SOLVENCY II BULLETIN – Issue 15: The State of Play & Outstanding Issues

1. The Commission brings pragmatism and purpose to bear on Solvency II

Following CEIOPS’ final advice for the level 2 implementing measures, the European Commission now has ownership of the drafting of the measures in consultation with Member States through the Solvency Experts Group (SEG) and key industry stakeholders through a more informal process. The ABI is therefore actively engaged both at a national and European level, providing input and feedback to those who sit at the SEG meetings, and to the CEA which has been asked to provide feedback on the draft proposals by the Commission.

Simultaneously, CEIOPS is preparing the draft technical specifications for the Quantitative Impact Study (QIS) 5 exercise which will be held across Europe from end July until October 2010. Based on their final advice for the level 2 implementing measures, CEIOPS will be sending the QIS 5 technical specifications by end March 2010 to the European Commission who will be again consulting key industry stakeholders until end May before the final specifications are released in July.

2. The Commission's proposals for level 2

The Solvency Experts Group has met five times, between early December 2009 and end March 2010, to discuss the Commission’s draft proposals for the level 2 implementing measures. So far, the Commission has prepared and revised the following level 2 implementing measures (IM):

Whilst this is still early days, key changes have been introduced compared to CEIOPS’ draft and final advice, in particular:

·          Future premiums (irrespective of whether it increases or decreases the TP) recognised in principle (IM 13)

·          Diversification is to be taken into account at the level of the portfolio in the calculation of the risk margin (IM 13)

·          Several references to proportionality and materiality have been introduced across the board in order to reduce the regulatory burden based on the size of a subsidiary or a business line (IM 2, IM 6, IM 9, IM 10)

·          The basic risk free rate will be derived from the swap rate adjusted for credit risk (IM 20)

·          A 12 year transitional measure has been introduced for the calculation of the risk free rate for annuity providers on business in force prior to Solvency II implementation (IM 20)

The Solvency Experts Group (SEG) will continue to meet until June 2010 inclusive, to discuss outstanding issues and upcoming draft proposals from the Commission. The next meeting of the SEG is scheduled for the 29^th – 30^th March and will notably cover: the risk free rate and the liquidity premium (IM 20), the Pillar I dampener (IM 15), duration based equity risk (IM 16), Participations (IM 17), repackaged loan investments (IM 18).  

Whilst some highly significant changes have been introduced in the Commission's level 2 implementing measures, we must continue to press for political support across Europe to ensure these positive changes are agreed by Member States who in many cases delegate their representation to the same supervisors involved in preparing the original CEIOPS advice. In addition, there are further issues where we are keen to secure progress, including  the calibration of the SCR, market risk, Non Life and Health risks; the MCR; intra group transactions; partial internal models; group solvency; entity specific parameters; third country equivalence.

3. What QIS 5 will need to achieve
 

QIS 5 will constitute a live test exercise of the Solvency II framework and the detailed technical implementation. We will therefore need to ensure the final technical specifications of this exercise are set appropriately.

The ABI and other European organisations, such as European Insurance Association (CEA) are therefore committed to working with the European Commission in a fundamental re-calibration of the CEIOPS advice, before the QIS 5 exercise is launched. In particular, we believe the following areas will need to undergo considerable changes to ensure Solvency II becomes a real step forward for the European insurance industry and its customers:

4. Spotlight on equivalence

Regarding equivalence the following three issues are key:

·          Which countries are likely to be obtain the equivalent status

·          What will be the consequences of non equivalence

·          The treatment of multinational groups

Key Markets

Our tentative importance ranking of non EU countries would be: Switzerland, US, Bermuda, Canada, Australia, Hong Kong, India, China, Japan, Guernsey. It is however very likely that there will be a significant gap between this ranking and the likelihood of these countries obtaining equivalence.

To summarise:

·         Switzerland is the closest regime to Solvency II and most likely to be considered equivalent.

·         Japan, Canada and Australia have a risk sensitive framework and might be granted equivalence with a few adjustments to their current rules if they decide to apply. Japan is unlikely to apply in the first wave as it is currently reforming its regulatory framework.

·         Bermuda is undergoing a profound reorganisation and is aiming to be equivalent with both the US and Solvency II. This is a serious challenge and the results remain to be seen.  

·         Hong Kong, India, Guernsey and China still have a traditional system and are unlikely to be considered for the first wave unless they transpose the directive directly (which could be an option for Guernsey).

·         Whilst the US do not have a federal with which to negotiate and the State rules are somewhat dated, they remain a key market for many EU insurance companies.

Consequences of the absence of equivalence

Bermuda is critical for reinsurance particularly for the UK. A significant share of the business in the London market is also done with the US. The risk would be to see a reduction in cross border transactions with companies opening subsidiaries in third countries.

However it is very difficult to consider the consequence of non equivalence without knowing what measure will be required in case of non equivalence and whether any transitional measure will be applicable.

Treatment of cross border groups

The group approach of Solvency II could mean that overseas subsidiaries of EU groups could be competitively challenged against local insurers and may therefore be priced out of some markets. There is a possibility that EU-based groups will be forced to re-structure and move their head office outside the EU which is not the outcome the Commission or the industry want to see.

For non EU groups operating in the EU we need more details on the modality of application of the EU sub group principle. In particular clarification is needed on what will be the extent of EU regulators supervisory power beyond the EEA subgroup and what level of reporting will be required.