Capital Modelling Under the Revised Solvency II Framework: Preparing for 2027

Written by Jonas Osman Abdelghafour — actuary and financial risk manager (FRM).

For every European insurer above a certain size, the Solvency Capital Requirement determines dividend capacity, reinsurance appetite, product strategy and the tone of the annual supervisory conversation. From 30 January 2027, the amended framework introduced by Directive (EU) 2025/2 — the Solvency II review — becomes applicable, together with the supporting Delegated Regulation changes and the revised EIOPA Guidelines on the valuation of technical provisions.

This article separates two things that are frequently conflated in board papers: the framework in force today, and the revised framework applicable from 30 January 2027. Until that date, the current Solvency II rules — including the existing risk-margin calculation and the 2022 Guidelines on the valuation of technical provisions — continue to apply in full.

What changes under Solvency II from 30 January 2027?

Directive (EU) 2025/2 was adopted on 27 November 2024 and published in the Official Journal on 8 January 2025. Member States transpose it by 29 January 2027, and the amended requirements apply from 30 January 2027. The main areas of change, at framework level:

• Risk margin. An exponential, time-dependent element — the lambda factor — is introduced into the risk-margin calculation, reducing the margin for long-term liabilities and its sensitivity to interest rates.
• Lambda factor. Reflected in the amended EIOPA Guidelines on technical provisions and in a new RTS aligning the simplified calculation of the risk margin. Both become applicable on 30 January 2027; the 2022 risk-margin Guidelines apply until then.
• Technical provisions. Consequential changes to valuation guidance, including the extrapolation of risk-free rates and the volatility adjustment under the long-term guarantee package.
• Proportionality. A formalised regime for small and non-complex undertakings, with proportionality measures across governance, reporting, ORSA and disclosure rather than case-by-case supervisory forbearance.
• Reporting and disclosure. A restructured Solvency and Financial Condition Report split between a policyholder-facing part and a professional-audience part, with revised templates and deadlines.
• Group solvency. Sharper rules on the scope of group supervision, the treatment of intragroup transactions, own funds at group level, and supervision of cross-border activity.
• Liquidity-risk management. Explicit liquidity-risk management plans, and supervisory powers to require action where liquidity vulnerabilities are identified.
• Macroprudential considerations. New tools and expectations, including the systemic-risk dimension of the ORSA and powers to restrict distributions in exceptional circumstances.
• Sustainability. Sustainability risks integrated into the prudent person principle, ORSA, and governance, with sustainability risk plans expected.
• Governance. Fit and proper requirements, diversity expectations at board level, and clearer allocation of responsibility for key functions.

Read the primary texts before writing internal policy: the Directive on EUR-Lex, and EIOPA's Solvency II review publications for the Guidelines and technical standards.

Risk margin and the lambda factor

The risk margin exists so that technical provisions equal the amount another undertaking would require to take over and meet the insurance obligations. It is the cost of holding capital for non-hedgeable risk over the run-off of the portfolio.

Under the current framework, the margin is a cost-of-capital projection of future SCRs discounted back, with a fixed cost-of-capital rate applied uniformly across the projection. On long-duration life business the result is large and interest-rate sensitive — the margin moves materially with rates even when the underlying risk has not changed.

Under the framework applicable from 30 January 2027, an exponential, time-dependent element — the lambda factor — is introduced so that capital projected far into the future contributes less than capital in the near term. Conceptually, the change recognises the diversification of risk over time. The consequences that matter commercially: a lower risk margin for long-duration liabilities, reduced interest-rate sensitivity of own funds, and a different economics for bulk annuity, longevity and retrospective reinsurance transactions. EIOPA has also issued an RTS aligning the simplified calculation of the risk margin with the new treatment, which matters for undertakings using proportionality-based approaches.

Two points of discipline. First, do not present pro-forma lambda-adjusted numbers as the current regulatory position — until 30 January 2027 the existing calculation and the 2022 Guidelines apply. Second, quantify the transition: the risk-margin release at the switchover is an own-funds movement the board should see in advance, not discover in a quarterly close.

What the revised framework means for capital modelling

The SCR definition is unchanged in principle — the 99.5th percentile one-year change in basic own funds — but the inputs move. A lower risk margin changes the starting balance sheet and therefore the stressed balance sheets that drive every module.

Standard formula users should re-run the whole calculation on the revised basis and isolate which of the movement comes from the risk margin, which from long-term guarantee measures, and which from reporting or scope changes. The standard formula remains a set of specific assumptions about calibration, correlation and diversification; where those diverge from the firm's risk profile — specialty non-life, equity risk through a cycle, catastrophe scenarios — an internal challenge calculation is still the right practice each reporting cycle.

Internal model users face a larger exercise. The proxy functions, the projection of future SCRs used in the risk margin, and the loss distribution all interact with the revised treatment. Diversification and dependency assumptions deserve fresh challenge: the reduction from the sum of module capitals to the diversified SCR is commonly thirty to fifty percent, driven by correlations that are hard to estimate and easy to under-challenge. Run the SCR at the point estimate, a plausible correlation stress and full comonotonicity, and put the delta in front of the risk committee.

Stress testing and scenario analysis should be repeated on the revised basis rather than scaled from old results; the sensitivity profile changes when the risk margin no longer amplifies rate moves. Every adjustment is a model change that must be classified, quantified and evidenced under the model change policy, then validated, documented and taken through governance.

The decision chain to keep visible in board material:

Regulatory change → assumptions → models → validation → capital → ORSA → management decisions

Each arrow is a control point. A firm that can walk a supervisor along that chain — showing where the 2027 changes entered the assumption set, how validation challenged them, what they did to the SCR, how the ORSA absorbed them, and which decisions changed — is in a materially better position than one that can only show a restated number.

Internal models: validation and model change before 2027

The substantive internal model tests — use, statistical quality, calibration, profit and loss attribution, validation — are unchanged in spirit and are exactly the lens to apply to the 2027 work.

• Model appropriateness. Confirm the model remains fit for the business it now covers, on the revised basis, not merely the basis it was approved on.
• Material assumptions. Re-derive and re-document the assumptions the revised framework touches, especially the projection of future SCRs used in the risk margin.
• Data quality. Reporting and template changes create new data flows; the accuracy, completeness and appropriateness assessment has to extend to them.
• Independent validation. Cyclical, risk-based and genuinely independent. The 2027 changes should be an explicit item in the validation plan, with a targeted attack on tail behaviour and on proxy fits under stressed calibrations.
• Limitations. State them. A limitations register that has not changed since approval is a signal, not a comfort.
• Model changes. Classify each 2027-driven change as major or minor, quantify its SCR impact, and reconcile the aggregate. Supervisors increasingly ask whether the accumulation of minor changes warrants re-approval.
• Documentation and governance. Reconciled year-on-year model change summaries, board minutes, and clear ownership of each key function.
• Use test and senior-management understanding. The board does not need the mathematics; it needs to know what drives the number, how sensitive it is, and where judgement dominates. If the model informs no decision, no documentation will rescue it.

My approach to this is set out in the model validation service and the three-lines governance note; see also model risk and independent validation.

Connecting capital modelling with ORSA

The ORSA is where the capital model stops being a calculation and starts being a management tool. Under the revised framework it also carries macroprudential and sustainability dimensions. The interactions worth modelling explicitly:

• Underwriting risk and pricing adequacy through a hardening or softening cycle.
• Market risk — rates, spreads, equity — and its now-different interaction with a lambda-adjusted risk margin.
• Credit risk on counterparties, including reinsurers and private-credit exposures.
• Catastrophe risk, with scenarios reconciled against the vendor and internal views.
• Climate risk, both physical and transition, over a horizon longer than the business plan; see the climate and catastrophe risk service.
• Liquidity, as a distinct constraint rather than a by-product of solvency.
• Reinsurance as a joint capital, earnings and liquidity lever, including recoverable timing.
• Geopolitical stress, which now transmits through investment portfolios and specialty lines simultaneously.
• Capital, as the aggregation of all of the above under a coherent dependency structure.

The ORSA scenario design note covers how internal model output feeds board-level scenarios, and the insurance and Solvency II practice describes how these run in engagements I lead.

Why liquidity deserves more attention under the revised framework

Solvency and liquidity are different failure modes. An insurer can be comfortably solvent and still unable to meet cash obligations at an inconvenient moment. The revised framework responds to this by requiring liquidity-risk management plans and giving supervisors powers where liquidity vulnerabilities are found. EIOPA's work on liquidity risk in the insurance sector is the reference material.

What a credible analysis contains:

• Liquidity vulnerabilities identified by source: mass lapse, collateral calls on derivative hedges, unit-linked switches, concentrated reinsurance recoverables.
• Stressed cash flows projected over short horizons — days and weeks, not only annual buckets.
• Collateral requirements under rate and FX moves, including eligibility and haircuts.
• Claims payments, particularly catastrophe clustering where outflow precedes recovery.
• Asset sales ranked by realistic realisable value in stress, not book classification.
• Reinsurance recoverables with realistic timing assumptions rather than instantaneous settlement.
• Contingency actions that are pre-agreed, sized and tested.
• Escalation with named owners, trigger levels and decision rights.

The technique is close to bank practice; the liquidity stress testing note covers the mechanics, and IRRBB beyond the headline EVE number covers the rate-sensitivity side.

Solvency II 2027 readiness checklist

1. Regulatory gap analysis against Directive (EU) 2025/2, the amended Delegated Regulation and the revised EIOPA Guidelines, with owners and dates.
2. Risk-margin impact assessment quantifying the lambda effect on technical provisions, own funds and the SCR at transition.
3. Model review covering the standard formula or internal model on the revised basis.
4. Assumption review for every assumption the revision touches, re-documented and re-approved.
5. Internal-model change assessment, classified, quantified and reconciled, with a view on re-approval.
6. Technical-provision review, including extrapolation, volatility adjustment and contract boundaries.
7. Reporting and data changes for the restructured SFCR and revised templates, tested end to end.
8. Liquidity analysis and a liquidity-risk management plan meeting the new expectations.
9. ORSA integration, including macroprudential and sustainability dimensions.
10. Validation plan naming the 2027 changes as a scoped, independent workstream.
11. Board governance — training, decision points, and a documented understanding of what moves.
12. Documentation refreshed rather than appended, with a clear audit trail.
13. Implementation testing — parallel runs on both bases before the switchover, with differences explained.

Preparing for the revised Solvency II framework from 30 January 2027

The mathematics of capital modelling is well defined, the software is mature and the calibration data is available. What determines whether a model runs the business or merely reports on it is the discipline around use, calibration, validation and change control.

Treat the revised framework as a change to the insurer's risk and capital decision framework, not as a regulatory reporting exercise. A lower and less rate-sensitive risk margin changes reinsurance economics, product pricing, hedging strategy and dividend capacity. New liquidity, macroprudential and sustainability expectations change what the board is accountable for. Firms that model the transition early, validate it independently, and route the results through the ORSA into actual decisions will enter 2027 with a defensible position. Firms that restate a number in January 2027 will spend the following year explaining it.

If your capital model is due a refresh, or you are preparing for the revised framework, see insurance and Solvency II services, financial risk and ALM, or get in touch.