Solvency II
Solvency II is the European Union’s prudential framework for insurance and reinsurance companies. Applying since January 2016, it is designed to ensure insurers understand their risks, maintain sufficient financial resources and can continue meeting obligations to policyholders, including during periods of financial stress. Unlike earlier rules that relied more heavily on simple measures of business volume, Solvency II uses a risk-based approach. The capital an insurer must hold depends on the nature and scale of risks arising from its underwriting, investments, operations and counterparties.
The three pillars
Solvency II is organised around three connected pillars.
Pillar 1: Quantitative requirements
Pillar 1 covers the valuation of assets and liabilities, the calculation of insurance obligations and the capital insurers must maintain.
Insurers must calculate technical provisions, representing the amount needed to meet expected policyholder claims and expenses. These generally comprise a best estimate of future cash flows and a risk margin reflecting the uncertainty involved.
Pillar 1 also establishes two capital thresholds:
- The Solvency Capital Requirement, or SCR, is the main risk-based capital requirement. It is calibrated so that an insurer should be able to absorb losses over the following year at a 99.5% confidence level.
- The Minimum Capital Requirement, or MCR, is a lower threshold representing the minimum level of capital below which policyholders would face an unacceptable level of risk. Breaching it can lead to the withdrawal of the insurer’s authorisation if capital is not restored.
Insurers must hold eligible own funds to cover these requirements. Own funds are classified into tiers according to characteristics such as permanence, availability and capacity to absorb losses.
Standard formula and internal models
An insurer can usually calculate its SCR using the standard formula, a prescribed regulatory approach covering risks such as:
- Life, non-life and health underwriting risk
- Market risk
- Counterparty default risk
- Operational risk
The standard formula allows for diversification because losses across different risks may not occur simultaneously.
Alternatively, an insurer may use a full or partial internal model that better reflects its particular risk profile. Internal models require supervisory approval and must satisfy detailed standards relating to statistical quality, calibration, validation, documentation and their genuine use within risk management.
Pillar 2: Governance and supervision
Pillar 2 covers governance, risk management and supervisory review.
Insurers must maintain effective systems and controls, including actuarial, risk management, compliance and internal audit functions. They must also complete an Own Risk and Solvency Assessment, or ORSA, evaluating their specific risks, future capital needs and ability to remain solvent under different scenarios.
The ORSA is forward-looking and complements the regulatory capital calculation rather than replacing it.
Pillar 3: Reporting and disclosure
Pillar 3 requires insurers to report detailed financial and risk information to supervisors and disclose certain information publicly.
A key public document is the Solvency and Financial Condition Report, or SFCR, which explains the insurer’s business, governance, risk profile, valuation methods and capital position.
EU reforms and Solvency UK
The EU completed a major review through Directive (EU) 2025/2. The revised rules, applying from 30 January 2027, strengthen proportionality, sustainability-risk management, macroprudential supervision and oversight of insurance groups and cross-border activity.
Following Brexit, the UK developed a separate regime commonly known as Solvency UK. It retains the core risk-based structure of Solvency II but includes UK-specific changes to areas such as the risk margin, matching adjustment, reporting and internal-model approval. The reformed UK framework was implemented fully from the end of 2024.
