Guy Carpenter & Company has published a report on impications of the European Union's revised insurance laws through Solvency II, which are expected to be fully in operation by 2012.

The new report, entitled Internal Models - A Winning Solution for Solvency II, examines the implementation of internal capital models in companies' enterprise risk management (ERM) strategies for compliance with the impending Solvency II provisions of the European Union's (EU) revised insurance law.

"For most small companies, using a formulaic standard model in order to comply with Solvency II's solvency capital requirement will likely be adequate," said Frank Achtert, senior vice president at Guy Carpenter.

"For larger organisations, however, developing an internal capital model as part of a broader ERM strategy offers a number of distinct advantages, in addition to regulatory compliance."

Mr. Achtert added: "These advantages include a better evaluation of a company's risk profile in light of its risk appetite, the implementation of an accurate capital management approach, better measurements of returns on risk-adjusted capital for individual business segments, a more complete understanding of the relative contribution of the major categories to a company's overall risk profile and the ability to provide quantitative input into an M&A process. In this sense, integrating an internal capital model can turn a regulatory burden into a competitive advantage."

According to current projections, Solvency II requirements will likely be fully implemented at the end of 2012.

The EU's proposal for a thorough revision of its insurance law provides a two-tiered approach for determination of regulatory capital adequacy. The first tier, or minimum capital requirement, is the threshold below which an insurer will not be able to write business.

The second, the solvency capital requirement, is the threshold below which an insurer will likely need to discuss remedies with regulators. To calculate this companies will have the choice of a standard model, an internal capital model or a combination of both.