Analysis & Opinion

Tracking changes in the Directive

The Solvency II Directive was officially adopted on 5 May 2009 and incorporates a number of changes from the original draft. The following points have been adapted from the FSA’s Feedback Statement 09/0 and should also be considered alongside EMB’s original explanatory document ‘Understanding the Directive' .  

Firms should note that the implementation date for Solvency II has now been definitely set at 31st October 2012.

Systems of governance (Pillar 2) and reporting requirements (Pillar 3) under Solvency II

a) Following a debate around the need for appropriate convergence of the Own Risk Solvency Assessment (ORSA) across the Member States, the Directive includes the possibility that further Level 2 implementing measures may be adopted to further specify the elements of the assessment.

b) The Directive Article on the actuarial function within firms makes a stronger reference to proportionality, in that actuarial expertise and knowledge should be commensurate with the nature, scale and complexity of the risks the firm is subject to.

Demonstrating adequate financial resources (Pillar 1)

a) The Directive allows for the limits applicable to the various own fund ‘tiers’ (i.e.
Tiers 1, 2 and 3) to be adjusted through Level 2 implementing measures. This is because the limits set out in the Directive are now minimum requirements. This could mean, for example, that firms are required to hold more than 1/3 of their Solvency Capital Requirement (SCR) in Tier 1 capital. The possibility to divide the capital tiers into further ‘sub-tiers’ (e.g. ‘core Tier 1’; ‘innovative Tier 1’) at Level 2 has been removed.

b) There has been an addition to the Directive to allow for Level 2 implementing measures to be developed to align restrictions on firms’ investments in tradable securities of ‘repackaged’ loans with corresponding requirements in other sectors.

c) There is also a further addition to the Directive dealing with significant deviations from the assumptions underlying the standard formula calculation. Where the risk profile of the firm deviates significantly from the assumptions underlying the standard formula, the Directive now gives supervisors the power to require a subset of the parameters in the standard formula calculation in relation to the life, non-life and health underwriting risk modules to be replaced with appropriate undertaking-specific parameters.

d) The Directive Article dealing with the calculation of the Minimum Capital Requirement (MCR) now states that the MCR shall not fall below 25% nor exceed 45% of the firms’ SCR. This is a change from 20% and 50% respectively in the former draft Directive. The absolute floors of the MCR have also been increased.

Use and approval of internal models

The Directive Article on the general provisions for the approval of full and partial internal models stated in the original Commission proposal Directive that undertakings would be required to provide supervisory authorities with an estimate of the SCR determined in accordance with the Standard Formula for two years after approval. This provision remains; however, instead of a requirement for two years, there is now supervisory discretion as to whether undertakings will be required to provide this estimate.

Group support
 
The Directive as adopted does not include the ‘group support’ regime (the proposal that subsidiaries meet their Minimum Capital Requirement using locally held capital but rely on a parental guarantee to meet the Solvency Capital Requirement.) The Directive does, however, envisage the Commission will review the benefits of a group support regime within three years following implementation of the Solvency II regime.

Although the group support provisions have been omitted, the articles dealing with group supervision remain. This means that there will still be a requirement for lead (group) supervisors to review the Group SCR calculation and the ability to specify capital add-ons where necessary, in consultation with local regulators. Furthermore, there are provisions setting out the role of ‘supervisory colleges’.

Additional changes

The Directive as adopted includes a Member State option to allow a duration-based approach to the calculation of the capital charge applied to equity risk in relation to prescribed types of business as a Member State option. This approach would allow for insurers, subject to supervisory approval, to link the calculation of the capital charge for the risk of equity price falls to the duration of the liabilities and the typical holding period of the equities held against those liabilities. This approach will be subject to a review three years after the implementation of the Solvency II regime, with a particular focus on cross-border effects of the use of this approach.

The Directive as adopted also now includes a symmetrical anti-cyclical adjustment mechanism (a so called ‘Pillar I dampener’) to the standard (non duration-based) equity risk charge. The adjustment mechanism is designed to allow for a reduction in the capital charge applied to equity holdings when equities markets are falling, and conversely an increase in the charge in a rising market. The precise design and functioning of the adjustment mechanism are being determined at Level 2.

Additionally, if there is an exceptional fall in financial markets, the Directive makes allowance for supervisory authorities to extend the period during which the firms must return to full compliance with its SCR. 

Beyond the wording changes of the ratified Directive, the ongoing consultation process for the detailed implementation measures needed to bring about Solvency II will significantly determine what insurers are required to do in order to comply. Details of all CEIOPS consultation papers can be found at http://www.ceiops.eu/content/view/14/18/

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