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European insurers 'disappointed' as work continues to iron out Solvency II kinks

European insurers are "disappointed" with proposed revisions to Solvency II following the European Commission's 2018 review of the capital regime's so-called delegated regulation.

With little scope for large changes to the regime from the most recent exercise, hopes are now on the wider-ranging 2020 review to bring the improvements both insurers and regulators want to see.

Solvency skirmishes

The European Commission in November published draft legislation that would make changes to the delegated regulation, which stipulates how country regulators implement the directive. Olav Jones, deputy director general of pan-European insurance trade body Insurance Europe, said that although the draft text contained a number of simplifications and improvements, the association was disappointed because it "fails to address the unnecessary barriers to provision of long-term products and long-term investment."

One area of concern is the EC's proposed reduction in the capital calibration for equities that insurers hold long-term to 22% from 39%. The original calibration was based on the risk of a stock market crash, and the reduction reflects the fact that holding on to equities for longer mitigates the effects of such an event.

But while deeming the 22% calibration "much more appropriate," Jones said the criteria for qualifying for the lower calibration were defined "in the wrong way" and so "it is very unlikely that any insurer will qualify. The impact will therefore be zero." He added that Insurance Europe is calling on the EC to take "swift action" to amend the proposal.

The trade body also wants a reduction on the 6% cost of capital element of the risk margin, a key component of insurers' capital requirements under Solvency II. It wants the EC to improve how the national component of Solvency II's volatility adjustment, which mitigates the effect of short-term fluctuations in bond spreads, is triggered. And it has called for the removal of "unnecessary limits" on the loss-absorbing capacity of deferred taxes.

Insurers are not the only ones that did not get what they wanted from the 2018 review. The EC postponed looking at the interest rate risk element of Solvency II until the 2020 review, a decision that European Insurance and Occupational Pensions Authority Chairman Gabriel Bernardino told the regulator's annual conference in November that he regretted.

EIOPA advised the EC in February that the current method understates interest rate risk in a low-yield environment, and estimated that its proposed method could reduce the solvency ratio for life insurers exposed to the low-yield environment by 14 percentage points on average.

2020 vision

Kamran Foroughi, a director at Willis Towers Watson, said revisions in 2019, which would be related to older consultations, "are relatively limited in nature." However, the 2020 review is expected to be far more wide-ranging. It will mainly focus on Solvency II's long-term guarantee measures, including the volatility adjustment and the matching adjustment, which must be reviewed by Jan. 1, 2021.

"I think they want to extend the review to something much broader and review possibly all aspects of the standard formula," said Benjamin Serra, a senior vice president at rating agency Moody's. The standard formula determines how much capital insurers have to hold under the regulation, and is used by companies without regulatory approval to use their own internal models to calculate capital requirements.

"It is a very broad review ... so all scenarios are possible," Serra said.

There are hopes that the 2020 review will resolve insurers' gripes with Solvency II's risk margin, a capital buffer companies have to hold in excess of the best estimates of their liabilities. Insurance Europe's Jones said there is "strong evidence" that the risk margin can and should be cut, adding that "a more fundamental review of its purpose and calculation" is needed in 2020.

Preparing for change

But just as the 2020 review could be an opportunity for insurers to turn Solvency II more to their favor, "it is possible that the regulators may argue for a revisit of some of the elements that today are sustaining Solvency II ratios," said Taos Fudji, a senior insurance analyst at S&P Global Ratings. These include the matching adjustment and the transitional measures designed to ease insurers into Solvency II over time.

To prepare, Fudji suggested that insurers needed a thorough understanding of the elements supporting Solvency II "that may be tweaked or modified during the 2020 review."

Willis Towers Watson's Foroughi noted that with European Parliament elections due in May 2019, there could be a consultation or call for advice in the first quarter, which might prove challenging for insurers given how busy they are with full-year reporting. But he urged them to play an active role and "make sure they plan to allow some time for that response."

EIOPA on Dec. 19 launched a consultation on reporting and disclosure requirements under Solvency II, which will also be reviewed in 2020. It gave two months for responses.