The Solvency II 2020 review is currently underway, but what changes are the captive insurance industry expecting to see?
The Solvency II directive, which came into effect on 1 January 2016, is a European Union law that codifies and harmonises the EU insurance regulation.
Solvency II was a milestone for European insurance regulation and supervision. The directive is the first common supervisory framework in the EU and set global standards. It sets the basis for the integration of the single market for insurance in Europe.
The system is based on a forward-looking and risk-based approach, requiring the highest risk management standards and active monitoring and steering of the risk an insurer is facing.
It ensures fair competition and consistent consumer protection across the EU and allows insurers to provide their product cross-border.
However, Solvency II has added a lot of complexity to the process and structures of companies and supervisors, presenting a significant regulatory burden.
As Guenter Droese, executive director, European Captive Insurance and Reinsurance Owners Association (ECIROA), says: “Solvency II introduced a lot more work which follows the three pillars with the respective requirements and a challenging volume of reporting, leading to some changes in the organisational structure.”
Where captives in the past didn’t provide the prescriptive information to their owner which they now need, Droese notes that this can be qualified as an advantage for the captive owner.
He explains: “Before the implementation, some captives covered the main requirements anyway; for those which chose a rather simple and low-level performance the additional workload and especially the reporting has grown dramatically—with huge differences between the various domiciles.”
“The level of professionalism has been increased and the comparability between the various companies is now to a certain extent possible—even when a very limited number of interested parties has read publicly available reports,” he adds.
Although the majority of captives do not suffer under the new regime, which Droese says to a certain extent means “business as usual”.
However, with the new regulatory regime, the industry was also faced with the Organisation for Economic Co-operation and Development’s (OECD) base erosion and profit shifting (BEPS), which Droese notes “raised some challenging requirements regarding captives”.
He says: “We strongly believe that our exchange of views with OECD has been fruitful and the concerns raised are respected by the majority of our captives, bearing in mind that most of the BEPS paper requirements are covered to a great part by similar or same principles and rules of Solvency II.”
THE BIG REVIEW
Almost four years since it’s go-live date and the Solvency II Directive is currently under review. In February this year, the European Commission called for the European Insurance and Occupational Pensions Authority (EIOPA) to provide technical advice for a comprehensive review of the Solvency II Directive.
The areas being reviewed include long-term guarantees measures and measures on equity risk; methods, assumptions and standard parameters used when calculating the Solvency Capital Requirement standard formula; member states’ rules and supervisory authorities practices regarding the calculation of the minimum capital requirement; and group supervision and capital management within a group of insurance or reinsurance undertakings.
Beyond that minimum scope, other parts of the Solvency II framework were also identified by the EC services or by stakeholders as deserving a reassessment, such as the supervision of cross-border activities or the enhancement of proportionality principles, including as regards reporting, and also others.
A public consultation was already completed during the summer that focused on the draft advice on reporting and disclosure and on insurance guarantee schemes.
The second public consultation, which is currently in process, focuses on technical advice covering all advice other than on reporting, disclosure and insurance guarantee schemes.
The deadline for the second consultation is on 15 January 2020. EIOPA’s publication of opinion is expected to be published in June 2020, with a final report from the EC and a potential legislative proposal due at the end of 2020.
One association that has been working closely with EIOPA is the Federation of European Risk Management Association (FERMA). The association has a dedicated working group of risk managers and other captive specialists, who according to 7, CEO of FERMA, “have already been successful in putting proportionality for small insurance entities very high in the EIOPA agenda”.
Beaupérin explains: “Our network of members has told us that member states are not consistent in the way they apply the proportionality principle. Our focus, therefore, is primarily to get improvements to the application of proportionality for small and less complex insurers like captives, which are used by around 30 percent of risk and insurance managers in Europe according to FERMA’s 2018 European Risk Manager Survey.”
Published on 15 October, EIOPA’s consultation paper on the 2020 review stated that it had reviewed the rules for exempting insurance undertakings from the Solvency II Directive, in particular, the thresholds on the size of the insurance business.
As a result, EIOPA proposed to maintain the general approach to exemptions but to reinforce proportionality across the three pillars of the Solvency II Directive.
EIOPA also proposed to double the thresholds related to technical provisions and to allow the member states to increase the current threshold for premium income from the current amount of €5 million to up to €25 million.
During a webinar that FERMA held in late August, those involved were asked if their captive benefitted from proportionality measures put in place by the local supervisor in relation with Solvency II. Most respondents did not know whether they benefit from proportionality measures, with 21 percent answering yes and 38 responding no.
When asked if these results came as a surprise, Laurent Nihoul, general manager, group head of insurance at Arcelor Mittal, said: “Yes and no”.
On the same webinar, EIOPA’s head of supervisory process department, Ana Teresa Moutinho confirmed that they have different applications of proportionality across Europe and shared that it is difficult for EIOPA to streamline their analysis for only captives—which is something they are working on.
Florian Wimber, head of European affairs and international insurance, Insurance Ireland, explains that the system is generally based on the assumption of a representative insurer. Insurers with a specific risk profile have the opportunity to apply for the use of internal models.
These internal models, however, require supervisory authorisation and the development of such models and the governance around the application process is, usually, “very burdensome” for smaller insurers, including captives.
Companies such as captives usually apply the “standard Solvency II” and according to Wimber, “due to the special nature of captives, Solvency II does not appropriately reflect the business model. Complying with these ill-fitting standards is an inappropriate burden for the respective companies”.
Wimber believes as a matter of principle, Solvency II should be applied proportionately to the nature, scale and complexity of the risk inherent to an insurer.
He explains: “Such a proportionate application of Solvency II should mean that the compliance burden for less complex insurers and captives is more tailored. Unfortunately, a recent EIOPA assessment found that the principle of proportionality is very inconsistently applied across the EU.”
Insurance Ireland also teamed up with the EC and EIOPA to ensure that captives are appropriately reflected under Solvency II.
Wimber explains that as a next step, it will be “crucial that the industry develops concrete proposals on how Solvency II can be amended during the current review to better reflect the characteristics of captives and apply the principle of proportionality more consistently”.
Wimber stresses that in accordance with the general principles of Solvency II, Insurance Ireland believes that the system should reflect each risk appropriately—including sustainability risks.
He adds: “We oppose ideas of a green benefitting or brown penalising factor under Solvency II. EIOPA’s initiative to take a closer look at the risk exposure of companies is supported and so is an enhanced reporting of these risks.”
Wimber says: “It will have to be assessed how Solvency II sets disincentives towards the goals of a sustainability strategy.”
“This particularly applies to certain short-termism and penalising character of Solvency II on long-term investments which particularly limit the ability of insurers to invest in sustainable projects.”
Adding that “certain calibrations of Solvency II—such as risk margin—will have to be reviewed to free-up unnecessarily bound capital.”
Beaupérin explains that FERMA also provided contributions EIOPA, the first involved the integration of sustainability risks in Solvency II and the Insurance Distribution Directive (IDD) and the second focused on the general place of sustainability within Solvency II.
It also responded to the consultation on Solvency II revision which focused on reporting and disclosure.
Beaupérin says it welcomed EIOPA’s view that there is a mismatch in the time horizon of Solvency II capital requirements and climate change impacts.
She adds: “EIOPA also stated that it did not consider sustainability risk as a separate category of risk, a view which we share.
However, EIOPA maintained its position that scenario analysis and stress testing on climate change should be part of the own risk and solvency assessment (ORSA). We believe it is overly prescriptive and disproportionate for small and less complex insurers.”
Also discussing EIOPA’s paper on sustainability within Solvency II was Droese, who suggests that sustainability considerations have been discussed since the ‘Club of Rome`s’ activity in the late 1960s.
Droese says: “Now it seems necessary to remind all companies in the economy to protect our planet and by the way to reduce all kind of avoidable emission and to invest in those activities which are more carefully regarding CO2 reduction but also with regard to all other kinds of pollution.”
The way forward chosen by governments and politicians using certificates, financial instruments and tax penalties, according to Droese, will not be appropriate and efficient considerations and measures to reduce the emissions with the necessary speed—the real economy, have to change their production, goods, services and processes.
He continues: “EIOPA is demanding what makes sense in its broadest form. We believe that captives don’t have the appropriate tools and volume to contribute very intensively to these necessary changes. The investment strategy of the captive usually is aligned with the strategy of the parent company.”
AWAITING THE CHANGE
As EIOPA considers to adjust over the next years level two rules of Solvency II, which have been discovered by local supervisors and all other stakeholders as not perfect for either the supervisor or the insurers, Droese says the main factors which will help to reduce or limit or improve some of the level two rules have been identified as the proportionality principle and its application.
Droese says: “We strongly believe that during the coming six or ten years regulatory adjustments will have a positive effect on the workload, cost and performance of all insurers, not only on captives.”
“A Solvency III concept deems unnecessary once these adjustments are integrated on level two.”
Although it could be 12 months before the European Commission publishes its Solvency II review, in that time Beaupérin states that FERMA will continue the dialogue and advocate for an assessment on how the principle of proportionality is currently interpreted in the various member states and for a consistent approach to its application.”
