prudential Regulation Authority maintains separate Solvency UK reporting requirements, including requirements for reporting reference dates from 31 December 2024. The PRA’s insurance reporting information.
The EU review and the January 2027 changes
As of September 2026, the EU has adopted a review of Solvency II whose main national implementing provisions apply from 30 January 2027. Member states must adopt and publish those provisions by 29 January 2027. Directive (EU) 2025/2, Article 4.
EIOPA’s revised reporting and disclosure guidelines also apply from 30 January 2027; its earlier guidelines remain applicable until then. The effective date therefore matters when choosing reporting guidance or assessing a requirement. EIOPA’s revised reporting and disclosure guidelines.
