- The Solvency II Directive came into force on January 1st 2016. Now almost four years into implementation, the European Commission has tasked the European Insurance regulator, EIOPA, to go through a detailed assessment both to evaluate the success of the regulation, and to identify areas for improvement
- At close to 900 pages, the Consultation document covers a variety of topics (19 in total), which EIOPA sorts into three main categories, the first relating to the review of the Long Term Guarantee measures; the second looking at the potential introduction of new regulatory tools in the Solvency II Directive, notably on macro-prudential issues; and the third focusing on more general revisions, including the SCR
- Given the importance of Solvency II to the insurance industry as a whole and the complexity of interoperating these in-depth reviews, we’ve used our detailed knowledge and experience with the Solvency II framework to identify what we believe to be the critical elements for all stakeholders with asset management responsibilities
- We have reduced the 900 pages to 20 pages of key points and recommendations, sticking as much as possible to the work of the Regulator
Now almost four years into implementation, the European Commission has tasked the European Insurance regulator, EIOPA, to go through a detailed assessment both to evaluate the success of the regulation, and to identify areas for improvement.
According to EIOPA, the Solvency II framework fundamentally works well. This is why the approach is more of an evolution than a revolution, with the first step taken through this public consultation on its Technical Advice.
At close to 900 pages, the Consultation document covers a variety of topics (19 in total), which EIOPA sorts into three main categories, the first relating to the review of the Long Term Guarantee measures; the second looking at the potential introduction of new regulatory tools in the Solvency II Directive, notably on macro-prudential issues; and the third focusing on more general revisions, including the SCR.
More specifically, for asset management considerations, there are a few themes that emerge:
Re-calibrating the factors
- After 4 years of data and practical experience of implementing the framework, it is unsurprising that some of the modules require a degree of either recalibration or reengineering
- This is evidenced through the discussions on the Last Liquid Point (LLP), calculation methods of the Volatility Adjustment, or recalibration of the various Market Risk SCRs
- The persistence of negative rates was not foreseen in the original framework, and its consequences are the subject of constant analysis by EIOPA, through the discussions on the review of – first and foremost – the Interest Rate Risk SCR, which return after initially being rejected by the Commission, but also through other topics (e.g. VA)
- Lower for longer rates coupled with a renewed focus on market discount rates has led to heavier impacts on countries with guaranteed rate constraints and/or longer liabilities. As such, the Netherlands and Germany appear to be more vulnerable to some crucial discussions, notably the LLP extension.
- EIOPA is also clearly appearing through this document as the guardian of the “spirit” of the Regulation, clarifying some sections which were too loosely left to interpretation
- This is the case of the Matching Adjustment, addressing the issue of the asset eligibility criteria (although already well treated by the PRA)
- This can be seen also through the discussion on the use of ‘Transitionals’ as an (unnecessary) solvency boosting mechanism
- Recommendations can also go the other way, when insurers have been deemed unnecessarily prudent: for example, EIOPA concludes that diversification benefits for MA portfolios should not be limited in the Standard Formula.
Below is an executive summary, our 20 pages synthesis(PDF) is accessible at the top of the page
We note the following key recommendations by EIOPA of particular interest:
EIOPA opens up the possibility to extend the Last Liquid Point for the Risk Free Rate to 30y or even 50y for the Euro curve, with significant negative impacts expected in Germany and the Netherlands especially
Matching Adjustment (MA)
- EIOPA advises to remove the limitations to the diversification benefits for MA, portfolios in the SCR Standard Formula
- EIOPA advises that the eligibility of restructured assets be clarified, requiring that:
- The underlying assets provide a sufficiently fixed level of income;
- The restructured asset cash flows are supported by loss absorbency features such that those cash flows are sufficiently fixed in term and will remain so even as operating conditions change;
- Where the underlying assets include financial guarantees, those guarantees do not result in additional matching adjustment;
- The undertaking is able to properly identify, measure, monitor, manage, control and report the underlying risks.
- EIOPA proposes to improve the calculation of the VA by using a Cash Flow Freeze approach as well as allowing negative spreads for corporate and government bond portfolios
- EIOPA proposes 2 combinations of options to design a Permanent VA:
- One that would split the VA into a permanent VA reflecting the long-term illiquid nature of insurance cash flows and its implications on undertaking’s investments decisions; and macro-economic VA that would only exist when spreads are wide in particular during a financial crisis that affects the bond market.
- Another that would be based on undertaking-specific weights, and would therefore make a macro-economic or country VA obsolete.
- For Dynamic VA in internal models, EIOPA advises that the DVA could be maintained, if risk disincentives are solved in the VA (‘at source’).
- EIOPA advises to strengthen disclosure on transitionals,, in particular where undertakings comply with the SCR without the transitional the reasons why it is used should be provided
- Approvals after 1 Jan 2016: EIOPA advises to allow new approvals for the transitionals only in specified cases
- EIOPA proposes to add the beta method (as an option) in order to assess the criterion of lower volatility
- EIOPA advises to require that undertakings demonstrate that the valuation of the strategic participation does not significantly depend on, nor is significantly correlated to, the performance of the insurance undertaking and changes in own funds of the insurance undertaking
- In the current framework no diversification limitations are set for LTE: this means the LTE would be treated similar to the current equity risk sub-modules, simply adding up the different requirements for equity risk and jointly aggregating them via the existing correlation matrices with the other market risks.
- EIOPA advises no diversification between LTE and other equity risks. This option would imply that diversification of LTE would be partly limited as the LTE equity risk charge would be added up to the type 1 and type 2 equity charge and no diversification with short-term equity risks would apply.
- EIOPA recommends that only diversified portfolios are eligible for LTE treatment.
- Finally, EIOPA proposes to exclude controlled intra-group investments from LTE
- EIOPA sticks with its advice to model interest rate risk in the standard formula with a relative shift approach, parameters of which vary in function of the maturity.
- The impact would be significant for the shorter end of the upward shocked curve, and across the entire curve for the downward shock curve (which is almost unshocked in the current framework for the Euro curve)
- EIOPA details possibility to create “long term investments in bonds and loans”, similar to LTE
- But final advice is to stick with current calibration as it is already considered too low.
The Consultation period will end on January 15th 2020.
Natixis Investment Managers
RCS Paris 453 952 681
Capital: €178 251 690
43 avenue Pierre Mendès-France 75013 Paris
This communication is for information only and is intended for investment service providers or other Professional Clients. The analyses and opinions referenced herein represent the subjective views of the author as referenced unless stated otherwise and are subject to change. There can be no assurance that developments will transpire as may be forecasted in this material.
Copyright © 2019 Natixis Investment Managers S.A. – All rights reserved