Long awaited proposals to reform the EU Solvency II insurance regime are published

On 22 September 2021, the European Commission adopted, among other measures, a Proposal for an extensive revision of the Solvency II Directive. There are several immediate objectives of this reform, including facilitating insurers to increase their long-term investments in order to contribute to the political agenda of the European Union (e.g. Capital Markets Union or the European Green Pact). Another highlight of the Proposal is the increased relevance of the principle of proportionality, already present in Solvency II, and defined as the application of rules proportionate to the scale, nature and complexity of the risks inherent to the insurance business. The review exercise also includes a Proposal for a new Directive on the restructuring and resolution of insurance undertakings. To achieve these goals, the Proposal:

• incentivises long-term sustainable funding of insurers;
• improves the measurement of risk sensitivity;
• mitigates excessive short-term volatility of insurers' positions;
• improves proportionality;
• enhances the quality, consistency and coordination of insurance supervision in the European Union;
• combats the potential build-up of systemic risks in the sector; and
• creates a legal regime to prevent extreme scenarios from requiring the restructuring or resolution of an insurer in the event of insolvency.

Main changes included in the Solvency II review

Corrective measures relating to long-term guarantees are introduced, in particular concerning the grossing up of risk-free interest rates and the adjustment for volatility.

Regarding the former, it is proposed to amend Article 77a, which defines the rules for the extrapolation of the term structure of risk-free interest rates, so that such extrapolation takes into account financial market information for the maturities for which the term structure is extrapolated.  As regards volatility adjustment, it is proposed to amend Article 77d to make new cases of volatility adjustment subject to authorization by the competent authorities.  In order to mitigate the risk that the volatility adjustment compensates beyond investment losses due to an increase in credit spreads, an institution-specific 'credit spread sensitivity coefficient' is introduced.

 A new dimension of the proportionality principle will allow small insurers to be exempted from the scope of Solvency II. This would create a more appropriate framework for insurers with a low risk profile.

The Proposal includes:

• Amendment of Article 4 to increase the thresholds for exclusion from the scope of application of the rule;
• New Articles (29a to 29e) to (i) set out the criteria for the identification of insurers with a low risk profile; (ii) determine the proportionality measures applicable to such entities; or (iii) set out the reporting obligations of such entities;
• Insurers with a low risk profile may concentrate several key functions in one person;
• Insurers may update certain internal policies (e.g. risk management, remuneration, internal control, internal audit and outsourcing) every three years instead of annually;
• Two-year periodicity (instead of annually) for low-risk institutions and captive insurers to conduct their solvency assessment.

The information required from insurers will be better aligned with the information needed by the addressees.

To this end, it is proposed to amend Article 51 on the solvency and financial condition report to split the report into two parts, the first part, addressed to policyholders and beneficiaries of insurance policies, which should contain key information on the business, business performance, capital management and risk profile; and the second part, addressed to analysts and other market participants, which should contain specific information on the governance structure, technical provisions or solvency position of the institution.

With regard to compliance with prudential rules, it is proposed:

• To amend Article 45 to include adverse economic scenarios in the internal risk and solvency assessment;
• To amend Article 132 to include macroeconomic considerations in the principle of investment prudence;
• The add new articles 144a to 144c to impose the obligation to develop liquidity indicators to properly monitor this risk. 

In relation to cross-border group activity, it is proposed:

• To amend Article 18, to require entities applying to operate in another Member State to provide information on previous refusals or withdrawals of authorisation in other Member States;
•  To add a new Article 33a concerning minimum requirements for the exchange of information between home and host Member State authorities;
• To include an Article 159a empowering the host supervisory authority to request from the home supervisory authority information on the solvency situation of the undertaking, including the possibility to request the carrying out of a joint on-site inspection.

As regards insurance groups;

• Article 212 is amended to facilitate the identification of undertakings which are part of a group;
• Article 213 is amended to bring insurance holding companies and mixed financial holding companies directly within the scope of the EU prudential framework, e.g. by requiring them to meet governance requirements;
• Articles 244, 245 and 265 are amended to extend the list of indicators on the basis of which group supervisors may define significant intra-group transactions and risk concentrations; and
• the Articles on the group solvency calculation are amended to provide some clarification on the rules governing the group solvency calculation. 

In order to better manage and monitor climate and systemic risks, new requirements for long-term climate change scenario analysis will be introduced.

In particular, it is proposed to introduce a new Article 45a on climate scenario analysis, whereby insurers will be required to identify any significant exposure to climate change related risks, and to assess the impact of such scenarios on their business model. In addition, a new article 304a is included which mandates the European Insurance and Occupational Pensions Authority ("EIOPA") to review, until 2023, the prudential treatment of assets or activities associated with climate or social objectives, and to periodically review the scope and calibration of the parameters of the natural catastrophe risk formula.

Developing the regulatory framework for the recovery and resolution of insurance institutions

The proposal for an Insurance Recovery and Resolution Directive aims to ensure that both insurers and competent authorities can deal with significant financial difficulties in the sector in order to mitigate their consequences and the potential impact on the economy. To this end, competent authorities will have the necessary legal instruments to maintain cover for policyholders and beneficiaries, while preventing taxpayers from indirectly paying for the insolvency of insurers.

The proposed Directive has a similar structure to the relevant legislation applicable to credit institutions. In particular, it is divided into the following main blocks:

Scope, definitions and competent authorities (Articles 1 to 3): the scope of the Directive is the management of situations of near-insolvency or insolvency of institutions subject to the Solvency II regulatory framework. It also provides for Member States to set up resolution authorities specific to the insurance sector.

Preparedness (Articles 4 to 17): restructuring and resolution planning for insurance institutions. This section regulates the resolution and restructuring plans of insurance undertakings, as well as the assessment of these plans by the competent authorities.

Resolution (Articles 18 to 66): establishment of common parameters to determine the application of resolution tools. In addition, the different resolution tools that may be applied by the competent authorities are regulated (i.e. sale of business, bail-in, bridge institution, asset separation and revocation of the administrative authorisation to enter into new contracts). Ancillary provisions relating, inter alia, to the valuation of assets and liabilities, collateral, procedural obligations or rights of recourse are also developed.

Resolution of cross-border insurance groups (Articles 67 to 71): taking into account the cross-border nature of insurance groups, an authority will be set up at European level under the direction of EIOPA to coordinate the preparatory and resolution activities to be carried out by national authorities in order to ensure optimal solutions at European Union level. 

Relationship with third countries and sanctioning regime (Articles 72 to 82): a legal framework for cooperation between European and third-country authorities is created, with the aim of effectively controlling the resolution of insurance institutions operating in third countries. Finally, a sanctioning regime is developed for competent authorities to enable them to take effective, proportionate and dissuasive measures to ensure compliance with the resolution framework.

Next steps and pending procedures

Following the publication of the Proposal by the European Commission, it will be discussed by the European Parliament and the Council. The Commission has asked the European Parliament and the Council to make rapid progress in the inter-institutional negotiations; in parallel, the Commission will start work on the delegated acts that will complement the amendments to the Solvency II Directive.

Authored by  Pablo Muelas.