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P2.T7.414 Solvency II versus Basel III: differences

Nicole Seaman

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AIMs: Explain the difference between the Basel II/III and the Solvency II frameworks for the capture of diversification benefits. Explain the difference between Basel II/III and the Solvency II frameworks with respect to: 1) risk classes and capital requirements, 2) risk measure and calibration, 3) time perspective, and 4) valuation. Compare and contrast the Basel II/III and Solvency II frameworks with respect to qualitative risk management aspects, including the internal risk management process, governance, and supervision. Describe the key differences between Basel II/III and Solvency II with respect to public disclosure.

Questions:

414.1. Assume the following three levels of with respect to the potential treatment of diversification benefits:
  • Level 1: Within a specific risk class or business line
  • Level 2: Across specific risk classes or business lines
  • Level 3: Across legal entities
Which is nearest to a true statement about similarities (or differences) between the two regulatory frameworks, Basel III and Solvency II, with respect to the treatment of diversification benefits?

a. Neither Basel III nor Solvency II acknowledge any of the levels
b. While Basel III acknowledges only Level 1 diversification benefits, Solvency II acknowledges all three levels
c. While Solvency II acknowledges only Level 1 diversification benefits, Basel III acknowledges all three levels
d. Both Basel III and Solvency II acknowledge all three levels


414.2. Both Basel III and Solvency II employ a three pillar structure. The first pillar (Pillar One) in each establishes quantitative capital requirements, although the mechanics differ. For example, Solvency requires a fixed confidence level of 99.5% in order to ensure a one-year solvency probability for the insurance company as a whole. The first pillar in Basel III has more variety. The second pillar (Pillar Two) concerns the supervisory review process. In which of the following areas (or criteria) of supervisory review is a DIFFERENCE between the two frameworks MOST apparent?

a. Only one of the two frameworks attempts to account for (include) all material risks
b. Only one of the two frameworks locates the internal risk management process as an integral part of risk management
c. Only one of the two frameworks explicitly expects additional capital requirements in excess of the first pillar (Pillar One) capital requirements
d. Only one of the two frameworks emphasizes the possibility for early intervention on the part of supervisory authorities.


414.3. In regard to differences between the Solvency II regulatory framework for insurance companies and the Basel III regulatory framework for banks, each of the following is true EXCEPT which is false?

a. In regard to internal capital models, Basel III adopts a purely principles-based approach especially for credit risk, but Solvency II is rules-based throughout
b. Solvency II offers theoretically deeper insight into a firm's risk situation due to its total "holistic" economic balance sheet approach, compared to Basel III's primary reliance on book values, but this depth comes at the cost of greater complexity
c. With respect to assessment typology, whereas Basel III gives banks a choice between two or three levels of sophistication (e.g., standardized, FIRBA or AIRBA for credit risk), Solvency II gives insurance companies a choice between five levels of sophistication; i.e., from standard formula with simplifications to full internal model
d. Pillar Three (Disclosure Requirements) is somewhat similar between the two regulatory frameworks with a few minor exceptions, including: whereas Basel III requires only public disclosure, Solvency II addresses public disclosure as well as the harmonization of supervisory reporting; and the public disclosure demands concerning qualitative requirements for risk management are more detailed in Solvency II

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