On Wednesday 22 September, the European Commission presented two proposals for directives designed to consolidate the ‘Solvency II’ prudential rules governing the insurance and reinsurance sector and to stimulate long-term investment in this flourishing industry.
“We’re adjusting the rules, not revamping them”, said European Commission Vice-President Valdis Dombrovskis, arguing that the ‘Solvency II’ framework, in place since 2016, has been internationally recognised as leading the way and that it had helped the industry weather the crisis.
According to the EU institution, the Covid-19 pandemic caused the average solvency ratio of the insurance sector to fall to 235% (-7%), a level that remains well above the minimum required threshold of 100%.
Given this solvency rate, the European Commission considers that the legislative review under consideration will make it possible to free up €90 billion in capital requirements in the short term to allow insurance companies to invest to contribute to the post-Covid-19 economic recovery.
Among the suggested measures are: - the modification of long-term collateral measures, in particular the volatility adjustment, to improve how the regulatory framework mitigates the effects of short-term market volatility in the event of a financial crisis; - the revision of the long-term equity asset class to make it easier for insurers to benefit from preferential capital treatment on equity investments; - the revision of the risk margin to reduce its size and volatility.
The last two measures will be implemented through implementing measures once the legislative procedure revising the ‘Solvency II’ framework has been finalised.
“This is not a gift to the insurance industry. (...) What we're doing here is making sure the insurance industry, and the capital it holds, can serve the wider EU society in our transition towards sustainability”, assured the European Commissioner for Financial Services, Mairead McGuinness. She added: “In the long we're talking about freeing up capital of up to €30 billion when all these measures come into play. In the beginning we liberate €90 billion in the short term, over perhaps up to 10 years. And of course we’ll increase the capital requirements in terms of the volatility issues”. In particular, by taking more account of the low interest rate environment.
In order to make prudential rules more proportionate, the European Commission also proposes raising the thresholds above which the ‘Solvency II’ framework applies to insurance companies. According to the proposal, companies whose annual gross written premium income remains below €15 million, as opposed to the current €5 million, will no longer be affected.
In addition, the proposed Directive suggests creating a specific category of smaller and less complex insurance entities, which would benefit from lighter rules. The criteria (Article 29) for determining these entities depend on the share of life and non-life insurance in the business model. For example, for non-life companies, the annual gross written premium income should be less than €100 million and less than 5% of annual gross premiums for activities outside the home country.
The European Commission also proposes to improve the supervision of insurance companies. We propose to “extend EIOPA’s powers to act as an ombudsman” for national supervisors and to give it the ability to “conduct on-site inspections on its own initiative”, Dombrovskis said.
The legislative reform should also strengthen the management of climate risks by (re)insurers by introducing a requirement to analyse long-term climate change scenarios. In addition, the European Insurance and Occupational Pensions Authority (EIOPA) will conduct climate stress tests. It will have to report, by 2023 at the latest, on new evidence on environmentally or socially harmful investments, with a view to possible changes in the ‘Solvency II’ prudential framework.
MEP Sven Giegold (Greens/EFA, Germany), who has the lead on this dossier, said that with the reform, prudential insurance rules will continue to have “more holes than Swiss cheese”. According to him, by freeing €90 billion of capital in the short term, the legislative proposal is going in the wrong direction, contrary to strengthening policyholder protection and financial stability. For example, according to Mr Giegold, the increased use of a reduced level of risk weighting (22%) does not reflect the real level of risk inherent in the long-term investments that the proposal seeks to stimulate.
Speaking on behalf of Insurance Europe, Olav Jones welcomed the reduction in capital requirements, which he said would have to be “substantial and permanent” to enable the industry to meet its share of the funding for the ‘European Green Deal’. The same applies to the desire to make the rules more proportionate, although, according to Mr Jones, some of the reporting provisions could add “undue cost and complexity”.
See the Directive revising the ‘Solvency II’ framework: https://bit.ly/3EHQOJ9
See the Communication on the implementing measures of the future revised framework: https://bit.ly/3nT4efv
A new default resolution framework
In a separate Directive proposal, the European Commission presents a regime for the resolution of an insurance company that is failing or likely to fail.
As detailed by EUROPE (see EUROPE 12795/1), the provisions introduced aim to give the means to the Member States’ resolution authorities to proceed to a resolution of a failing company, notably on a cross-border basis with the creation of colleges of resolution authorities.
The future rules are inspired by the existing framework for banks and central clearing houses, although they do not go as far in terms of governance, since the supervision and resolution of insurance companies remains at national level.
This is “minimal harmonisation”, a European official acknowledged.
See the Insurance Companies Resolution Directive: https://bit.ly/3CCGyju (Original version in French by Mathieu Bion)