EIOPA’s Opinion on the 2020 review of Solvency II

In December 2020, the European Insurance Occupational Pensions Authority (EIOPA) published its Opinion on the 2020 review of Solvency II.  While this will not directly affect UK firms, we believe that in the short-term at least, it is likely that the Prudential Regulation Authority (PRA) would make similar changes to UK regulations, in order to keep equivalence. The PRA is conducting its own review of Solvency II, with the aim of ensuring that prudential regulation in the UK meets UK needs, the first stage of which was the publication of its Call for Evidence in October 2020.

Following the introduction of Solvency II in January 2016, the insurance industry now uses a risk-based approach to measure and reduce risks.  Insurers under Solvency II have significantly strengthened their risk management and governance models. Therefore, although there is room for improvement, we believe the Solvency II framework is working well overall.

The key reason for the review was to check that Solvency II is still fit for purpose especially given the current economy – does Solvency II still work in the current low interest pandemic ridden economy?

The new rules are seen as coming into force after the Commission has reviewed them and they will require changes in the Delegated Act.  Therefore, they will probably take a year or so to be put into place.

Three key areas where EIOPA believes improvement is needed are stated below.

• Balanced updating of the regulatory framework such that there is a balanced overall impact on insurers.
• Recognition of the economic situation such that economic events like low interest (and negative interest) are not ignored.
• Regulatory tool box completion, including better policyholder protection.

The main features of EIOPA advice are given below.

Long term guarantee measure and equity risk

This includes changes to:

• risk-free rates extrapolation such that it reflects market rates better for euro liabilities beyond twenty years;
• volatility adjustment such that insurers are rewarded for holding illiquid liabilities;
• size and volatility of the risk margin especially for long term liabilities, by introducing a factor reducing the impact of SCR on the risk margin by duration; and
• criteria for the ability to hold equity long-term and ensuring the equities are diversified holdings only.

Consistency of treatment

Contract boundaries wording is tightened to remove the ability to terminate the life insurance contract term if the insurer does not repeat an underwriting assessment.  This means that contracts with reviewable premiums need their term extending if there is no underwriting assessment.  The Expected Profit In Future Premium (EPIFP) element is redefined for unit-linked policies.  Future management actions is also redefined in a tighter manner.  Expenses on renewal need to include their share of overhead expenses.

Solvency Capital Requirement

The view is that negative and low interest rates should be reflected in the SCR by increasing the capital requirement for the interest rate shock.  The interest rate stress will now be much greater on downward movements, as it includes a fixed movement in rates as well as a proportionate movement.  Equity symmetric adjustments will widen their range to +/-17% from +/-10%.  This will act as a further buffer on equity movements.

Proportionality

Solvency II exclusion levels are proposed to double to €50m technical provision and allow states to come up with higher limits between €5m and €25m of premiums.  EIOPA believes there should be the introduction of a new process for applying proportionality.  It also proposes proportionality rules for using simplifications on technical provisions.  Proportionality including its transparency and effectiveness across the three pillars of Solvency II should be increased.  For example, low risk undertakings (which are specified) can apply a simplified approach to the quantification of the SCR for immaterial risks, can apply for individuals to carry out a combination of key functions, need only carry out an ORSA every two years, can review written policies less frequently and have exemptions from some Pillar 3 templates.

Macro prudential policy

The view is that the micro prudential framework should be supplied with a macro prudential perspective and tools and measures to address all sources of systemic risk should be introduced.

Recovery and resolution

EIOPA believes a recovery and resolution framework should be developed for insurers and reinsurers which aims to increase policyholder protection and financial stability in the European Union.  It also lays out requirements for greater co-operation between regulators.

Insurance guarantee schemes

EIOPA would like an Introduction of insurance guarantee schemes or similar for the benefit of policyholders and financial stability.

Reporting

There are various small changes in SFCR, RSR, quarterly reporting templates and annual reporting templates.