Solvency II is under review
Solvency II legislation requires the European Commission to carry out a number of reviews of how particular aspects of Solvency II are working in the next few years. The first of these is a review of the standard formula used to calculate the Solvency Capital Requirement.
Solvency II is the regulatory regime for the European Union (EU) insurance industry and applies to EU insurers and reinsurers from 1 January 2016. It uses a risk-based approach to establish harmonised EU-wide financial requirements, governance and risk management standards and rules on reporting and public disclosure.
The first review of Solvency II is of the standard formula used to calculate the Solvency Capital Requirement (SCR), which the European Commission aims to complete by 31 December 2018. It has asked the European Insurance and Occupational Pensions Authority (EIOPA) to provide advice on specified items.
EIOPA issued a discussion paper on the review in December 2016. Lloyd’s responded to this paper, and contributed to responses by Insurance Europe and the Reinsurance Advisory Board (RAB).
EIOPA published a consultation paper on its first set of advice to the Commission on the standard formula review in July 2017, for comment by the end of August 2017. It covers simplified calculations, look-through approach for investment related vehicles, reducing reliance on external credit ratings, treatment of guarantees and exposures to regional governments and local authorities, risk-mitigation techniques, undertaking specific parameters and information on loss-absorbing capacity of deferred taxes. Lloyd’s did not respond to the paper but Insurance Europe and the RAB submitted responses on behalf of the industry.
A second consultation paper on EIOPA’s second set of advice is expected by the end of the year. It will cover the risk margin, simplifying the look-through approach, policy options on loss-absorbing capacity of deferred taxes, premium and reserve risks, catastrophe risks, mortality and longevity risks, counterparty default risk, currency risk at group level, interest rate risk, own funds, unrated bonds and loans, unlisted equity and strategic participations.
Once the United Kingdom (UK) has left the EU it will not have to comply with Solvency II and can make changes to its insurance regulatory system. However, if its insurance regulatory regime differs from that of the EU, the EU is less likely to agree to allow UK insurers access to the EU single market.
Lloyd’s key message is that, although Solvency II is not perfect and we are still assessing its implementation, the insurance industry has invested heavily in implementing it and there is no appetite to replace or change the fundamentals of Solvency II.
We consider that there are elements of Solvency II that could be revised, to the advantage of insurers and their clients, since regulatory costs falling on insurers are ultimately borne by insurers’ customers. Examples include:
- Reducing the complexity and extent of its Pillar III supervisory reporting requirements.
- Introducing greater flexibility to regulatory processes for obtaining permission to change internal models.
- Removing requirements for firms using internal models to calculate their SCR using the standard formula.
- Aligning the Solvency II Balance Sheet with Generally Accepted Accounting Principles (GAAP).
What can we expect?
EIOPA aims to finalise its advice regarding the items included in its latest consultation paper in October 2017. It will then send final advice to the European Commission. It aims to send the second set of advice to the European Commission by February 2018.
The UK, on the UK Government’s timetable, will exit the EU in March 2019. At that date, the UK will no longer be required to apply the Solvency II Directive and the EU’s direct legislation on Solvency II will cease to have effect in the UK. Nevertheless, the EU’s Solvency II activities are still relevant to Lloyd’s, because:
- The review may be complete before the UK leaves the EU.
- The UK’s insurance regulatory regime will remain based on Solvency II.
- If the UK wants to retain access to the EU single insurance market, it probably needs to retain a similar regime to Solvency II.
- It is possible that the UK and the EU will agree transitional arrangements, extending the period in which Solvency II applies directly to the UK after the UK’s exit.
- After the UK has left the EU, Lloyd’s proposes to retain access to EU markets via an EU presence. This presence will be subject to Solvency II.