EIOPA VIEW: What’s next for Solvency II?
With Solvency II currently under review, Justin Wray, deputy head of policy, EIPOA, updates insurers on the issues shaping the assessment and what could happen next.
Sara Benwellposted on Wednesday, January 22, 2020
The Solvency II review should come as no surprise to the insurance industry. One of the conditions of the implementation of the regulation was that an assessment would be built in, says Justin Wray, deputy head of policy, European Insurance and Occupational Pensions Authority.
However, companies that may be hoping for changes to the underlying principles behind the regulation are set for disappointment.
Wray explained: “We prefer evolution and not revolution because the three-pillar approach that underpins prudential supervision of Solvency II is something that we consider to be a valid approach.
"We prefer evolution and not revolution"
“Moreover, the European commission who gives us our remit for the advice were very clear and said “the fundamental principles of the Solvency II directive should not be questioned in the review”.”
Despite these limitations, the review is broad in scope and covers a lot more ground than what was required under the legal provisions.
EIOPA has been asked to review 19 areas in total. Here’s some of the main areas of change, and where EIOPA is heading:
Long-term guarantees and volatility adjustments
These were the final part of the Solvency II package to be agreed. Indeed, they were so contentious that agreement was contingent on a commitment to review after a few years.
Wray said: “One reason for this is that the provision of long-term guarantees is, in itself, a sensitive subject but they are also financially important as well.
“If you look at the long-term guarantee measures, matching adjustment VA and so on… if you aggregate their technical provisions it is something like 74 per cent of all technical provisions in the EU.
"The provision of long-term guarantees is, in itself, a sensitive subject"
“In other words, these measures make a huge part of the market and they make a huge difference to the financial position of the insurers who use them.”
EIPOA has not come to any conclusions on this issue so far, and is very much in the fact-finding stage, however, Wray explained that EIPOA will definitely be making recommendations to change the rules around extrapolation that will be particularly significant for the Eurozone.
Volatility adjustment is another measure that is facing regulatory scrutiny.
“We will look at both and see what stakeholders say"
Wray said: “We were asked to look at two different approaches to the VA, one puts a greater separation between the economic rationale for the VA and the mitigation of sudden changes in spreads and the other approach is to say that rather than having a single VA per country and per currency that you do it on an undertaking specific basis.
“We will look at both and see what stakeholders say… there are many different ways of cutting the cake.”
On equity risk, when EIPOA looked at the volatility of equity over different periods, it wasn’t clear that there is significantly lower volatility for holding equities over long periods..
Wray said: “We are genuinely interested in what the experience has been on equity holding. We will look at what is there and what the commission has put in its latest delegated regulation on long term equity and we will take it forward from there.”
EIPOA conducted a thorough review of risk margin a couple of years ago and is satisfied that the measures are working as they should to protect policy holders in the event of an insurer needing to transfer its policies.
As a result, EIOPA doesn’t intend to recommend any changes to the regulations, but did say it was open to hearing new views and evidence from members.
"The risk margin is not necessarily overdone and actually it does what it is meant to."
Wray said: “We found that if you look at the transfer values, the risk margins and, in particular, the transfer of closed books of businesses so that you have less distortion from things like good will then actually the values are broadly similar and so there is an argument that the risk margin is not necessarily overdone and actually it does what it is meant to.
“At this stage we aren’t recommending a change.”
Interest rate risk
When the calibration of interest rate risk was initially set, it was just before the prolonged period of low interest rates that insurers are currently grappling with. Now, EIOPA is reconsidering the measures in light of the new economic normal.
“The ability of the system to cope with very low or negative rates is limited and events have taken over the calibration"
Wray said: “It is clear to us that if you are seeking to calibrate interest rate risk on the basis of information up to the red line then you are not going to have a reflection of today’s world. You know that Solvency II seeks to capture the 1 in 200-year risks but on interest rates, the reality turned out to be far worse than a 1 in 200-year event.
“The ability of the system to cope with very low or negative rates is limited and events have taken over the calibration and it is EIOPAs firm view that there needs to be a change.”
Macro prudential themes
When it comes to prudence, the impact of insurers collectively in the financial system needs to be taken into account, not just the prudential position of individual firms.
As a result, EIOPA wants to take a more “European approach” and has six principals that it intends to take further.
Wray explains: “On recovery and resolution, and proportionality’s fundamental guiding principles there are significant differences and we aren’t intending to impose a one size fits all.
“We believe that a European network of national insurance guarantee schemes should be established"
“What is sought is an approach that is proportionate to the issue which is the significant differences that there are in these areas between different members.
“For insurance guarantee schemes, confidence in cross border trade, freedom of services and freedom of establishment will be increased if there is greater confidence in insurance guarantee schemes.
“We believe that a European network of national insurance guarantee schemes should be established across the EU with sufficient harmonisation and funding.”
Wray says that EIOPA plans to be consultative on all of the changes it is considering and will be asking insurers to provide a lot of information.
Wray said: “There will be the feedback from consultation, the information requests are ongoing and then there will be this holistic impact assessment.
“The gun was fired in April 2018 and will finish this year. In January. we will put all of these together and start to finalise the proposals.”