Highlights of the European Parliament’s draft amendments to Solvency II
The European Parliament’s Committee on Economic and Monetary Affairs (the “Committee”) has recently published its comments on the proposed amendments to Solvency II. The key themes emerging from the comments are:
Proportionate supervision of low-risk profile undertakings
The proposed amendments to Solvency II set out several reforms to the supervision of low-risk profile undertakings, with a particular emphasis on ensuring that they are supervised in a manner which is proportionate to the risks inherent in their business.
To be classified as a low risk profile undertaking, insurers can apply to the national supervisory authority on the basis that they meet the relevant criteria. Following the Committee’s amendments, these criteria include no significant cross-border activity, compliance with the Solvency Capital Requirement (“SCR”), no capital add-on being imposed, inward reinsurance constituting less than 50% of GWP and technical provisions of less than €1 billion (for life insurers) or GWP of less than €100 million (for non-life insurers). The Committee’s comments also include the automatic classification of captive (re)insurers as low-risk profile undertakings.
Previously, supervisory authorities could only oppose such classification for non-compliance with the criteria, but the Committee’s amendments would also allow supervisors to object where the undertaking represents 5% or more of the home Member States’ life or non-life insurance market. Supervisory authorities will ordinarily only have one month to object to such classification. Low risk profile undertakings may avail of all of the proportionality measures set out in Solvency II (and in the proposed amendments to Solvency II), without having to obtain prior supervisory approval, for example in relation to frequency of regular supervisory reporting, governance requirements, frequency of the own risk and solvency assessment (“ORSA”), and limiting their sustainability reporting as per the simplified small-to-medium enterprise sustainability reporting standards in the Accounting Directive.
The Committee’s amendments propose that EIOPA will submit draft regulatory technical standards to specify the methodology to be used for classification of low-risk profile undertakings to the European Commission within 12 months from the entry into force of the Solvency II amendments.
Environmental, social and governance (“ESG”) issues
The Committee’s amendments would require (re)insurers to take into account short, medium and long term ESG risks in their system of governance, as well as setting quantitative objectives to improve gender balance in governance structures.
Risk management systems would also need to cover ESG risks in the investment portfolio and ensure that appropriate strategies, policies, processes and systems are in place in respect of ESG risks. Insurers and reinsurers (other than low risk profile undertakings) will be obliged to develop specific plans, quantifiable targets and processes to monitor and address ESG risks, including those arising from transition to a sustainable economy and achieving climate neutrality by 2050.
As part of the Committee’s amendments, the part of the Solvency and Financial Condition Report to be addressed to policyholders and beneficiaries would also have to include, in the description of the risk profile and capital management of the (re)insurer, a section on sustainability risks and the principal adverse impacts of the (re)insurer on sustainability factors.
Long-term equity investments (“LTEIs”)
The Committee’s amendments recognise that, given long-term nature of (re)insurance business, the prudential framework should be adjusted so that the SCR, calculated in accordance with the standard formula, allows for a more favourable treatment of LTEIs. The Committee’s amendments allow for a sub-set of equity investments to be treated at LTEIs where:
- the sub-set of equities is clearly defined;
- a policy for long-term investment management is set up for each LTEI portfolio and reflects the (re)insurers commitment to hold such LTEIs for a period in excess of five years on average. Such policy must be approved by the board, frequently reviewed against actual management of the portfolio and reported on in the ORSA;
- the investments consist only of equities listed in OECD member countries or unlisted equities of companies with their head office in OECD countries;
- the (re)insurer can satisfy the relevant supervisory authority that it can maintain the LTEIs over the five-year holding period; and
- the risk management, asset-liability management and investment policies of the (re)insurer reflect the intention to hold the LTEIs for a period of five years or more.
Where equities are held within collective investment undertakings or alternative investment funds such as European Long Term Investment Funds, these conditions may be assessed at the level of the funds rather than the underlying assets.
The capital charge for LTEIs is proposed to be equal to the loss in basic own funds that would result from a decrease of 22% in the value of the LTEIs. While this is likely to be attractive for most (re)insurers, the Committee proposals indicate that (re)insurers who adopt this approach to LTEIs will be ‘locked in’ and should not revert back to an approach that does not include LTEIs. If such an (re)insurer can no longer comply with the conditions, it would be required to inform its supervisor and cease to apply this more favourable capital charge.
Cost of capital and negative interest rates
The Committee has introduced some additional recitals in the proposed amendments to Solvency II, indicating that, to preserve the international competitiveness of EEA-authorised (re)insurers, the cost of capital should be decreased compared to the level set on the adoption of Solvency II, while maintaining a sufficient level of prudence and protection of policyholders. The calculation of the risk margin should also account for the time dependency of risks and reduce the amount of the risk margin, in particular for long-term liabilities. This would reduce the sensitivity of the risk margin to interest rate changes and the volatility of the prudential balance sheet.
The Committee’s amendments therefore propose that the risk margin will be calculated by determining the cost of providing eligible own funds equal to the time-adjusted SCR necessary to support the (re)insurance obligations over their lifetime and that the adjustment of the SCR will consist of an exponential and time dependent element. In addition, the Cost-of-Capital rate used in such determination is to be assumed to be equal to 4.5%.
The additional recitals introduced by the Committee also refer to the need to properly reflect extremely low and negative interest rates witnessed in recent years on the markets, which should be achieved via a recalibration of the interest rate risk sub-module to reflect the existence of a negative yield environment. The Committee’s amendments include a change to obligations of the European Commission to adopt delegated acts providing for calculation of the risk modules and sub-modules of the SCR in accordance with the standard formula, so that the interest rate risk sub-module shall reflect the risk that interest rates may further decrease even where they are low or negative, subject to a negative floor (which should be term-dependent).
Supervisory powers in deteriorating financial conditions
The comments of the Committee on the proposed amendments to Solvency II include an overhaul of the existing provisions regarding supervisory powers in deteriorating financial conditions. The proposed amendments would shift the initial focus of supervisory intervention from powers to safeguard the interests of policyholders and cedants to taking necessary measures to restore compliance with regulatory capital requirements.
Such measures must be proportionate to the risk and the extent of non-compliance and can include suspension or restriction of distributions, repayment or repurchase of own fund items and variable remuneration and bonuses. Such measures can also include updating or implementing pre-emptive recovery plans, to dovetail with the relevant provisions of the Insurance Recovery and Resolution Directive.
Only where the solvency position of the undertaking continues to deteriorate will the supervisory authorities have the power to take the measures necessary to safeguard the interests of policyholders and cedants. Nevertheless, these measures must be proportionate and reflect the level of deterioration in the solvency position.
Other notable items
Some other notable changes from the Committee on the proposed amendments to Solvency II are:
- amendments to the volatility adjustment to allow for undertaking-specific adjustments to the risk-corrected spread of particular currencies;
- expanding the supervisory powers to remedy liquidity vulnerabilities in exceptional circumstances, to include temporary restrictions or suspensions of dividends and other payments to shareholders or subordinated creditors, share buy-backs, repayment or redemption of own fund items, bonuses or other variable remuneration and suspension of redemption rights of life insurance policyholders;
- the establishment of mandatory collaboration platforms for supervisory authorities in relation to cross-border activities, to enhance supervision given the increasing amount and complexity of cross-border business in the EEA. Standing digital platforms are to be facilitated by EIOPA to enable efficient exchange of supervisory data, with powers for concerned national supervisory authorities to request additional information on the platform or for the home state supervisor to carry out a joint inspection, where there is non-compliance with the SCR.
The Member States will be obliged to adopt relevant laws to comply with the amendments to Solvency II by 30 June 2025 and to apply them from 1 January 2026.