Blog: Solvency II

Three implementing regulations that set down technical standards for Solvency II were published on 31 December 2015 in the Official Journal of the European Union. The three regulations cover:

• implementing technical standards relating to the templates for the submission of information to the supervisory authorities;
• implementing technical standards relating to the templates and structure of the disclosure of specific information by supervisory authorities; and
• implementing technical standards relating to the procedures, formats and templates of the solvency and financial condition report.

For further information: Official Journal of the European Union Solvency II technical standards

   Three implementing regulations that set down technical standards for Solvency II were published on 31 December 2015 in the Official Journal of the European Union. The three regulations cover:

• implementing technical standards relating to the templates for the submission of information to the supervisory authorities;
• implementing technical standards relating to the templates and structure of the disclosure of specific information by supervisory authorities; and
• implementing technical standards relating to the procedures, formats and templates of the solvency and financial condition report.

For further information: Official Journal of the European Union Solvency II technical standards

The Prudential Regulation Authority (PRA) has issued its supervisory statement ‘Solvency II: third-country insurance and pure reinsurance branches’ (SS44/15). It is addressed to third-country branch undertakings (non-EEA insurance undertakings that have a UK branch) and includes third-country pure reinsurance branches (non-EEA insurance undertakings that have a UK branch that solely carries out reinsurance activities). The statement replaces the Supervisory Statement 10/15 ‘Solvency II: third country branches’ (published in March 2015) and sets out in detail the PRA’s expectations of third-country branch undertakings.

Key points include:

• Compliance with the guidelines. The PRA expects third-country branch undertakings to comply with EIOPA Branch Guidelines and, in light of those guidelines, comply with the applicable rules in the PRA Rulebook as if the scope extended to them.
• Important aspects of the EIOPA Branch Guidelines. Third-country undertakings are expected to maintain financial soundness at branch level to ensure that branch policyholders enjoy the same level of protection as policyholders of an EU insurance undertaking. When calculating branch own funds, only those assets that are available to pay the claims of branch policyholders in the event of a winding up event are to be included. Third-country undertakings are expected to provide the PRA with an analysis of the winding up regime, detailing the priority given to branch policyholders and how the assets would be distributed to those policyholders.
• Worldwide financial resources. In the PRA Rulebook, third-country branch undertakings are required to maintain adequate worldwide financial resources and assess their adequacy. For this purpose, the PRA will consider the undertaking’s compliance with its home country’s prudential regime. Third-country branch undertakings are expected to provide sufficient information so that the PRA may form an opinion on the adequacy of its worldwide financial resources.
• Scheme of operations. The PRA will request a scheme of operations that sets out all the information required under the Third Country Branches 5.1 part of the Rulebook as part of the application process for any third-country branch undertaking applying for a grant or variation of permission.
• Annual, quarterly and Day 1 reporting requirements. In meeting reporting requirements, the PRA expects third-country branch undertakings to use the reporting templates set out in the EIOPA Branch Guidelines so as to allow the PRA to decide which quarterly or annual quantitative reporting templates (QRTs) should be submitted by each undertaking. While all third-country branch undertakings are required to submit the Day 1 reporting QRT, undertakings should contact their usual supervisory contact to confirm which templates the PRA expects them to submit.

For further information: PRA publishes supervisory statement on Solvency II: third-country insurance and pure reinsurance branches

This supervisory statement is addressed to non-EEA insurance undertakings that have a UK branch (third-country branch undertakings). This includes non-EEA insurance undertakings that have a UK branch that solely carries out reinsurance activities (a third-country pure reinsurance branch). The statement replaces Supervisory Statement 10/15: Solvency II: third-country branches.

For further information: SS44/15 - Supervisory Statement on third-country insurance and pure reinsurance branches under Solvency II

Bermuda has been granted full equivalence by the European Commission under Articles 172, 227 and 260 of Solvency II. Japan has been granted temporary equivalence under Article 172 and provisional equivalence under Article 227.

For further information: Bermuda granted full equivalency under Solvency II; Japan temporary equivalency under articles 172 and 227

There have been published seven Commission Implementing Regulations setting out implementing technical standards (ITS) under the Solvency II Directive (2009/138/EC). Implementing technical standards are legislative provisions that set out much of the more technical detail required to implement Solvency II. They are made by the European Commission following expert advice from the European Insurance and Occupational Pensions Authority (EIOPA).

These latest ITS cover:

• Lists of regional governments and local authorities, exposures to whom are to be treated as exposures to the central government – relating to Article 109(a)(2)(a) of Solvency II;
• Procedures for decisions to set, calculate and remove capital add-ons – relating to Article 37(8) of Solvency II;
• Standard deviations in relation to health risk equalisation systems – relating to article 109a(4) of Solvency II;
• Procedures and templates for the submission of information to the group supervisor and for the exchange of information between supervisory authorities – relating to Article 249(4) of Solvency II;
• Procedures for assessing external credit assessments – relating to Article 44(4a) of Solvency II;
• The Equity index for the symmetric adjustment of the standard equity capital charge – relating to Article 109a(2)(b) of Solvency II; and
• Adjusted factors to calculate the capital requirement for currencies pegged to the euro – relating to Article 109a(2)(c) of Solvency II.

These ITS will enter into force on 2 December 2015, 20 days after their publication in the Official Journal. The first set of ITS dealt with the approval process for the matching adjustment, the use of internal models, ancillary own funds, undertaking-specific parameters and special purpose vehicles.

For further information: Second set of ITS published in Official Journal of the European Union

The PRA has published a consultation on its proposal to require an external audit of elements of the Pillar 3 disclosure under Solvency II.

The PRA is proposing to require an external audit of quantitative and qualitative information included in the ‘Valuation for solvency purposes’ and ‘Capital management’ sections of the Solvency and Financial Condition Report (SFCR) required of Solvency II firms. Where Solvency II requires the production of the SFCR, the PRA proposes to require the relevant elements to be externally audited, subject to two exemptions:

• The SCR will be exempt from an external audit if calculated using an approved full or partial internal model; and
• Where sectoral rules are used in the SFCR, this information would not be subject to an external audit.

The requirement for external audit would be implemented from 30 June 2016 for firms reporting under Solvency II. It would first impact insurers for accounting years ending on or after 30 June 2016 therefore. Feedback on the proposal, draft rules and draft supervisory statement are sought by 19 February 2016.

For further information: CP43/15: Solvency II: external audit of the public disclosure requirement

Sam Woods, Executive Director of Insurance Supervision in the Bank of England, spoke at an Association of British Insurers event about the final preparations for Solvency II. Mr Woods' speech provides a useful insight into the regulator’s view of Solvency II preparedness in the UK market. In his speech, Mr Woods remarks that the Prudential Regulation Authority (PRA) is currently reviewing around 300 applications of which 20 firms are seeking to use an internal model.  Mr Woods focuses much of his talk on some of the specific changes being introduced by Solvency II including the risk-margin which he believes should provide an extra degree of protection for policyholders. The risk margin should enable a wider range of ‘white knight’ deals to take place where a business is in distress because of the additional protection offered to a transferee. Mr Woods does express concern regarding the sensitivity of the risk margin. The PRA estimates that a 50bps increase in risk-free rates would reduce the risk margin for the UK life sector by approximately 30 per cent. Further, the risk margin is designed to capture “non-hedgeable” risks such as longevity. But are these risks non-hedgeable given the use of swaps and other methods? Mr Woods also considers the perception that there will be a “higher bar” to meet than the 1-in-200 standard (equivalent to a BBB rating). He states that for many firms they may seek to pursue a higher bar but this is not required by the PRA.

For further information: Director of insurance supervision at the PRA reviews progress to Solvency II

The European Insurance and Occupational Pensions Authority (EIOPA) has issued Guidelines on the supervision of branches of third-country insurance undertakings. These Guidelines relate to Articles 162 to 171 of the Solvency II Directive (2009/138/EC). The purpose of the Guidelines is to ensure a consistent, efficient and effective protection of policyholders of such third-country undertakings within the EU. In particular, the Guidelines aim to ensure, as a minimum, the same level of protection of policyholders of a branch of a third-country insurance undertaking as that they enjoy when they are dealing with an EU firm whether in its home Member State or through a branch under Directive 2009/138/EC.

These Guidelines allow for alternatively proportionate supervision methods to protect policyholders of a branch in the context of valuation, own funds and submission of information under Solvency II. The scope of these Guidelines covers only branches of third-country insurance undertakings, which carry out direct life and non-life insurance business. The Guidelines equally cover branches which are subject to either equivalent or non-equivalent supervision as set out under Solvency II.

The Guidelines cover: conditions for authorisation of a branch, the requirement for a scheme of operations which includes an analysis of the comparability of the solvency rules of the home state and Solvency II, the requirements for an analysis of how branch assets and liabilities can be calculated, supervisory powers over the branch, location of branch assets, branch accounting and regulatory reporting.

For further information: Guidelines on the supervision of branches of third-country insurance undertakings

In quick response to the advice received from EIOPA above, the European Commission has amended Solvency II to introduce infrastructure investment as a new asset class. The Framework Directive and Solvency II Delegated Regulation have been amended to reflect the policy change. In particular:

• The amendments introduce the concept of "qualifying infrastructure investments" which are investments that present preferable risk characteristics. Insurers will need to hold a lower level of capital against such qualifying investments.
• Investments in European Long-Term Investment Funds (ELTIFs) will benefit from lower capital charges under Solvency II, bringing such funds in line with investments in European Venture Capital Funds and European Social Enterprise Funds.
• Equities traded on multilateral trading facilities (MTFs) are granted the same capital charge as equities traded on regulated markets.
• The application of a transitional measure for equity investments is extended to unlisted equities so that insurers do not suddenly withdraw from equity investments.

The European Commission press release can be viewed here.

In February 2015 the European Commission asked EIOPA for advice on the identification and calibration of infrastructure investment risk categories in the Solvency II Delegated Regulation (Commission Delegated Regulation (EU) 2015/35 on Solvency II). A consultation paper was then published by EIOPA in July. Formal advice to the European Commission, published on September 29, suggests creating a new asset class under the standard formula for infrastructure project investments under Solvency II. Investment in infrastructure is high up the EU policy agenda and the European Investment Bank estimates that up to £2 trillion will be needed by 2020.

Insurers and pension funds could play a significant part in such projects but currently have to hold a high level of capital to support such investments. In response to this issue, EIOPA has suggested a proposal to meaningfully reduce risk charges for qualifying project investments in both debt and equity. For qualifying infrastructure project debt investments the spread risk charge will be amended using a modified credit risk approach, leading to a reduction of around 30 per cent in the risk charge applied to a BBB rated infrastructure project. Risk charges for equity investments would fall between a 30 and 39 per cent range.

In quick response to the advice received from EIOPA above, the European Commission has amended Solvency II to introduce infrastructure investment as a new asset class. The Framework Directive and Solvency II Delegated Regulation have been amended to reflect the policy change. In particular:

• The amendments introduce the concept of ‘qualifying infrastructure investments’ which are investments that present preferable risk characteristics. Insurers will need to hold a lower level of capital against such ‘qualifying’ investments.
• Investments in European Long-Term Investment Funds (ELTIFs) will benefit from lower capital charges under Solvency II, bringing such funds in line with investments in European Venture Capital Funds and European Social Enterprise Funds.
• Equities traded on multilateral trading facilities (MTFs) are granted the same capital charge as equities traded on regulated markets.
• The application of a transitional measure for equity investments is extended to unlisted equities so that insurers do not suddenly withdraw from equity investments.

For further information:

EIOPA final advice on identification and calibration of infrastructure investment risk categories

European Commission press release: new EU rules to promote investments in infrastructure projects

September 2015

EIOPA published the finalised second set of Solvency II Guidelines. National supervisory authorities in the EU must confirm whether they will comply with these Guidelines by November 9, 2015. The Guidelines help to ensure the consistent application of Solvency II across Member States. The first set of Guidelines was published in February 2015. 

The second set of Guidelines covers the following Solvency II concerns:

• Reporting for financial stability.
• Extension of the recovery period in exceptional adverse situations.
• Exchange of information on a systematic basis within colleges.
• Implementation of the long-term guarantee measures.
• Methods for determining the market share for reporting.
• Reporting and public disclosure.
• Recognition and valuation of assets and liabilities other than technical provisions.
• Systems of governance.
• ORSA.

EIOPA S2 Guidelines

September 2015

EIOPA has developed this opinion (addressed to competent authorities in those third countries deemed to be either equivalent or provisionally equivalent under Solvency II) in relation to third country groups and considers the third country capital requirement to be taken into account in the group solvency calculation, the assessment of the availability of own funds at group level and the monitoring of the solvency position of the group over a period of time.

The opinion identifies potential obstacles in achieving convergent practices across these competent authorities where the ‘deduction and aggregation’ method is used (method 2). In particular, EIOPA has identified risks of certain competitive disadvantages which might arise from the use of differing methods of calculating the solvency of relevant groups. In particular, EIOPA has concerns in relation to how the Solvency Capital Requirement (SCR) of the related third country undertaking is aggregated in the group SCR, the assessment of the availability of eligible own funds at group level and how the group solvency position is to be monitored on an ongoing basis.

For the time being, the European Commission has determined that the regimes of Australia, Bermuda (with the exception of rules on captives), Brazil, Canada, Mexico and the United States are considered to be provisionally equivalent and that the regime in Switzerland is equivalent. Provisional equivalence will run for 10 years from January 1, 2016.

EIOPA Opinion on the group solvency calculation in the context of equivalence

September 2015

Equivalence of Switzerland under Solvency II

The European Parliament has decided not to object to the European Commission’s decision to grant full equivalence to the Swiss insurance regulatory regime in all three areas of Solvency II: solvency calculation (Article 227); group supervision (Article 260); and reinsurance (Article 172). The Commission’s decision takes the form of a delegated act, which was published by the European Commission on June 6. As both the Parliament and Commission have not objected to the delegated act, it can now be published in the Official Journal of the EU and is expected to enter into force 20 days after publication.

EIOPA Solvency II equivalence progress report on Bermudian supervisory regime

EIOPA has issued a progress report (dated July 31) on the latest developments in the supervisory regime of Bermuda. EIOPA provided the European Commission with a final report on third country equivalence assessments for Bermuda under Articles 172, 227 and 260 the Solvency II Directive in March 2015.

Since that advice, however, Bermuda has made substantial amendments to the regulations applicable to reinsurers, and consequently the Commission considered that a further progress report was necessary for it to take fully informed equivalence decisions later in 2015. The report describes the latest developments based on material provided by the Bermuda Monetary Authority. EIOPA provides further advice on the status of the legislative regime and a view on whether the caveats to full equivalence identified in the March report have been addressed.  

EIOPA S2 equivalence progress report: Bermuda

August 2015

The PRA has published a consultation on a draft supervisory statement which sets out the regulator’s expectations of firms and its general approach to the following EIOPA Guidelines:

• Set 2 of the Solvency II ITS and Guidelines, published in July 2015
• System of Governance published on February 3, 2015
• ORSA published on February 3, 2015

The supervisory statement also provides further commentary on certain Guidelines where the PRA considers that this will be useful for firms. This additional commentary is provided in relation to:

• Recognition and valuation of assets and liabilities other than technical provisions
• Methods for determining the market shares for reporting
• Reporting for financial stability purposes
• Reporting and public disclosure
• ORSA.

For further information:
CP30/15: Solvency II: applying EIOPA Set 2, System of Governance and ORSA Guidelines

August 2015

This paper consults on revisions to Supervisory Statement 10/15 Solvency II: third-country branches, published in March 2015, concerning the PRA’s approach to third-country insurance and pure reinsurance branches under the Solvency II Directive.

The main changes to the supervisory statement are:

• The expectation that third-country branch undertakings comply with the requirements in the EIOPA Branch Guidelines (published in Set 2 of the Solvency II Guidelines) that are relevant to them and comply with the rules in the PRA Rulebook that apply to third-country branch undertakings (in line with the EIOPA Branch Guidelines) and that undertakings with pure reinsurance branches also do so as if those guidelines applied to them.
• Details of how the PRA expects third-country branch undertakings to report to the PRA where those EIOPA Branch Guidelines permit the PRA to take a proportionate approach according to the nature, scale and complexity of the branch business.
• In particular, third-country branches will be required to use the XBRL format for reporting and provide an analysis of the home country winding-up regime.

For further information:
CP31/15: Solvency II: third-country insurance and pure reinsurance branches

August 2015

The PRA has published a statement on its website to specify that, regardless of whether the insurer and reinsurer are within the same group, Solvency II will require that the ceding entity’s balance sheet must be valued independently of the reinsurer and similarly, the reinsurer’s balance sheet must be valued independently of the cedant. In particular, the cedant should not take credit for any matching adjustment (MA) benefit available to the reinsurer.

Where an insurer has reinsured part of a portfolio for which it has obtained approval to use the MA, that approval will relate only to the valuation of technical provisions of that insurer and does not automatically extend to any reinsuring entity to which the risk is ceded. The PRA considers that the reinsuring entity can only take credit for any MA benefit where it demonstrates that it has met all the MA requirements. Firms will therefore need to apply for MA approval for the reinsuring entity in these cases.

For further information:
PRA provides clarification on intra-group reinsurance of matching adjustment business

August 2015

The PRA has issued a supervisory statement applicable to all Solvency II firms reporting under UK generally accepted accounting principles (GAAP) rather than using international accounting standards (IFRS). 

Article 9 of the Solvency II Regulation contains a derogation which allows firms the option of recognising and valuing assets and liabilities under UK GAAP for Solvency II purposes, subject to three conditions. Supporting evidence must be provided to the usual supervisor if firms wish to take advantage of the derogation. 

This supervisory statement lists those UK GAAP treatments which the PRA considers to be consistent with Article 75 of the Solvency II Directive, in full or in part. The PRA notes that the derogation addresses recognition and valuation of assets and liabilities and, since most of the differences between UK GAAP and IFRS relate to the level of detail which must be disclosed, it is expected to have a limited effect in the UK.

For further information:
SS38/15: Consistency of UK generally accepted accounting principles with the Solvency II Directive

July 2015

Draft Implementing Technical Standards

The following draft ITS were submitted to the European Commission for endorsement:

• Regional governments and local authorities treated as exposures
• Equity index for the equity dampener
• Currency shock for currencies pegged to the euro
• Standard deviations in relation to health risk equalisation systems
• Supervisory transparency and accountability
• Capital add-ons
• Risk management: procedures when assessing external credit assessments
• Templates for the submission of information to the supervisory authorities
• Procedures, formats and templates of the Solvency and Financial Condition Report
• Submission of information to group supervisor and exchange of information and exchange of information between supervisory authorities.

EIOPA will submit the final ITS on application of the equity transitional to the Commission shortly.

The Commission has three months from submission to decide whether or not to endorse the ITS. Once endorsed, the ITS will be translated into all official EU languages and become legally binding.

Guidelines

The second set of Guidelines were published for consultation in December 2014. EIOPA has now published final reports for these Guidelines covering:

• Recognition and valuation of assets and liabilities other than technical provisions
• Implementation of the long-term guarantee measures
• Extension of the recovery period in exceptional adverse situations
• Methods for determining the market shares for reporting
• Reporting for financial stability purposes
• Reporting and public disclosure
• Exchange of information on a systematic basis within colleges
• Supervision of branches of third-country insurance undertakings.

For further information:

EIOPA publishes second set of draft ITS and Guidelines

July 2015

In a speech at the ABI, Sam Woods, Executive Director of insurance supervision at the PRA took the opportunity to ‘bust two myths’ about the approach to capital under Solvency II that the Bank of England will take. First, the idea that the Bank is planning to use Solvency II to increase required capital across the sector and, second, that the regulator intends to recreate the current ICAS regime under the guise of Solvency II.

Myths

Woods dismisses market concerns that the PRA will use Solvency II to increase levels of capitalisation or ‘load the sector’ with more capital in preparation for the new regime stating clearly that ‘there is no such plan’. The PRA believes that the current regime secures an appropriate level of capitalisation and means the insurance sector is in a good position to shift to Solvency II.

Addressing the second myth, Woods explains that Solvency II will be the foundation of the PRA’s approach and the regulator will fulling embrace the change that accompanies the new regime. The EU is moving towards a harmonised, risk-based, transparent and ‘going concern’ regime, which means some significant changes to the shape of the balance sheet and the PRA’s assessment of financial resources. Woods notes that the risk margin in particular is a fundamentally new component of the UK regulatory framework and the source of some tension. Regardless of the debate around the risk margin and its calculation, it is part of the Solvency II legislative framework and, therefore, the PRA must implement it accordingly.

Transitional measures

Having dealt with the myths, Woods goes on the assure firms that they will be given plenty of time to adjust to the new regime and that those firms who wish to make use of transitional measure will be given the freedom to do so. The PRA advocates an ‘orderly transition’ which will promote financial stability and support the regulator’s objectives of safety and soundness and policyholder protection.

According to the PRA, the Solvency II Directive sensibly includes transitional measures which allow firms significant breathing space as they adapt to the new regime. Woods explains that the Bank will allow full use of transitional measures by those firms that qualify to use them and that, consistent with the approach being taken across Europe, the transitional asset created by the transitional deduction from technical provisions (TDTP) will qualify as Tier 1 capital. Woods argues that there needs to be a shared understanding of the practical details about how transitional measures will operate in order for them to achieve their purpose. The PRA will be working with firms to ensure transparency in the way in which transitionals apply including how measures might apply to books of business that are subject to a Part VII transfer, and the frequency with which some measures need to be re-calculated.

Internal models

On the process of internal model approvals, it is the PRA’s intention that, following a thorough and consistent review of firms’ applications, final decisions on all models will be made and communicated to firms in early December.

For further information:

PRA speech: Adapting to Solvency II

July 2015

EIOPA has issued a consultation paper on its Advice to the European Commission on the identification and calibration of infrastructure investment risk categories. EIOPA welcomes views in particular on the following proposals:

• Definitions and criteria to identify qualifying infrastructure debt and equity investments, which may warrant a different standard formula treatment
• Calibration for qualifying infrastructure investments
• Additional risk management requirements
• Possible obstacles to infrastructure investments that are not justified by prudential considerations.

The consultation period ends on August 9. EIOPA intends to submit its final advice to the Commission by September 2015.

For further information:

CP on the identification and calibration of infrastructure investment risk categories

June 2015

In supervisory statement 23/15, the PRA sets out its expectations of firms seeking permission to apply a volatility adjustment (VA) in accordance with Regulation 43 of the Solvency 2 Regulations 2015 (see article below). This statement has been subject to public consultation and takes into account the feedback received. In particular, the statement clarifies:

• the items that should be included in an application to use the VA;
• how the PRA will use the content of applications to assess whether the statutory conditions for approval to use the VA have been satisfied; and
• how the VA approval process will work and its interaction with other Solvency II approval processes.

The VA is an adjustment to the discount rate used in calculating insurance liabilities. The aim is to reduce the need for insurers holding long-term assets to take short-terms measures in response to temporary volatility. The VA will require supervisory approval before it can be relied upon, therefore, the PRA will need to be satisfied that the conditions sets out in Regulation 43(4) of the Solvency 2 Regulations are met before granting permission to apply the VA.

When compiling a VA application, firms should have regard to the principle of proportionality: the greater the impact of the VA on the firm’s financial position and risk profile, the greater the expected level of detail and justification in the application. The following information should be included in an application:

• the firm’s written policy on risk management;
• the liquidity plan projecting the incoming and outgoing cash flows in relation to the assets and liabilities subject to the VA;
• where the reduction of the VA to zero would result in non-compliance with the Solvency Capital Requirement (SCR), an analysis of the measures the firm could apply in such a situation to re-establish the level of eligible own funds covering the SCR or to reduce its risk profile to restore compliance with the SCR;
• the assessment of compliance with the capital requirements, with and without taking into account the VA;
• any additional information that the firms believes is relevant; and
• a cover letter stating that the application is endorsed by the board and that the conditions in Regulation 43(4) have been satisfied.

The PRA also sets out, at a high level, how firms could demonstrate compliance with the three statutory conditions in Regulation 43(4) and provides the following supporting detail indicating what the PRA will look for when assessing whether the following conditions for approval are met:

Condition 1: the VA is correctly applied to the relevant risk-free interest rate term structure in order to calculate the best estimate. Firms should clearly describe the liabilities to which the VA is intended to apply, the currencies in which these obligations are denominated, and the countries in which they are sold. Firms should also confirm that they do not apply a matching adjustment to these obligations.

Condition 2: the firm does not breach a relevant requirement as a result or consequence of applying the VA. The prudential risks created by inappropriate use of the VA were highlighted by HM Treasury in its consultation on the VA. In light of this, firms are expected to consider their compliance with the risk management requirements and the prudent person principle in the relevant parts of the PRA Rulebook. Firms must show that the underlying assumption that volatility is temporary is appropriate given their risk profile. Firms should demonstrate that they have fully identified any liquidity risk (or other risks) that are introduced or affected through the use of the VA, and that they have the adequate understanding, risk mitigation techniques and financial resources to manage those risks.

Condition 3: the application of the VA does not create an incentive for the undertaking to engage in pro-cyclical investment behaviour. In this context, pro-cyclical behaviour can be described as a firm increasing the risk profile of asset portfolios (by buying risky assets) during stable or upturn periods, and then derisking those asset portfolios (by selling those risky assets) during unstable or downturn periods. Firms should describe the interaction between the investment policy and the use of the VA in their application. In determining whether this condition is satisfied the PRA will consider a firm’s liquidity plan and the effect of forced sales of assets on the firm’s own funds.

The PRA will determine all applications for VA approval within six months from the date that a complete application is received. For applications that are not dependent on other approval decisions (such as internal model applications) the PRA will endeavour to make decisions within six weeks. Firms are encouraged to include a completed checklist (provided on the Bank of England website) with their applications. When submitting a VA application, firms should inform the PRA of any other approvals for which they have applied (e.g. matching adjustment) or for which they intend to apply during the next 12 months.

For further information:

SS23/15: Solvency II: supervisory approval for the volatility adjustment

March 2015

The Solvency 2 Regulations 2015 were published by the UK Government. The Regulations implement in part the Solvency II Directive into UK law. The remainder of the Solvency II Directive will be implemented by FSMA and through binding requirements imposed by the PRA and FCA and through the directly applicable European Commission Delegated Regulation (EU) 2015/35.

The Solvency 2 Regulations 2015, alongside FSMA, establish the regulatory structure, rules and binding requirements for the PRA and FCA to regulate insurers and reinsurers according to Solvency II.

Part 1 of the Solvency 2 Regulations contain interpretative provisions, Part 2 deals with the manner in which the PRA should supervise insurers and reinsurers, Part 3 deals with the regulation of groups and Part 4 and Schedules 4 and 5 confer powers on the PRA to grant insurers and reinsurers approval for particular matters such as the use of the matching adjustment and volatility adjustment.

Part 5 and Schedules 1 and 2 contains amendments to primary and secondary legislation in order to implement Solvency II into UK law, including amendments to FSMA.

For further information:

Solvency 2 Regulations 2015 (2015/575)

February 2015

The FCA and the PRA have published a joint consultation paper (FCA CP15/5 and PRA CP7/15) on the Approach to non-executive directors in banking and Solvency II firms & Application of the presumption of responsibility to senior managers in banking firms. For insurers, the proposals build on two consultation papers published in November 2014: PRA CP26/14 on the Senior Insurance Managers Regime (SIMR); and FCA CP14/25 on changes to the Approved Persons Regime for Solvency II firms.

In terms of Solvency II firms, the PRA proposes to approve the following NEDs in insurers:

• Chairman (Senior Insurance Management Function (SIMF) 9).
• Chair of the Risk Committee (SIMF 10).
• Chair of the Audit Committee (SIMF 11).
• Chair of the Remuneration Committee (SIMF 12).
• Senior Independent Director (SIMF 14).

In addition, the PRA proposes to make NEDs in group, holding or parent companies who exercise significant influence on the affairs of the insurer subject to approval by the PRA as a Group Entity Senior Insurance Manager (SIMF 7). The PRA also proposes to require insurers to allocate two of the Prescribed Responsibilities (detailed in CP26/14) to a NED: oversight of the firm’s remuneration policies and practices; and maintenance of whistleblowing procedures. Firms will be allowed to allocate any other Prescribed Responsibilities to either a NED or an executive under the SIMR. The Conduct Standards proposed in CP26/14 will apply as enforceable rules on all NEDs within scope of the SIMR.

The FCA’s view is that it would be disproportionate to subject standard NEDs in Solvency II to stricter regulation. The FCA therefore proposes to specify the Chair of the Nominations Committee function for Solvency II firms, but no additional NED roles. The deadline for comments on both consultations is April 27, 2015.

For further information: 

PRA CP7/15 and FCA CP 15/5: Approach to non-executive directors

February 2015

The PRA has published a consultation paper (CP5/15) on applying EIOPA’s first set of guidelines under Solvency II. The PRA states that it intends to comply with all of the set 1 guidelines and expects firms to comply with the guidelines that apply to them in a proportionate manner.  

The PRA is consulting a draft supervisory statement that provides further commentary on the set 1 guidelines relating to:

• Ancillary own funds.
• Classification of own funds.
• Ring-fenced funds.
• Treatment of related undertakings, including participations.
• Loss-absorbing capacity of technical provisions and deferred taxes.
• Group solvency calculation.

The PRA is not consulting on those guidelines that apply exclusively to supervisory authorities (i.e. operational functioning of colleges, methodology for equivalence by national supervisory authorities and the supervisory review process). These will be integrated into the PRA's internal supervisory approach. The deadline for responses to CP5/15 is March 19.

For further information: 

CP5/15: Applying EIOPA’s first set of Solvency II guidelines

February 2015

EIOPA has announced a new work stream on infrastructure investments by insurers. Following its previous work on the regulatory treatment of long-term investments and, in particular, the advice on high quality securitisation, EIOPA is now concentrating its analysis on a more granular treatment of infrastructure investments. EIOPA intends to:

• Develop a definition of infrastructure investments that offer predictable long-term cash-flows and whose risks can be properly identified, managed and monitored by insurers.
• Explore possible criteria for the new class of long-term high quality infrastructure assets covering issues such as standardisation and transparency.
• Analyse the prudentially sound treatment of the identified investments within Solvency II, focusing on their specific risk profile.

To produce the best possible outcomes on this challenging task, EIOPA plans to engage actively with stakeholders and is organising a roundtable with prominent and high level representatives from public authorities, insurance industry, infrastructure industry, asset management and academia with the objective to exchange views.

February 2015

EIOPA has published its final reports on guidelines on a system of governance and own risk and solvency assessment (ORSA) under Solvency II. These two reports complete the first set of Solvency II guidelines, the majority of which were finalised in December 2014. In summary:

• The final report on guidelines on a system of governance sets out the requirements for the sound and prudent management of undertakings, without unduly restricting them in choosing how to organise themselves.
• The final report on guidelines on ORSA contains incentives to a better understanding of the undertaking's overall solvency needs and capital allocation, as well as the interrelation between risk and capital management in a forward-looking perspective.

Within two months of the guidelines being issued, each competent authority must confirm whether it complies, or intends to comply, with them.

The guidelines will become applicable on January 1, 2016.

For further information: 

EIOPA-BoS-14/253: system of governance
EIOPA-BoS-14/259: ORSA

January 2015

The PRA has issued a consultation paper on transitional measures and the treatment of participations under the Solvency II Directive. In CP3/15, the PRA consults on draft rules to implement Solvency II transitional measures for risk-free interest rates and technical provisions. The transitional measures aim to avoid market disruption potentially associated with the move to a new regulatory regime, and to limit interference with the existing availability of insurance products. The proposed rules are designed to ensure a smooth transition towards the full requirements of the Solvency II regime.

Solvency II specifies a transitional measure on risk-free interest rates in Article 308c, which is designed to enable firms to transition from their current discount rate requirements to the corresponding Solvency II requirements. This transitional measure is a deduction from the amount of Solvency II technical provisions. Solvency II also specifies a transitional measure on technical provisions in Article 308d, which is calculated as an adjustment to the relevant risk-free interest rate term structure used to discount admissible insurance obligations. Both transitional measures apply for 16 years. Firms need to apply to the PRA for approval to rely on the transitional measures.

The PRA plans to publish a policy statement, together with the final rules and supervisory statements, as part of a wider policy statement providing feedback and final rules to implement Solvency II in March 2015.

For further information:

CP3/15 Solvency II: transitional measures and the treatment of participations

January 2015

Paul Fisher, Deputy Head of the PRA and interim Executive Director of Insurance Supervision, gave a speech on Regulation and the future of the insurance industry in which he explained that the successful implementation of Solvency II is a top priority for the PRA. With transposition of the Directive into the UK rulebook underway, the PRA will be open for applications for internal models, matching adjustment etc. from April 1, 2015.

Fisher reiterated the PRA’s belief that the UK insurance industry is in a good position, having had the risk-based ICAS regime around for ten years. The PRA is not looking to use Solvency II as an opportunity to raise capital requirements across the board and will implement the Directive as intended, without gold plating. Solvency II strengthens the linkage between capital and risk management requiring firms’ management to decide upon their chosen risk appetite and the precise details of their risk models. The PRA will not seek to restrict innovation in the market or fix firms’ business models to be identical but will ensure that firms hold capital commensurate to their risk exposures.

The introduction of the Prudent Person Principle, says Fisher, is an example of how risk management and strategic decision making will be owned by the insurer and its management. The shift from quantitative to qualitative rules means insurers will have more flexibility in their investment choices. The PRA wants to avoid undue influence on the asset allocation behaviour of insurers and will not promote one asset class over another. The Prudent Person Principle will ensure that firms fully understand and manage their investment risks. Specifically, insurers must be able to demonstrate that they can ‘properly identify, measure, monitor, manage, control and report on their investment risks and not place reliance upon information provided by third parties’.

On the role of management, Fisher notes that there has been some industry uncertainty around the PRA’s expectations of non-executive directors for firms that have internal risk models. Non-executive board members are not expected to be technical experts in risk modelling, however, each board collectively should understand the key strengths, limitations and judgements within their model. The PRA wants non-executives to have ‘the right tools and sufficient knowledge to be able to challenge model outputs, rather than follow them slavishly’.

The PRA also recognises some other challenges facing the industry in particular the changes to the UK taxation system of the ‘at retirement’ market. This will have a significant impact on some insurers’ business models. The PRA remains, states Fisher, committed to working openly and transparently with the insurance industry to get the best outcome.

For further information:

Regulation and the future of the insurance industry

January 2015

The Commission Delegated Regulation which supplements the Solvency II Directive has been published in the Official Journal of the EU. The Delegated Regulation came into force on January 18, 2015.

The Delegated Regulation was adopted by the Commission in October 2014. The Council of the EU announced that it would not object to the Regulation and in January 2015 the time period for the European Parliament to object to the Regulation expired.

EIOPA finalises first set of guidelines for Solvency II and consults on second set of implementing technical standards and guidelines

On December 3, EIOPA published 18 reports containing the final version of the majority of the first set of guidelines required under the Solvency II Directive. EIOPA expects that the comply-or-explain procedure relating to these guidelines will run from February 2015 to March 2015.

EIOPA also issued 16 consultations relating to the second set of draft Implementing Technical Standards (ITS) and Guidelines required under Solvency II. Guidelines on third country branches and on technical advice relating to regulatory technical standards (RTS) on recovery plans and finance schemes were also published. Responses to the consultations are requested by March 2, 2015, with the exception of the consultation on the technical advice for which responses are requested by February 18, 2015.

UK regulators publish consultations on new regulatory framework for individuals

PRA proposals

On November 26, the PRA issued a consultation paper (CP24/14) on Senior insurance managers regime: a new regulatory framework for individuals. The proposals seek to update the PRA’s approved persons regime in order to implement the Solvency II Directive (the Directive) and to closer align the regime for insurers with that being introduced under the Senior Managers Regime for banks.

In a move away from ‘intelligent copy out’ the proposed regime seeks to provide more detailed elaboration on the fit and proper measures set out in the Directive. The proposals aim to ensure that the senior persons who run insurers, or who have responsibility for other key functions within the business, behave with integrity, honesty and skill. Although broadly aligned with the regime for banks the proposals take into account the different business model of insurers and will take into account the different risks and features of the industry.

The following Controlled Functions will be designated as Senior Insurance Management Functions (SIMFs):

• Chief Executive Officer (SIMF1)
• Chief Finance Officer (SIMF2)
• Chief Risk Officer (SIMF4)
• Head of Internal Audit (SIMF5)
• Third Country Branch Manager (SIMF19) (Third-Country branches)
• Chief Actuary (SIMF20)
• With-profits Actuary (SIMF21) (For with-profits firms)
• Chief Underwriter Officer (SIMF22) (General (re)insurance and Lloyd’s managing agents)
• Underwriting Risk and Oversight Function (SIMF23) (Society of Lloyd’s)
• Group Senior Insurance Manager (SIMF7) (Group)

None of the sanctions contained in section 36 of the Financial Services (Banking Reform) Act 2013, nor the presumption of responsibility contained in section 66B of the Financial Services and Markets Act 2000 will apply to the above SIMFs. The certification regime being applied to banks will not be required by insurers for their employees. The PRA proposes that the scope of individuals subject to approval before taking up their roles will be more role-specific than is currently the case under the existing approved persons regime. These individuals will be held to account for the ongoing safety and soundness of their firms and for the appropriate protection of policyholders.

Other individuals, known as ‘key function holders’ (included in the Directive) but who do not hold either a PRA or FCA controlled function will need to be pre-approved. The PRA will take appropriate action in relation to these individuals only where it considers that they do not meet fit and proper requirements on an ex-post basis. Other individuals on a parent/holding company board or holding key group functions will also be subject to this approach.

The PRA will apply a proportionate approach to the application of this regime with the result that smaller firms and third country branches may be able to combine responsibilities for different functions.

Key to the proposals will be the requirement for (re)insurers to maintain a ‘Governance Map’ identifying the individuals who run the firm along with the key function holders.

Certain ‘core’ responsibilities will need to be allocated amongst the controlled function holders (including FCA controlled functions) including such things as taking responsibility for ‘leading the development of the firm’s culture and standards’ and ‘embedding the firm’s culture and standards in its day-to-day management’. New conduct standards will be introduced for both SIMFs and key function holders.

FCA proposals

Also on November 26, the FCA issued a consultation paper (CP14/25) on Changes to the Approved Persons Regime for Solvency II firms. Solvency II requires that persons performing certain ‘key functions’ within firms are fit and proper. The FCA proposes to use its existing approved persons assessments but with adaptations where individuals will be carrying out Solvency II key functions.

The FCA anticipates that the existing FCA-designated controlled functions that are most likely to be Solvency II key functions are:

• Significant Management (CF29)
• Compliance (CF10)
• Apportionment and oversight (CF8)

The FCA is not proposing to expand the existing scope of the above controlled functions. Any individual performing any Solvency II key function which falls outside the above categories will be picked up by the PRA ‘key function holder’ regime.

The FCA proposes to amend the Fit and Proper Test for Approved Persons (APER) in order to take into account the Solvency II framework when making an assessment. This will include consideration of the firm’s own assessment of a candidate under PRA rules and requirements contained in either the Solvency II Regulations or EIOPA guidelines.

To more closely align the regime applied to insurers to that applied to banks, the FCA proposes to require pre-approval of all individuals taking up executive and other functions within firms not otherwise approved by the PRA. These people will become FCA Significant Influence Function (SIF) holders. The FCA will continue to consent to individuals performing PRA functions from a conduct perspective.

In the joint PRA/FCA Strengthening accountability in banking: a new regulatory framework for individuals (CP14/14), the regulators proposed new Conduct Rules for approved persons. The FCA believes that these Conduct Rules are appropriate to insurers as well as banks. For insurers, however, the Conduct Rules will only be applied to those functions that require pre-approval. The proposed conduct rules build on the existing APER rules with two additions: individuals would be obliged to pay due regard to the interests of customers and treat them fairly; and those in positions of particular responsibility must ensure that any delegation of their responsibility is to an appropriate person and that they oversee the discharge of the delegated responsibility effectively. The rules will be divided into two tiers: Individual Conduct Rules applied to all PRA and FCA approved persons in Solvency II firms; and a second tier applied only to FCA SIF holders in such firms.

The FCA proposes that the functions of Chief Risk Officer and the Chief Internal Audit Function should be designated as FCA SIF holders in Insurance Special Purposes Vehicles (ISPVs). Although the PRA proposes not to require pre-approval for these roles in ISPVs, the FCA believes that these functions remain important from a conduct perspective and will pre-approve candidates on this basis. Furthermore, not all controlled functions are required in the UK branches of EEA Solvency II firms and there will be a general override where the assessment of whether someone is fit and proper is reserved to the home state. However, where the functions are required and the override does not apply, EEA branches will be subject to the same approach as applied to UK firms.

Both consultations close on February 2, 2015.

For further information:

Senior insurance managers regime: a new regulatory framework for individuals (CP24/14)

Changes to the Approved Persons Regime for Solvency II firms (CP14/25)

Results of EIOPA stress test 2014

EIOPA has published a report setting out the results of its 2014 EU-wide insurance stress test. The exercise aimed to test the overall resilience of the insurance sector and identify its major vulnerabilities and consisted of two elements: a core stress module focussed on group results covering asset price stresses and insurance specific stresses; and a low yield module at individual level focusing specifically on the impact of low interest rates.

A total of 167 insurance groups and individual undertakings representing 55 per cent of gross written premium for the EU market participated in the core stress test module. A total of 225 undertakings representing 60 per cent of gross technical provisions participated in the low yield module. Participation was sufficiently representative to be able to draw inferences of a systemic nature. Insurance undertakings estimated a baseline scenario using the Solvency II regime, without internal models. In addition, undertakings tested a number of severe macro-economic and insurance specific shocks, including a prolonged period of low yields and a sudden reverse in interest rates.

In summary, the results revealed that:

• In general, the insurance sector is sufficiently capitalised in Solvency II terms.
• 14 per cent of companies have a SCR ratio below 100 per cent.
• The sector is more vulnerable to a ‘double hit’ stress scenario that combines decreases in asset values with a lower risk free rate, however, 56 per cent of undertakings would have a sufficient level of capital under the most severe ‘double hit’ stress scenario. Major vulnerabilities were mass lapse, longevity and natural catastrophes.
• In a prolonged low yield scenario, 24 per cent of insurers would not meet their SCR. A continuation of the current low yield conditions could see some firms face problems in meeting their promises to policyholders in 8-11 years’ time.

As a follow up to the stress test, EIOPA issued a set of recommendations to NSAs in order to address in a coordinated way the identified vulnerabilities. NSAs are recommended to engage in a rigourous assessment of the firms’ Solvency II preparedness, in particular regarding the situations where capital increases and/or balance sheet management actions will be needed.

For further information:

EIOPA insurance stress test 2014

EIOPA consults on product governance guidelines for competent authorities

EIOPA has decided to follow the FCA and develop guidelines for Member State competent authorities on product oversight and governance for consumer products. This represents the developing move away from consumer protection measures at point of sale (i.e. status disclosure and product information) towards a more intrusive and pre-emptive regulatory approach. Clearly, like the FCA, EIOPA will expect firms to have in place advanced systems in order to ensure that products are not sold to the wrong markets.

This consultation follows a mandate given by the Joint Committee of the ESAs after it published a Joint Position of the ESAs on Manufacturers’ Product and Oversight & Governance Processes (November 2013). EIOPA sees its mandate to issue guidelines in the light of Article 41(1) of Solvency II: ‘Member States shall require all insurance and reinsurance undertakings to have in place an effective system of governance which provides for sound and prudent management of the business’.

Among the implications of the guidelines is that firms will need to take a much more robust approach to product testing. This may include undertaking stress-tests which take into account changes in the financial strength of the firm as well as reviews of how policy terms and conditions may impact the target audience and whether products may be affected by changing tax environments.

For the general insurance market, EIOPA suggests that an assessment of a product may include a review of the expected claims ratio and claims payment policy. This would require firms to review products should the claims ratio be higher or lower than expected. Firms would also have to take into account whether products overlap with coverage already provided to customers. Terms and conditions should be reviewed to see if they meet the needs of the target audience and reviewed to ensure that that audience understands the policy terms and limitations.

For the investment market, product testing should consider what would happen to the risk and reward profile of the product following changes to the value and liquidity of the underlying assets, how the risk-reward profile of the product is balanced and how might the tax environment change the product outcomes.

EIOPA is seeking feedback on the following 12 guidelines:

• Establishment of product governance and oversight arrangements.
• Role of the manufacturer’s administrative, management or supervisory body.
• Review of product governance and oversight arrangements.
• Management of conflicts of interest in product design.
• Target market.
• Knowledge and ability of staff involved in the design of products.
• Product testing.
• Product monitoring.
• Remedial action.
• Distribution channels.
• Outsourcing of the product design.
• Documentation of product governance and oversight arrangements.

Responses are due by January 23, 2015.

For our insight into product governance please refer to our briefing Beyond law: understanding the scope of conduct regulation.

PRA consults on further measures for Solvency II implementation

On November 21, the PRA issued a consultation paper (CP24/14) on further measures for implementing the Solvency II Directive. The PRA proposes to make changes (as consulted on by the FSA in CP12/13) to align its rules with Solvency II and move them to the Solvency II Firms section of the PRA Rulebook.

The consultation proposes changes in the following areas:

• Appointment of actuaries. The proposed rules cover appointment and termination of actuaries and the relationship between firms and their actuaries and between actuaries and the regulator. The purpose of these rules is to ensure that insurers have access to adequate actuarial advice both in valuing liabilities to policyholders and in exercising discretion affecting the interests of with-profits policyholders.
• Schemes of operation. This chapter sets out proposed changes to the requirements in respect of run-off operations for Solvency II. The rules propose changes to terminology, take account of the proposed rules for the Society of Lloyd’s and UK firms in difficulty, and clarify the level at which information and documentation is to be provided in respect of third country branches.
• Regulatory reporting national specific templates (NSTs) specific to the Society of Lloyd’s. The proposed templates will ensure that the PRA receives quantitative data that is essential for the effective supervision of participants in the Lloyd’s market after Solvency II implementation. The PRA proposes a requirement for the Society of Lloyd’s to complete NST numbers NS.12 and NS.13 because the nature of the capital structure needs to be reflective in the way in which the PRA applies the requirements of Solvency II to the calculation of the solvency capital requirement and the format of its reporting. NS.13 is required so that the PRA can collect information necessary to assess whether any shortfall in a syndicate’s own funds compared to its reporting point can be met by the Society of Lloyd’s own funds. To ensure a an efficient data collection, the PRA proposes a new rule, 7.3, in the Reporting Part of the draft PRA Rulebook (in CP16/14) requiring the Society of Lloyd’s to submit the Lloyd’s reporting templates to the PRA at the same time as the Society submits its quantitative reporting templates.

CP24/14 also includes five draft supervisory statements which set out the PRA’s expectations of firms, and give further clarity, on:

• Regulatory reporting exemptions.
• Regulatory reporting, internal model outputs.
• ORSA and the ultimate time horizon – non-life firms.
• The quality of capital instruments.
• The treatment of pension scheme risk.

The PRA notes that the final Solvency II Regulations (the Delegated Acts and the Implementing Technical Standards) have not yet been adopted. The guidance in CP24/14 is therefore subject to changes depending on the final versions.

Consultation on CP24/14 closes on January 30, 2015. The PRA will publish a Solvency II policy statement with feedback, including the finalised rules and the final supervisory statements, in 2015 Q1.

For further information:

Solvency II: further measures for implementation - CP24/14

European Commission adopts Delegated Regulation

On October 10, the European Commission adopted the Regulation that will introduce much of the detail of Solvency II. The framework Directive which was adopted in November 2009, and has been subsequently amended by Omnibus II, specifies that the European Commission should adopt a Delegated Act (the published Regulation) which sets out detailed implementing rules. Like most Regulations, the Solvency II Delegated Regulation will have direct effect once adopted to ensure that there is consistency in implementation.

The Regulation has not been subject to specific public consultation although various stakeholders have seen iterations of the Regulation in advance of its adoption. The Council of the EU and the European Parliament can object to the Commission’s Delegated Regulation but have a limited window in which to do so.

The Regulation as adopted by the Commission can be found here. A total of 26 annexes have also been published.

Solvency II is due to come into force on January 1, 2016.

Solvency II update: PRA developments

The PRA held its Solvency II conference: countdown to implementation on October 17. In the lead up to the conference, the PRA issued a number of publications setting out its current thinking around some policy issues and providing feedback to firms on work carried out so far.

Two communications were issued on Solvency II approvals. The first was CP23/14: Solvency II approvals setting out the proposals for guidance and expectations of firms in the formal application process for internal model and other approvals, including the matching adjustment (MA) and undertaking specific parameters. The Appendix to CP23/14 includes six checklists that firms should use when submitting approval applications to avoid delays that may arise from incomplete applications.

Alongside this CP, a letter from Paul Fisher on the MA was published. The letter includes feedback on firms’ trial submissions and the PRA’s expectations for the pre-application phase of MA approval. The PRA will be accepting submissions for the MA pre-application process between December 1, 2014 and January 6, 2015.

Finally, in a speech given at the City Banquet, Andrew Bailey, PRA Deputy Governor, explained that the PRA will be using Solvency II models in an ‘appropriately diagnostic fashion’ but ‘will not hesitate to withhold approval of an inadequate or opaque model’. Bailey highlighted incentives, specifically remuneration and governance, as an area of focus for the regulator. Parliament has legislated to introduce the Senior Managers regime for banks and the PRA will consult on implementing the fit and proper requirements of Solvency II, with the intention of aligning the regimes where possible. The key principle is that there should be a presumption of senior management responsibility and the PRA will set out the meaning of the statutory requirement that senior managers will need to show that they have taken the steps that a person in their position could reasonably be expected to take to prevent breaches of PRA requirements.

PRA issues third consultation on Solvency II transposition

On August 11, the PRA issued a consultation paper (CP16/14) setting out proposed changes to the PRA Rulebook in order to implement the Solvency II Directive, as amended by the Omnibus II Directive. This is the third consultation paper on Solvency II transposition and follows CP11/22 and CP12/13 published by the FSA in November 2011 and July 2012 respectively.

Overview

With Omnibus II now in force, the PRA is consulting on rules to transpose the amendments to Solvency II and implementation of those areas deferred from the previous two consultations. Omnibus II introduced a number of substantive changes, most significantly the long-term guarantees (LTG) package which comprises a set of measures to ensure that the new solvency regime is adequate for insurance products offering an element of guaranteed return. Draft rules consulted on in CP11/22 and CP12/13 therefore require amendments to reflect the LTG package along with the other provisions introduced by Omnibus II such as transitional arrangements and supervisory reporting.

CP16/14 consists of four sections:

• Section 1 covers the proposed rule changes to implement changes introduced by Omnibus II including the matching adjustment, the volatility adjustment, risk management for LTG measures, transitional provisions, external credit rating assessments and requirements relating to groups.
• Section 2 considers areas not covered in the previous two consultations or where the PRA’s approach has developed. In particular it includes new proposals on surplus funds following feedback on CP12/13. Other issues include insurance special measures, third country insurance branches and reporting.
• Section 3 provides feedback on responses to two parts of CP12/13: the approach to Lloyd’s; and public disclosure of capital add-ons and undertaking specific parameters (USPs).
• Section 4 provides an economic cost benefit analysis of the LTG package.

Future consultations

Further changes to the PRA’s Rulebook are expected, along with supervisory statements in order to implement the new solvency regime. Areas include but are not limited to:

• The PRA’s expectations for approval processes (such as the volatility adjustment approval process, if implemented) planned for Q4 of 2014.
• Further national specific reporting templates which the PRA may consider necessary.
• Transitional measures to enable firms to adapt to the new regime in an appropriate and proportionate way.
• Further rules covering third country branches.

The PRA states that it will need to make amendments to the Approved Persons Regime to take into account the Solvency II measures relating to governance and the fitness and propriety of relevant individuals. The PRA notes its intention to align the approved persons regime more closely to the regime proposed for banks, but explains that the regimes will not be identical. Recognising that many groups contain both banks and insurers, the PRA states that operating two distinct regimes would be complex and inefficient for such firms and the regulator itself. A consultation on proposals to implement changes in the Approved Person Regime is expected later this year.

Finally, the PRA intends to consult on rules relating to with-profits business (possibly alongside a supervisory statement) later this year. The consultation is likely to have regard to the PRA’s objectives, Solvency II requirements and the interaction with the FCA’s conduct regime in respect of with-profits.

The deadline for responses on CP16/14 is November 7, 2014. The PRA is expected to publish a policy statement with feedback, finalised rules and supervisory statements in early 2015. The deadline for transposition of Solvency II is March 31, 2015.

For further information:

CP16/14 – Transposition of Solvency II: Part 3

HM Treasury consultation on Solvency II policy issues

HM Treasury has also issued a short consultation intended to complete the consultation process on how the government should implement the Solvency II Directive. The Treasury published a consultation in November 2011 but has been unable to proceed before now due to the delay in adopting the Omnibus II Directive.

The consultation seeks views on two policy issues related to Solvency II transposition:

The use by undertakings of the volatility adjustment and whether it should be subject to prior approval by the PRA

The volatility adjustment is one of the LTG package measures, introduced to cover those insurance products which would not be eligible for the matching adjustment. The detail on how the volatility adjustment is to be calculated and applied will be set out in the implementing measures. The volatility adjustment raises prudential issues, however, and it is the government’s view that the measure may be less appropriate for liquid or volatile liability types, such as products with significant surrender risk meaning a firm could be undercapitalised relative to the true risks it faces. To help avoid inappropriate use of the volatility adjustment, a safeguard was introduced which would allow the PRA to approve the use of the volatility adjustment on a firm by firm basis.

The government is seeking comments on whether the use of the volatility adjustment should be automatic, or whether approval from the PRA should be required before a firm could apply the volatility adjustment. Should the government decide that PRA approval is required, decisions on approval will be communicated within 6 months of application and the process would be transparent, proportionate and timely.

The approach to be adopted in removing business permissions where an undertaking fails to meet the Minimum Capital Requirement

The second issue the government is consulting on arises out of the obligation on the PRA to withdraw authorisation where an undertaking does not comply with the Minimum Capital Requirement. In the UK, the problem of insurance firms in financial difficulties has often been addressed by run-off over a course of time. The government considers that Article 144 of the Solvency II Directive would require a firm to be closed to new business but would permit the firm, where appropriate, to continue to manage existing insurance contracts, subject to on-going supervision by the PRA. Respondents are asked whether they agree with the government’s approach to the de-authorisation of insurance firms and, alternatively, what the consequences would be, particularly for policyholders, if firms were not permitted to enter into run-off.

The consultation closes on September 19, 2014. HM Treasury will issue a further consultation later this year to include feedback on this and the previous Solvency II consultation, an updated impact assessment and final statutory instrument to be submitted for Parliamentary approval.

For further information: 

HM Treasury: Solvency II: resolving the remaining policy issues for UK transposition

Omnibus II published in OJ

The text of the Omnibus II Directive was published in the Official Journal of the EU on May 22 and entered into force on May 23.

The Omnibus II Directive, among other things, amends the Solvency II transposition date to March 31, 2015 and the application date to January 1, 2016.

For further information: 

Omnibus II published in OJ

PRA publishes Supervisory Statement on Solvency II technical provisions and internal models for general insurers

The PRA has published Supervisory Statement SS 5/14: Solvency II: calculation of technical provisions and the use of internal models for general insurers.

The aim of the Statement is to set out the PRA's expectations in relation to the firms’ preparations towards Solvency II compliance by ensuring that general insurers are setting an adequate level of technical provisions and hold sufficient capital.

The Statement covers:

• Technical provisions - Realistic assumption and adequate methods including the risk margin and events not in data (ENID).
• Internal models – Material risks (including ENID), consistency of with technical provisions, assumptions and techniques, data, risk mitigation, management actions, validation standards, external models and data, and data from third party models.

For further information: 

PRA publishes Supervisory Statement on Solvency II technical provisions and internal models for general insurers

Council approves amending rules for the insurance industry

The Solvency II amending directive, known as Omnibus II, was passed on April 14 having been adopted by the Council of the EU at first reading. Omnibus II was adopted by the European Parliament on March 11.

The Directive is now awaiting publication in the Official Journal of the EU and will enter into force twenty days after it is published.  

With this stage near completion, the European Commission is expected to publish the draft level 2 delegated acts imminently.

For further information:

Council approves amending rules for the insurance industry

EIOPA issues first set of Solvency II Implementing Technical Standards

On April 2, EIOPA issued the first set of Solvency II Implementing Technical Standards (ITS) for consultation. ITS are regulatory tools to assist firms and supervisors’ preparations for the Solvency II approval processes, due to start on April 1, 2015. The Omnibus II Directive grants power to EIOPA to draft these standards.

The consultation papers cover proposed ITS on:

• Internal models approval processes.
• Procedures to be used for granting supervisory approval for the use of ancillary own-fund items.
• The process to reach a joint decision for group internal models.
• Procedures to be followed for the approval of the application of a matching adjustment.
• Special purpose vehicles.
• The supervisory approval procedure to use undertaking-specific parameters.

Responses to all six consultations should be submitted by June 30 using the template provided. EIOPA is expected to submit the final draft ITS for endorsement by the European Commission by October 31, 2014. The second set of ITS is likely to be consulted on late this year or early in 2015. Meanwhile, the Commission’s Delegated Acts containing detailed implementing measures are expected to be made public in the summer.

Firms should review their preparations for Solvency II in light of the ITS consultations. The timetable leading up to implementation on January 1, 2016 is challenging and firms should have a clear understanding of the key dates on the horizon and ensure their preparations for the new regime are well advanced.

For further information:

EIOPA consultation papers

Omnibus II adopted in European Parliament plenary

On March 11, the European Parliament adopted the Omnibus II Directive, the last element needed to amend the Solvency II framework directive, granting additional powers to EIOPA and introducing a package of measures to support long-term products. Firms can now continue their preparations on the basis that the new Solvency regime will come into force on January 1, 2016.

The final Omnibus II text agreed by the trialogue in November last year introduces substantive changes to the Solvency II Directive. In particular, Omnibus II clarifies the role of EIOPA, specifies areas in which EIOPA can propose harmonised technical standards and ensures supervisory convergence and cooperation between national supervisors. Omnibus II also includes a package of measures to facilitate insurance products with long-term guarantees and transitional measures both for EU insurers and third countries moving towards equivalence. Insurers will continue to be able to match long-term liabilities with investments in long-term assets such as infrastructure projects. Omnibus II also contains measures to mitigate the effects of artificial volatility, such as a matching adjustment for annuity business, a volatility adjustment, extrapolation of the risk-free interest rate, transitional measures and the extension of the recovery period.

The final Omnibus II text has not been published yet. The Council of the EU will need to formally adopt the Directive before it is published in the Official Journal. The next stage of Solvency II implementation is now underway. The Commission is preparing a Delegated Act containing a large number of detailed implementing rules which is expected this summer. Meanwhile, EIOPA is developing implementing technical standards aimed to ensure implementation on January 1, 2016 goes smoothly.

There is significant work for firms to do to finalise their preparations. Reporting has perhaps lagged behind internal model preparations but financial information for 2014 will need to be submitted in July 2015 and own risk and solvency assessments will be required even sooner.

For further information:

European Parliament: Omnibus II vote press release

Lloyd’s Solvency II 2014 guidance notes

The Society of Lloyd’s has issued 2014 guidance notes on Solvency II and risk assurance. The guidance notes provide information on Lloyd’s ongoing approach to the implementation of Solvency II, the proposed Solvency II and risk assurance timetable and expectations of managing agents for 2014 during the current ‘soft landing’ approach. Lloyd’s continues to assume an implementation date of January 1, 2016 but notes that this could still be subject to change.

Points of interest include:

• Agents are expected to refocus their efforts on their Solvency II programmes in 2014 and Lloyd’s aims to make its Lloyd’s internal model IMAP submission to the PRA during spring 2015. The expectation on managing agents is that all syndicates are able to demonstrate that they have an internal model which meets the full Solvency II tests and standards by the end of 2014. Lloyd’s anticipates that the level of PRA review and interaction with both Lloyd’s and the market on Solvency II will increase in 2014, and those agents that cannot demonstrate that they will meet the tests and standards should expect increased scrutiny.
• Lloyd’s is comfortable that EIOPA’s guidelines do not impose any requirements on managing agents not already covered by the Lloyd’s Solvency II programme. Lloyd’s will not be rating agents against the guidelines in 2014, however Lloyd’s does need to be able to demonstrate to the PRA that managing agents are meeting the guidelines. A mapping exercise will be conducted in 2014 to assess the requirements of EIOPA’s guidelines against the elements of Lloyd’s Solvency II programme.
• Two new quantitative returns will be required for 2014: a standard formula SCR calculation in May and a Pillar 3 dry run in September.
• Lloyd’s will require a Board confirmation of Solvency II status to be submitted in December 2014. Lloyd’s will review and evaluate all submissions to determine each agent’s final Solvency II rating and these ratings will form a key part of the Lloyd’s internal model submission in 2015.

A proposed timetable of key dates for 2014 can be found in Appendix 1.

For further information:

Lloyd’s Solvency II and risk assurance 2014 guidance notes

EIOPA report on the functioning of colleges

On February 20, EIOPA published a report on the functioning of colleges of supervisors and the accomplishments of the 2013 action plan.

In 2013, the main aim of the action plan was to make further progress in improving effectiveness by enhancing the risk analysis and efficiency of supervision, and enhance the understanding and knowledge of EIOPA's guidelines for preparing for implementation of Solvency II. Generally EIOPA found, during last year, colleges improved the efficiency and effectiveness of their work. Consequently, the quality of supervision of EU insurance groups has improved.

The majority of colleges now have in place their basic procedural and organisational architecture. EIOPA explains that the focus for 2014 should be on: risk assessment; agreement on a co-ordination arrangement; and implementing the Solvency II guidelines.

The report also lists the priorities and tasks for colleges in 2014, which are outlined in more detail in EIOPA's 2014/15 action plan for colleges.

For further information:

Report on the Functioning of Colleges and the Accomplishments of the 2013 Action Plan

Omnibus II plenary vote delayed

The European Parliament has updated its procedure file indicating that the Omnibus II Directive will be considered at its 10 to 13 March 2014 plenary session.

The plenary vote on Omnibus II was previously expected to take place on 25 February.

In terms of the Solvency II timeline, current expectations (subject to change if the Omnibus II Directive is delayed) are that the European Commission will publish ‘near final’ delegated acts in April 2014 for formal adoption in August/September 2014. Final agreement on the delegated acts is expected in February 2015.

EIOPA has indicated that it will consult on the level 3 technical standards and guidelines as soon as possible during 2014. The Commission is due to start implementing technical standards early in 2015.

Regulators will be given the powers they need to take decisions from April 2015 and the regime will go live on 1 January 2016.

Quick Fix Directive published in Official Journal of the EU

On 18 December 2013, the second Solvency II Quick Fix Directive was published in the Official Journal of the EU.

The Directive extends the implementation date of the Solvency II Directive to 1 January 2016. The deadline for transposition into national law is extended to 31 March 2015.

The Quick Fix Directive entered into force on 19 December 2013.

For further information: Solvency II Quick Fix Directive (2013/58/EU)

Solvency II – a turning point

On 12 December, the PRA published a speech by Julian Adams, Director of Insurance, on what the latest Solvency II developments means for the PRA’s implementation of the new regime. Firms should note the followings points highlighted by Adams:

• The transposition date has been set for 31 March 2015, meaning that the Member States will be empowered to give Solvency II regulated approvals from 1 April 2015. Now is the time for firms to reassess priorities and make a concerted push to be able to demonstrate compliance in two years time.
  Adams focuses on three areas of the trialogue agreement on Omnibus II: the matching adjustment; equivalence; and transitional arrangement for technical provisions. Generally, the PRA welcomes the measures agreed by the trialogue parties but notes that a number of details are still to be determined and it expects to have discussions with firms on some of the issues.
• The PRA understands that the Commission aims to publish delegated acts next summer, but that a stable version is likely to be ready by March. Implementing technical standards are expected to be produced by the Commission in three waves, with the first wave due to be adopted in October 2014. These instruments will translate high level policy into practical reality and Adams urges firms to stay apprised of developments in delegated acts, technical standards and guidelines.
• The PRA will be adopting an ‘intelligent copy out’ approach to its Handbook, meaning it will follow the words of the Directive text as closely as possible. The PRA may issue supervisory statements where it considers that general guidance is needed to clarify its expectations of firms.
  Firms will need to continue to meet existing regulatory requirements until Solvency II is implemented. Where possible, the PRA will look for ways that firms may be able to use their preparations for Solvency II to meet the current supervisory regime. The PRA will be asking groups to discuss with their supervisor how they intend to prepare for the new regime and the specific requirements it places on groups.
• Adams describes the ORSA as the cornerstone of Solvency II and firms are expected to submit an annual ORSA supervisory report from January 2014 onwards. The PRA attaches considerable importance to the ORSA and the role it will play in future to support the Threshold Condition that insurers must have appropriate non-financial resources and robust risk and capital management systems.
• The PRA thinks it reasonable to expect firms to be ready for Solvency II based reporting six months before implementation, meaning that firms falling within the thresholds should be able to submit their reports in July 2015. The PRA will continue to review the practicability of the reporting timetable but warns firms to prepare for higher quality reports and better synchronised reporting under Solvency II.
• Now that the timetable is certain, the PRA will no longer be flexible in terms of IMAP submissions. The PRA will continue to be robust in its approach to internal model approval and models must meet the required tests and standards, capture all quantifiable risks, and deliver prudently sound outcomes in a range scenarios.

Adams concludes that there is a significant amount of work to be done to be ready for 1 January 2016. Beyond Europe, Adams notes that the industry is at a point of fundamental change in the development of global insurance regulation with the IAIS’ work on the ComFrame initiative and a global insurance capital standard. It is imperative that firms stay abreast of the wider global developments and commit the time and resource need to keep pace.

For further information: Julian Adams speech: Solvency II – a turning point

PRA publishes a supervisory statement on how firms should apply the EIOPA Solvency II preparatory guidelines

On 12 December, the PRA published a supervisory statement to assist firms within scope of Solvency II in their preparations for its implementation in 2016. The statement sets out the PRA’s expectations for firms in terms of meeting the outcomes envisaged in the Solvency II guidelines published by EIOPA in October (the Guidelines). The statement provides some limited national interpretation on aspects of the Guidelines.

The statement will come into effect on 1 January 2014 and cease to operate on the day prior to implementation of Solvency II, 1 January 2016.

Although the Guidelines are addressed to the competent authorities of each Member State, the PRA expects firms to have regard to the outcomes in the Guidelines whilst also continuing to meet the existing PRA rules. Much of the Guidelines are consistent with existing PRA handbook provisions but firms should read, assess and implement the substantive provisions of the Guidelines in order to ensure that they are ready for the new regime. The PRA has sought to be proportionate in its application of the Guidelines to ensure that there is a minimal risk of two regimes running concurrently.

The Guidelines cover four fundamental aspects of firms’ preparations for Solvency II, namely:

• systems of governance;
• forward-looking assessment of the undertaking’s own risks based on the principles in the Own Risk and Solvency Assessment (ORSA);
• submission of information to national competent authorities; and
• pre-application for internal models.

The statement recognises that firms’ progress towards the Guidelines will be incremental. There will be a general ‘phasing-in’ in areas where there will be different expectations regarding a firm’s progress over time. The ORSA submitted in 2015 should therefore be more advanced than the one submitted in 2014.

More specific phasing-in periods will be applied to the submission of information. Thresholds will be applied to ensure that only firms above a certain threshold will need to meet these submission of information requirements.

For each of the four areas of preparation the statement identifies where firms need to focus their efforts and where the Guidelines require more than existing PRA handbook provisions.

For further information: PRA publishes Solvency II supervisory statement

Solvency II timetable finally takes shape as agreement is reached on Omnibus II

Late on 13 November agreement was reached between the European trialogue parties on the Omnibus II Directive which is likely to enable the introduction of Solvency II with effect from 1 January 2016. The agreement is expected to be approved when the European Parliament votes on Omnibus II, currently scheduled for 25 February 2014.

Omnibus II contains amendments to the Solvency II Framework Directive and includes the provision of specific tasks for EIOPA. In particular, it clarifies the role of EIOPA in ensuring harmonised approaches on the calculation of technical provisions and capital requirements.

Progress on Solvency II had stalled because of negotiations on the treatment of long-term guaranteed products and issues related to the calculation of annuity liabilities. The agreed version of Omnibus II means that insurers will continue to be able to match long-term liabilities with investments in long-term assets such as infrastructure projects. Omnibus II will also contain measures to mitigate the effects of artificial volatility, such as matching adjustment for annuity business, a volatility adjustment, extrapolation of the risk-free interest rate, transitional measures and the extension of the recovery period.

In addition, the Omnibus II agreement contains:

• measures to alleviate the burden in terms of reporting for what the Commission describes as small and medium sized insurers; and
• agreed transitional measures on third country equivalence which could include long term (e.g. 10 years) equivalence assessments by the European Commission which could be of significant value for international groups.

The “quick fix” Directive extends the Solvency II application date to 1 January 2016. The proposed date for transposition has been delayed until 31 March 2015.

Omnibus II to be considered at 24 to 27 February 2014 plenary session

The European Parliament's procedure file currently indicates that the proposed Omnibus II Directive will be considered at the plenary session to be held from 24 to 27 February 2014.

Agreement on Omnibus II has been delayed several times due to ongoing negotiations between the European Parliament, the European Commission and the Council of the EU.

The detailed rules of Solvency II cannot be finalised until the text of the Omnibus II Directive is adopted.

PRA plans to assess firms’ compliance with EIOPA’s preparatory guidelines over 2014 and 2015

After an extended period of very little progress on Solvency II, preparations for the new regime appear to be gathering pace. In a consultation paper published on 21 October, the PRA has set out its proposals for implementing EIOPA's Solvency II preparatory guidelines (the Guidelines). Firms are reminded that the Guidelines apply to NCAs and will be used by the PRA to assess firms’ preparedness for the new regime.

The PRA notes that it will review firms’ preparations in a proportionate and risk-based manner and expects firms to apply the Guidelines according to the nature, scale and complexity of their business. The draft supervisory statement aims to clarify the PRA’s expectations of firms, approach to the Guidelines, and interpretation of certain aspects. The four areas covered by the supervisory statement are set out below with a link to the relevant EIOPA guidelines.

System of governance

The PRA generally considers the system of governance guidelines to be consistent with current expectations around general standards of group governance, systems and controls and the fit and proper criteria applied to approved persons. Firms are, however, encouraged to make the necessary changes to ensure their governance issues take into account the greater scope and granularity of requirements under Solvency II. Firms should be prepared to explain to the PRA any changes required to satisfy governance requirements, measures for making these changes and any difficulties faced. The Guidelines will also assist firms in preparing their annual SFCR covering governance issues once Solvency II enters into force. Firms will need to review their existing governance and risk management systems, identify where improvements need to be made, and take appropriate action ahead of the implementation deadline.

Organisational structure is a key issue that firms can start to address now. Group governance and Board responsibility will need to be reviewed for compliance and firms must ensure that Board members and key function holders are fit and proper and have the appropriate skills and experience for their respective roles. The PRA warns that firms must ensure the Board is fully aware of its responsibilities post-implementation and recommends using the preparatory phase to allocate and segregate responsibilities and reporting lines, and consider provisions to deal with conflicts of interest. Firms are also encouraged to review their existing outsourcing arrangements and reliance on outsourcing. Firms should be prepared to document their outsourcing approach, including contingency plans in the event of a service provider failure.

EIOPA proposal for guidelines on the system of governance

Forward-looking assessment of the undertaking’s own risks, based on the principles for the Own Risk and Solvency Assessment (ORSA)

Firms are advised to use the time before implementation to develop their ORSA. The Guidelines will assist firms in designing, compiling and trialling their risk management framework in preparation for the standard expected for an ORSA from 1 January 2016. The ORSA should reflect the specific risk profile and governance mechanism of each firm and group, capturing all known risks. As such, the PRA will not prescribe the format or content of the ORSA but will review firms’ assessments and provide feedback where appropriate. The PRA makes the following key points that firms should bear in mind when developing their ORSA:

• A robust process should be put in place to assess, monitor and measure all risks and to ensure that the output from the assessment forms an important part of the firm’s strategic and decision-making processes. Once in place, firms can then start to perform the assessment based on their overall risk profile and solvency needs.
• Board involvement will be more extensive and members are expected to play an active part in various stages including how the ORSA should be designed and documented, risk identification and mitigation and approving and communicating the finished product. Firms will need to plan a schedule of Board meetings to allow adequate time to work on ORSA development.
• Results and insights from the ORSA should inform firms’ capital management and business planning, as well as product development and design.
• Firms should identify the best time to complete work on the ORSA and inform the PRA well in advance of when their ORSA will be submitted. Due to the volume of ORSAs expected, the PRA plans to stagger its review in a risk based, proportionate approach.

Two annual assessments are proposed during the preparatory phase, intended for firms to demonstrate their ORSA progress to the PRA. The second assessment is expected to be of a higher standard taking into consideration market conditions, risk profile changes and experience gained from the previous year. EIOPA has adopted a staggered approach to the ORSA guidelines. In 2014, firms will need to base the assessment of own solvency needs on valuations and capital requirements applicable to the individual firm (ICAS, ICAS+ or Solvency I). In the second year, firms are expected to perform their forward calculations on a Solvency II basis. The PRA recommends that the 2015 assessment should cover all material risks, including non-quantifiable risks such as reputational or strategic risk, and the extent to which they are to be covered by capital or addressed by way of risk management techniques, or a combination of both.

EIOPA proposal for guidelines on forward looking assessment of own risks

Submission of information to NCAs

The PRA will apply proportionate, risk based thresholds for quantitative and qualitative reporting from life, non-life, individual firms and groups. During the preparatory period, firms are expected to develop systems and structures aimed at delivering high quality information for supervisory purposes. The PRA plans to review and evaluate information submissions to ensure firms are making adequate progress in time for full implementation.

EIOPA proposal for guidelines on submissions of information to NCAs

Pre-application for internal models

The PRA explains that it will continue to work with firms in the internal model approval process (IMAP). Internal models continue to be developed and firms are expected to put into practice the relevant guidelines. Firms with models that are sufficiently stable are encouraged to begin testing and refining their models based on experience. Firms engaged in the pre-application process are reminded that it is not a pre-approval process and the PRA may not approve their model. Feedback on models will be provided in line with the agreed timetable.

EIOPA proposal for guidelines on pre-application for internal models

The PRA suggests that many of the Guidelines should not present an additional burden for firms and largely reflect good practice in conformity with existing rules, however, firms should be aware of the anticipated changes over the next two years and the level of detail the PRA expects as we progress towards Solvency II implementation.

The consultation closed on 15 November and the PRA plans to finalise the supervisory statement prior to the Guidelines coming into effect on 1 January 2014.

For further information: CP9/13 Solvency II: applying EIOPA’s preparatory guidelines to PRA-authorised firms

Commission proposes extending Solvency II application date to 1 January 2016

On 2 October, the European Commission published a proposal for a Directive to extend both the implementation and first application of Solvency II.

This is the second “quick fix” Directive to ensure the legal continuity of the current Solvency I provisions until the complete Solvency II package is in place.

Under the proposed timetable, Member States will be required to transpose the Solvency II regime into national law by 31 January 2015.

The Commission proposes extending the application date to 1 January 2016.

EIOPA final Guidelines on preparation for Solvency II

EIOPA issued the final Guidelines for the preparation of Solvency II on 27 September. EIOPA issued draft guidelines for consultation in March this year covering the key areas of the Solvency II regime: system of governance, ORSA principles, submission of information to NCAs; and pre-application for internal models. EIOPA received over 4000 comments during the consultation period.

The Guidelines aim to increase preparedness of insurers and supervisors once the Solvency II regime is in force. NCAs must decide how best to implement the Guidelines into their national regulatory or supervisory framework.

EIOPA expects to issue the Guidelines in all official EU languages on 31 October with the application date of 1 January 2014. NCAs will have two months from the date of issuance to report to EIOPA their compliance or intention to comply. In February 2015, NCAs will be required to submit a progress report on implementation of the Guidelines.

In response, the PRA has announced that it plans to publish for consultation a Supervisory Statement in relation to the Guidelines in the coming weeks. The Supervisory Statement will include expectations of firms from 1 January 2014.

PRA plan to implement early warning indicators sparks debate

A recent speech by Andrew Bailey, CEO of the PRA, outlining the regulator’s plans to continue with its Solvency II preparation has prompted criticism from the industry. Bailey defended his recent assessment of the “shocking” implementation of Solvency II but confirmed that the PRA continues to work with its European counterparts and the ESAs.

The PRA is hopeful that the outstanding issues will be resolved, and final agreement on Omnibus II reached, by the end of the year. This timeframe is not guaranteed, however, and the PRA has adopted a planning horizon of 31 December 2015. During this period firms will be able to use their Solvency II internal models to meet the current ICAS requirements; an approach knows as ICAS+.

Plans to make early adjustments to incorporate the ORSA into the existing regime will, according to the PRA, ensure that UK firms are better prepared when Solvency II is finally introduced.

The introduction of early warning indicators (EWIs) designed to monitor the on-going appropriateness of internal models has been met with strong resistance. Bailey explains that breach of an indicator’s threshold (calibrated in line with a firm’s SCR) would “trigger an immediate supervisory response”, most likely to be a capital add-on. Firms are expected to update their internal models regularly in order to reflect their changing risk profiles.

Work on possible indicators to monitor internal models is still being considered at European level, therefore, firms have raised concerns that the UK regulator is attempting to implement aspects of Solvency II ahead of the rest of Europe. The principle aim of the Solvency II Directive is to develop a pan-European solvency regime. Exceeding the terms of EU legislation, so-called “gold-plating”, is not allowed under Solvency II and, consequently, the PRA risks being accused of operating beyond its remit.

The PRA has defended its approach stating that Solvency II has so far failed to address potential issues resulting from an excessive reliance on modelled capital requirements. Bailey explains that early action to introduce “sensible backstops” for insurers will avoid the problems with capital level being set too low, as the PRA experienced in the banking sector.

Understandably considering the significant amount of time and resources spent on Solvency II thus far, some firms are reluctant to invest any more in a regime that is still some way from being finalised. Further, this could prove to be a temporary requirement if the PRA has to remove or substantially adapt these indicators once the Solvency II regime has been finalised.

For further information: Meeting the challenges of a changing world – the PRA view

EIOPA publishes report on the long-term guarantees assessment

Earlier this year EIOPA conducted an assessment of the long-term guarantees package proposed under Solvency II. Disagreement on the treatment of long-term guarantees in times of market stress had stalled EU negotiations on the final Omnibus II text, and threatened to further delay the already decade-long Solvency II project.

EIOPA published the results of the LTGA, along with its recommendations, on 14 June 2013. Gabriel Bernardino, EIOPA Chairman, stated the results of the LTGA “will provide the EU political institutions with a reliable basis for an informed decision on the long-term guarantee measures and a conclusion on the Omnibus II negotiations”.

The LTGA considered the following six regulatory measures aimed at ensuring an appropriate supervisory treatment of long-term guarantee products under volatile market conditions:

1. Adaptation to the relevant risk-free term structure or Counter-Cyclical Premium (CCP)
2. Extrapolation
3. “Classical” Matching Adjustment
4. Extended Matching Adjustment
5. Transitional measures
6. Extension of the Recovery Period.

Based on the outcome of the assessment, EIOPA:

• Supports (with some minor amendments) the inclusion of the extrapolation, classical matching adjustment, extension of the recovery period, and transitional measures.
• Advises that the trialogue parties replace the CCP with a formulaic, more reliable measure, known as the “volatility balancer”. The CCP is designed to reduce the impact of short-term volatility on the Solvency II balance sheet during crisis situations in financial markets. EIOPA states that extended application of the CCP has the potential to be detrimental to policyholder protection. Industry participants and supervisory authorities have raised concerns that the CCP might create “artificial stability” and is not an all-round crisis tool, for example, it does not addresses the challenges of a low-interest environment. In light of these concerns, EIOPA recommends the new volatility adjustment mechanism. EIOPA believes this measure will provide a solution to industry concerns and “deal in a predictable and permanent way with the unintended consequences of volatility”.
• Recommends that the extended matching adjustment be removed altogether. EIOPA suggests excluding the extended matching adjustment, whilst retaining the “classical” matching adjustment. The LTGA raised significant concerns about the complexity of the extended matching adjustment. In addition, EIOPA reported that the extended version of the matching adjustment could provide “false risk management incentives, in particular in terms of credit quality of assets and with regards to the management of liquidity risk”.

In a press release published alongside the LTGA report, Bernardino described Solvency II as “a sound framework that needs to be implemented as soon as possible”.

Meanwhile, the industry and commentators have expressed concern that the changes proposed by EIOPA, particularly the new volatility balancer, may prompt further political discussion and risk delaying the regime yet again.

EU trialogue discussions are expected to restart shortly, with agreement on the final Omnibus II text currently scheduled for 22 October 2013.

For further information:

EIOPA Technical Findings on the LTGA

EIOPA - LTGA Appendix 1

EIOPA – LTGA Appendix 2

Update on early warning indicators

Last year, the PRA advised IMAP firms that it intends to monitor the ongoing appropriateness of internal models post approval through the use of EWIs. In a letter dated 23 May 2013, Julian Adams, set out the PRA’s implementation plan in this area.

Prior to the formal implementation of Solvency II, the PRA intends to “trial the use of EWIs in the ICAS regime for all firms using an internal model for regulatory capital assessment”. The PRA believes this will assist its supervision to monitor any downward drift in capital, and allow the regulator to test the calibrations of EWIs prior to use following implementation of Solvency II.

Following industry feedback and a data analysis exercise, the PRA has developed separate indictors for life, with-profits, and general insurance business (including London markets).

Life and general insurance business

For life and general insurers, the PRA considers the ratio between the modelled SCR and the Solvency II pMCR to be an appropriate EWI. Prior to implementation the PRA will use firms’ ICG as the capital requirement, whilst the pMCR will be calculated using EIOPA’s long-term guarantees assessment specifications. The PRA has set the ICG to pMCR indicator threshold at:

• 300 per cent for life business (excluding with-profts); and
• 175 per cent for general insurance, including London markets.

According to Adams, these levels are set so that around 10 per cent of firms will fall below them allowing the regulator to understand how EWIs operate.

With-profits business

The data submitted by firms suggests that the simple pMCR may not be appropriate for with-profits funds. In addition to the simple ICG to pMCR ratio, the PRA will use the interim period to test an alternative modified indictor to reflect the complexity of with-profits funds. The regulator will assess at the end of this period whether the additional with-profits EWI is warranted.

The with-profits indicator thresholds have been set at:

• 125 per cent for the original (ICG to pMCR) ratio for with-profits business; and
• 200 per cent for the alternative modified indicator.

It is worth noting the following points:

• From September onwards, the PRA expects firms to aware of how their internal model performs against the EWIs.
• Firms should be prepared to discuss with their supervisor the performance of their internal models including the reasons for “any significant actual or potential change in position and the causes of those changes, especially any actual or potential fall below the thresholds”.
• The PRA plans to use the EWI as an input to ICAS or ICAS+ review panels.
• EIOPA is also considering implementing EWIs to monitor the ongoing appropriateness of internals models and the PRA is assisting with this project.

For further information: Monitoring levels of capital and early warning indicators – 23 May 2013

PRA letter to firms – May update

Julian Adams, Deputy Head of the PRA, in a letter to firms on 23 May 2013, providing an update on the UK implementation of Solvency II. Key points of interest include:

• The PRA will decide whether it intends to comply with the EIOPA’s preparatory guidelines once they have been published (currently expected in September). If the PRA does not intend to comply with any of the guidelines, it will have to provide the reasons for non-compliance within two months. Adams notes that “timing is difficult as it leaves little time for us and for you to prepare”.
• Uncertainty around the implementation timetable remains a significant issue and is unlikely to be resolved before the autumn, when work on the long-term guarantees assessment, Omnibus II discussions and the preparatory guidelines should come together.
• Having scaled back its work on Solvency II, the PRA has “reduced considerably” the cost to industry. Since the “ICAS+” approach was announced early this year, nearly half of IMAP firms have submitted requests to the PRA to leverage the work carried out on their internal models to meet the current regulatory requirements. Adams confirms that this work is at a preliminary stage and the PRA plans to share learnings from ICAS+ as soon as possible.

The letter also provides an updated timetable for the rest of the year.

For further information: Solvency II update – 23 May 2013

Industry invited to comment on guidelines for Solvency II preparation

EIOPA Chairman Gabriel Bernardino has stated that he remains confident that "Solvency II is coming closer". Bernardino believes that stakeholders recognise that 2013 is a crucial year for the new regime.

EIOPA plans to present the findings and conclusions of the long term guarantee assessment in June 2013. Bernardino notes that the authority has been encouraged by the level of participation across the member states with more than 500 undertakings taking part.

In addition, Bernardino states that EIOPA is busy preparing supervisors and undertakings for the Solvency II in a consistent way. As such, EIOPA has issued guidelines covering:

• system of governance;
• forward looking assessment of the undertaking's own risk;
• submission of information to national supervisors; and
• pre-application of internal models.

The guidelines aim to ensure that authorities put in place the most important aspects of the prospective supervisory approach by 1 January 2014. The consultations set out how authorities should approach the preparatory phase of Solvency II. EIOPA is keen to point out that, although there is no definitive timetable for Solvency II implementation, NCAs are expected to continue to progress in their preparedness for the new regime.

The deadline for comments on the guidelines is 19 June 2013. EIOPA intends to publish the final guidelines in Autumn 2013.

For further information:

EIOPA consultation papers

Article by Gabriel Bernardino, Chairman of EIOPA, for the BörsenZeitung

EIOPA confirms it is working towards January 2016 implementation

EIOPA Executive Director, Carlos Montalvo, has commented on the uncertainty around the implementation date of Solvency II. In an interview with Reactions magazine, Montalvo stated that EIOPA is “confident that the framework will be applicable in 2016” but that ultimately the decision rests with the European Council, European Parliament and the European Commission.

Montalvo does however confirm that EIOPA “will do the necessary work to make the implementation of Solvency II happen on January 2016”.

Finally, Montalvo urges parties to avoid reopening more issues once the long term guarantee issue is settled. He concludes that Solvency II, although it will not be perfect on day 1, is a good framework.

For further information: Interview with Carlos Montalvo

EIOPA opinion on interim measures

In preparation for Solvency II, EIOPA has published an opinion proposing a number of actions to ensure a consistent and convergent approach. EIOPA has identified the following key areas that need to be addressed to ensure proper management of undertakings:

• system of governance;
• pre-application of internal models; and
• reporting to supervisors.

In light of this, EIOPA expects national authorities to:

• Review and evaluate systems of governance ensuring sound and prudent management and assessment of risk.
• Ensure undertakings have in place an effective risk management system comprising strategies, processes and reporting procedures necessary to identify, measure, monitor, manage and report risks to which they are or could be exposed.
• Continue to work with undertakings engaged in the internal model pre-application process.

Guidelines on how to proceed in the interim phase leading up to Solvency II will be published by EIOPA shortly. Each national authority must inform EIOPA whether it complies, or intends to comply, with the guidelines within two months of issuance.

For further information: EIOPA opinion on Solvency II interim measures

Long-term guarantee package to be launched on 28 January 2013

EIOPA has confirmed that it intends to launch the technical assessment of the LTG package on 28 January 2013 in cooperation with national supervisory authorities. The assessment had been delayed while the trilogue decided on the scope of EIOPA's mandate. The terms of reference have not been published but the assessment is expected to include the counter-cyclical premium, the matching adjustment and the extrapolation method. 

The Omnibus II trilogue parties have requested that EIOPA assess the impact of the LTG package under Solvency II on policyholders, beneficiaries, insurance and reinsurance undertakings, supervisory authorities and the financial system as a whole. Participating undertakings are expected to submit qualitative and quantitative information by the end of March 2013. EIOPA is due to report its findings by 14 June 2013, with the Commission planning to publish the final report by 12 July 2013.

Agreement on Omnibus II is currently scheduled for the plenary session on 10 June 2013, but it looks likely that this will slip. Reports suggest that agreement on the final text will be delayed until July, or possibly September. 

For further information: Long-term guarantees package

EIOPA indicates Solvency II implementation date of 2016

November 2012

Gabriel Bernardino, EIOPA Chairman, has suggested that implementation of the Solvency II Directive could be delayed until 2016. In an interview with the Wall Street Journal, Bernardino stated that the 1 January 2014 start date is now "completely out of reach", confirming industry speculation that the current timetable will not be achieved. According to Bernardino, Solvency II could start to be implemented in either 2015 or 2016, but indicated that 2016 is more likely. It is anticipated that some elements of Solvency II, such as risk management, could be applied before the official start date which Bernardino states should be made clear in the new timetable.

Meanwhile, EU Commissioner Michel Barnier has reportedly proposed that implementation be delayed until 1 January 2015. In the absence of any official announcement, insurers have welcomed Bernardino’s comments. For those firms that have already invested significant resources to meet the 1 January 2014 deadline, however, further delays are not only frustrating but could prove very costly.

FSA delays IMAP submissions

October 2012

Julian Adams, FSA Director of Insurance, has stated that recent events render the current Solvency II timetable as "completely unrealistic", and a 2015 date is likely to be "very challenging". Commenting on the vast amount of time, effort and money already expended by the industry and the regulator, Adams echoes Gabriel Bernardino’s call for a new timetable to be produced at the earliest opportunity.

Adams notes that alternative dates range from 2015 to 2017 and possibly later, however, the PRA proposes adopting its own “sensible planning period”. The new approach allows firms in the IMAP process to choose a date up to a maximum of 31 December 2015 to submit their internal models to the regulator. The PRA believes this reflects the most pragmatic way forward and allows firms more time to complete the work they need to do for their submissions. Should a credible official timetable emerge, the PRA will reconsider its timeline.

The PRA's proposals

In the light of the ongoing delays to the new regime, the PRA has been exploring an approach to Solvency II that is consistent with the regulator's approach to supervision, builds on firms’ existing preparations for the new regime and allows firms to use this work to meet current requirements where possible. Adams therefore proposes an optional two-phase process allowing firms to use their Solvency II models to meet their existing ICAS requirements. The first phase requires firms to provide a reconciliation between the calculations performed to take account of the differences in the two regimes. In the second phase, the PRA will allow firms to use their Solvency II balance sheet and model for ICAS purposes without any further reconciliation.

The PRA is also considering the possibility that firms with relatively advanced ORSAs may be able to utilise parts of it to satisfy current requirements. A further area of concern for the PRA is reporting. In order to achieve its objectives, the regulator will require “enhanced information”, and will therefore look into supplementing the existing data it receives from firms.

Adams is keen to point out that the PRA does not intend to implement Solvency II earlier than the rest of Europe or 'gold plate' any requirements, and instead aims to deal effectively with the ongoing delays. Adams concludes that the PRA has had constructive discussions with the industry regarding its new approach and will continue to do develop these proposals in the coming weeks.

For further information: Julian Adams - the PRA's approach to insurance regulation

Further evidence of impending delays to Solvency II

October 2012

Following a number of recent developments, speculation is mounting that Solvency II may be pushed back by up to a year. EIOPA has been asked to carry out an impact assessment relating to the long-term guarantee package and report to the Commission before 1 February 2013. The Society of Lloyd’s has stated that the results of EIOPA’s impact assessment are expected in March 2013. Consequently, the adoption of Omnibus II could be delayed until the second quarter of 2013, as the final text cannot be agreed until the results of the impact assessment are known.

Insurance Europe issued a statement welcoming the impact assessment and stated that any subsequent delay in the implementation of Solvency II is regrettable but “it is vital that the results of the tests can be reflected in Omnibus II in order to ensure that the new regulatory regime is both appropriate and workable”.

Meanwhile, EIOPA has raised concerns regarding the "stagnant " Omnibus II negotiations and their impact on Solvency II in a letter from Gabriel Bernardino, EIOPA Chairman, to Michel Barnier, European Commissioner for Internal Market and Services and the other parties to the Omnibus II trialogue. Bernardino states that EIOPA is seriously concerned about the lack of a "clear and credible timetable" for Solvency II implementation. EIOPA requests "a realistic assessment of the expected time needed to deliver the different milestones" and asks that the parties set “operationally achievable timings". Finally, EIOPA states that consideration should be given to early implementation of some elements of Solvency II once the overall timetable has been agreed.

For further information:

EIOPA letter to European Commissioner - 4 October 2012

Lloyds’s: Solvency II implementation date

Insurance Europe: Impact assessment results should be reflected in Omnibus II

EIOPA to examine calibration and design of Solvency II capital requirements

October 2012

The European Commission has published a letter, dated 28 September 2012, to Gabriel Bernardino, EIOPA Chairman relating to work on the Solvency II regime. The letter highlights the essential role the financial sector plays in providing and channeling “long-term finance”. In light of this, EIOPA is asked to examine “whether the calibration and design of capital requirements for investments in certain assets under the envisaged Solvency II regime necessitates any adjustment or reduction under the current economic conditions, without jeopardising the prudential nature of the regime”.

EIOPA’s analysis will also consider the capital requirement for interest rate risk that reflects the difference in assets and liabilities matching between long and short term contracts; a component the Commission believes has been overlooked in studies on Solvency II incentives to date. The Commission requests that EIOPA focus mainly on “long-term finance” and includes a list of specific assets. Whilst there is no official definition of “long-term investment”, the Commission plans to publish a green paper on long-term finance in the EU later in 2012. In the meantime, EIOPA is advised to focus on finance over a time horizon that expands over the economic business cycle, such as 10 years. EIOPA is asked to coordinate its efforts, as far as possible, with both the EBA and ESMA.

Finally, in light of the urgency of the growth agenda and completion of the Solvency II implementing measures, EIOPA is asked to provide feedback before 1 February 2013.

For further information: European Commission letter to EIOPA

European Commission adopts Directive amending the transposition and application dates of the Solvency II Directive

September 2012

On 12 September 2012, the European Commission adopted the Directive amending the transposition and application dates of the Solvency II Directive. The text of the Directive has been published in the Official Journal of the European Union.

The European Parliament adopted the proposal on 3 July 2012, and the Council of the EU approved Parliament's position on 5 September 2012.

Under the amended timetable, Member States will be required to transpose the Solvency II regime into national law by 30 June 2013, with the new rules coming into force on 1 January 2014.

For further information: Directive amending the transposition and application dates of the Solvency II Directive

FSA update on development and use of early warning indicators

September 2012

The FSA has published a letter from Julian Adams, FSA Director of Insurance, to firms in its internal model approval process. The letter provides an update on the FSA’s plans to monitor the ongoing appropriateness of internal models after approval. In order to maintain an appropriate solvency standard delivered by internal models, the FSA is developing early warning indictors to ensure that the SCR will meet the Solvency II calibration on an ongoing basis. The regulator believes that early warning indicators:

• should be based on metrics that are independent from the internal model calculations;
• should be simple in their construction, calibration and application, avoiding complexity; and
• will, if breached, trigger an immediate supervisory response (likely to be a capital add-on).

The use of early warning indicators will form part of the supervisory review process for IMAP firms and the calibration of the indicators will, according to Adams “aim to identify significant deviations in firm risk profile with respect to the assumptions underlying the calculation of the SCR".

Following its June 2012 letter to firms setting out proposals for early warning indicators, the FSA received a number of responses. Adams notes that some respondents expressed support for a European approach and the FSA has shared its views with EIOPA. Some respondents suggested an alternative indicator to the proposed ratio between the pMCR and modelled SCR which the FSA is looking into. Adams also confirms that any early warning indicator will not be used as a condition to the approval of a firm’s internal model, with the fundamental purpose being “to limit subsequent downward SCR drift relative to risk profile”. Finally, Adams states that the indicator should be simple and easy-to-apply and, therefore, the FSA will not be providing calibration for indicators at individual firm level.

The FSA welcomes comments on early warning indicators by 26 October 2012.

For further information: Monitoring the ongoing appropriateness of internal models

FSA publishes IMAP data review findings

September 2012

The FSA has published interim feedback to IMAP firms. The feedback report is based on the FSA’s review of the quality of data used in the internal model and includes:

• an outline of the approach for the data review;
• a summary of the results; and
• detailed observations, with areas for firms to consider when preparing their application to use an internal model.

In summary, the FSA notes that most firms are “moving in the right direction” in terms of data requirements for their internal model. The report identifies ten findings mapped to the five sections of the external review. The FSA highlights some common issues within each section and provides its comments on how firms may address these issues. The issues highlighted can be summarised as follows:

1. Approach to managing data. The FSA notes that although all firms have established a data policy, ensuring a consistent interpretation and application of the policy remains a challenge for firms.
2. Implementation of the data policy. Feedback focuses on data governance, data ownership and large insurance groups. The FSA found that the majority of firms underestimated the time required to embed a group-wide data governance framework into ‘business as usual’, and had difficulty assigning data ownership. In terms of groups, consistent interpretation and application of templates, assumptions and standards of complex data transformations is required between local entity and group level.
3. Understanding of the data used. Key findings include the failure of firms to apply proportionality by conducting an impact and risk assessment. Most firms struggled with an efficient classification of data. The FSA’s comments note that efficient classification requires assigning each data item to exactly one class. In addition, the review revealed that many firms confused ‘data directory’ with ‘data dictionary’. The underlying purpose of the ‘data directory’ is to ensure good governance over data quality, therefore, the FSA suggests that firms should “consider all data and document the data items relevant to the internal model at a level of granularity that is appropriate for ongoing maintenance and use”.  
4. Controls over data quality. Some firms demonstrated inadequately designed or ineffective control over data quality. The FSA notes that it is critical for firms to be able to articulate the nature of data quality checks and demonstrate how the process operates with appropriate controls.
5. IT environment, technology and tools. The review found that many firms were implementing complex IT systems without a clear definition of user requirements, design, testing and appropriate controls. In relation to the use of spreadsheets, the FSA notes that it will be looking for appropriate controls such as reasonableness checks, input validations, peer reviews, logical access management, change and release management, disaster recovery, and documentation.

The FSA’s review work is not yet complete; therefore the report includes only its findings to date. In line with the current Solvency II implementation plan, the FSA aims to complete its review process by the third quarter of 2013.

For further information: IMAP data review findings

FSA publishes second consultation on Solvency II transposition

July 2012

On 11 July 2012, the FSA published CP12/13 Transposition of Solvency II Part 2; its second consultation on rules to transpose the Solvency II Directive into the UK Handbook. The consultation paper includes proposed rules and guidance on areas that were not covered, or were only partially covered, in the first consultation which was published in November 2011. In particular, the consultation focuses on: application of the rules to the Lloyd’s insurance market; FSA policy for separate disclosure of capital add-ons; and proposed changes to rules governing with-profits and unit linked business. The consultation paper is set out in four sections covering:

• Section 1 - Consultation process. This section discusses the European process and alignment with regulatory reform in the UK.
• Section 2 - This section includes feedback on the first consultation paper: CP11/22 Transposition of Solvency II - Part 1. The FSA received responses from 23 firms and organisations and summarises the key points raised in relation to the following issues: the FSA’s general approach to transposition; the SCR; the MCR; composites; conditions governing business; groups; and chapter 10 of SUP.  
• Section 3 - SOLPRU. In this section the FSA sets out its approach to the Lloyd’s market and capital add-ons and USPs. The FSA comments that, due to its unique structure and multiple participants, Lloyd’s poses specific challenges in implementing Solvency II. For the most part, the FSA has sought to apply the SOLPRU rules and guidance set out in CP11/22 to the Lloyd’s market. Additional provisions have been developed where required and supplemented by a new application chapter, SOLPRU 14. The FSA’s approach to Lloyd’s is based on two fundamental principles: Lloyd’s policyholders should benefit from the same threshold level of protection as other Solvency II policyholders; and the Directive requirements should, in general, be applied at the level where risk is managed. In relation to capital add-ons and USPs, the FSA intends to exercise its option of non-separate disclosure by providing firms with a two year transitional period from the date of implementation. During this time, firms would not need to separately disclose, in their solvency and financial condition report, any capital add-ons or USPs required by a supervisor. It should be noted, however, that this proposal only relates to prudential reporting requirements.
• Section 4 - Proposed amendments to the parts of the Handbook covering with-profits and linked long-term insurance business are detailed in this section. The FSA has stated that it is not making any material changes to its underlying policy on conduct regulation for with-profits funds. For consistency with the Solvency II Directive, the FSA has proposed consequential and largely technical changes to the current rules. The proposals do not conflict with recent changes to the COBS as part of the ‘With-Profits Regime Review’. In relation to linked long-term insurance business, this consultation deals with issues related to derivatives, stock lending, and governance that were not covered in CP11/23 Solvency II and linked long-term insurance business.

The FSA continues to take a largely “intelligent copy-out” approach to transposition and has followed the Level 1 text as closely as possible. Comments are invited on policy decisions where Solvency II requires or permits Member State discretion and where Handbook rules are necessary to address UK specificities. The consultation reflects the mainly maximum harmonising nature of the Directive and, therefore, does not reopen discussions on policy that has been agreed in Europe. The FSA has opted to consult at this stage because it considers it has sufficient certainty with regard to the Level 1 text that must be transposed, and any amendments expected to be introduced by Omnibus II is unlikely to affect the core principles of the Solvency II framework. In line with its aim to provide firms with the earliest possible certainty on UK implementation of Solvency II, the FSA believes it is the appropriate time to consult.

Issued not covered in the consultation are: national specific reporting templates; external audit; amendments to the FIT and SUP reflecting change in controlled functions; grandfathering existing ISPVs; and cost comparisons of using internal models versus standard formula for calculating firms’ SCR. The FSA has indicated that it will communicate further on these issues as and when appropriate.

The deadline for comments on the proposals is 11 October 2012. The FSA intends to collate the feedback from both consultations, together with the conduct elements contained in CP11/23, and publish a policy statement. The FSA advises that this timeframe is dependent on the European Commission adopting the Omnibus II Directive and final Solvency II Level 2 measures and, in addition, the legislative timetable for UK regulatory reform and FSA Handbook designation. The FSA has indicated that further consultations may be required once Omnibus II is adopted and the Level 2 text is finalised. Details will be provided when the policy statement is published later this year or in early 2013.

For further information: CP12/13 Transposition of Solvency II Part 2

EIOPA final report on draft guidelines on the ORSA

July 2012

On 12 July 2012, EIOPA published its final report on draft guidelines for the ORSA under the Solvency II Directive. The report sets out the outcome of, and provides feedback on, EIOPA's November 2011 consultation on the draft guidelines. In addition to underlining the purpose of the ORSA, the report provides details on how the ORSA is to be interpreted and sets out EIOPA’s expectations regarding the implementation of the ORSA by insurance undertakings. EIOPA has strongly encouraged the industry to use the current report in their early implementation of the ORSA. Among other things, the report raises the following issues:

• Insurers are expected to have the necessary competence and expertise to find “fit-for-purpose solutions” for the practical challenges of the ORSA.
• EIOPA points out that proportionality is a key feature of the ORSA and insurers should develop tailored processes to fit their own organisational structure and risk management systems.
• The undertaking’s AMSB needs to take an active role in the ORSA, particularly in relation to steering how the assessment is to be performed and challenging the results.
• Undertakings are required to submit a forward-looking assessment of their overall solvency needs to national supervisory authorities, indicating multi-year tendencies and developments. Overall solvency needs should be expressed in quantitative and qualitative terms and quantification complemented by qualitative description of the risks.

EIOPA explains in the report how it has amended and clarified the content of guidelines and the accompanying explanatory text in light of the feedback. Responses to the consultation have been published on EIOPA’s website.

For further information: EIOPA final report on ORSA

EIOPA publishes final report on Solvency II reporting and disclosure requirements

July 2012

On 10 July 2012, EIOPA published its final report on the 2011 consultations on quantitative reporting templates and guidelines on narrative public disclosure and supervisory reporting, predefined events and processes for reporting and disclosure. EIOPA Chairman, Gabriel Bernardino, emphasised the significance of the report stating that “insurance undertakings and supervisors need to start as early as possible with the implementation of reporting and disclosure requirements”.

In its feedback statement, EIOPA addresses both specific issues and general comments raised by respondents including: implementation and maintenance costs; proportionality and materiality; financial stability information; quarterly and fourth quarter reporting; and standard codes to be used in reporting. Alongside the report, EIOPA has published on its website the updated reporting templates, responses received to the consultation and two opinions of the EIOPA insurance and reinsurance stakeholder group. In a press release accompanying the report, EIOPA states that its proposal reflects a balanced approach towards costs and benefits. The proposed reporting templates, EIOPA believes, will improve the efficiency of risk-based Supervisory Review Process and, therefore, increase policyholder protection. Furthermore, EIOPA expects the reporting requirements to contribute to financial stability and allow the assessment and monitoring of market developments.

The reporting requirements are expected to change as a result of the ongoing discussions relating to the proposed Omnibus II Directive, and the future Solvency II implementing measures. Furthermore, the design or structure of the reporting templates may be affected by the development of the IT reporting standards. Despite this, EIOPA believes that the current package provides a stable view of the level of granularity of the information that supervisory authorities will need to receive. EIOPA has, therefore, urged the industry to use this package now as the basis for ensuring compliance with the Solvency II reporting and disclosure requirements during the implementation stage.

EIOPA expects that the full package on Solvency II reporting and disclosure, with all changes incorporated, will be available later in 2012. The implementing technical standards will be submitted by EIOPA for endorsement by the European Commission.

For further information: EIOPA final report

FSA feedback statement on Solvency II and linked long-term insurance business

June 2012

The FSA has published its feedback on linked long-term investments under Solvency II. The feedback considers the changes to rules currently contained in chapter 21 of the COBS. The consultation paper, published in November 2011, set out the FSA’s proposals for changes to the rules and guidance on the operation of unit-linked and index-linked insurance policies. In its feedback statement, the FSA commented that it was surprised to have only received 20 responses to the consultation, given its significance in the UK life insurance sector. Notably, the amended Handbook text was not published with the feedback statement. The FSA intends to publish a policy statement “in the near future” which will include all the Handbook changes consulted on as part of Solvency II transposition.

The rules relating to the operation of unit-linked and index-linked insurance policies are primarily contained in COBS 21. Chapter 2 of the feedback statement summarises the responses received to the FSA’s proposed amendments of COBS. The FSA notes that, despite a wide range of responses, there was broad agreement with its general approach and, therefore, the FSA intends to:

• Remove the exemptions to specific categories of linked business in COBS 21.1.R.
• Delete the parts of COBS 21.2 that effectively duplicate rules in chapter 7 of SOLPRU.
• Make some minor amendments to the rules in COBS 21.2 relating to issues that are specific to the conduct regulation of linked business and which are not affected by the prudential requirements of Solvency II.
• Remove the definition of an institutional linked policyholder in COBS 21.3.
• Amend COBS 21.3 to include a list of specified asset types that can be used where the policyholder is a natural person bearing the direct investment risk.
• Maintain its existing position in relation to unlisted securities and not introduce a limit for unlisted securities.

Chapter 3 of the feedback statement addresses some general points raised in the consultation. The FSA makes the following comments in response:

• Proposals on derivatives and governance will be included as part of a further consultation on implementing Solvency II.
• Where possible, the FSA will seek to give certainty as to implementation of Solvency II. It is the FSA’s intention that firms are given as much time as possible to implement the rule changes.
• Any security that is admitted to an official list in the EEA qualifies as a listed security. Under the current definition, securities listed in areas such as Japan and the US would be considered unlisted. It is not the FSA’s policy intention to limit listed securities to the EEA only, therefore, this will be given further consideration and clarified in the final Handbook rules.

For further information: Solvency II and linked long-term insurance business

EIOPA publishes paper on third country equivalence measures

June 2012

On 14 June 2012, EIOPA published a paper on third country equivalence measures under the Solvency II Directive. The paper provides information on equivalence transitional measures, proposed under the draft Omnibus II Directive and explains work EIOPA is currently undertaking further to the European Commission’s request for technical input in February 2012.

The Commission has developed a transitional regime for Solvency II equivalence for third countries which either have a risk based regime similar to Solvency II or are willing and committed to move towards such a regime over a pre-defined period (5 years in the Commission’s initial proposal). For those third countries that have indicated that they are interested in being covered by the transitional provisions, the Commission has requested that EIOPA carry out an analysis including:

• Whether persons working for, or on behalf of, the supervisory authorities are bound by obligations of professional secrecy. Professional secrecy equivalence is a prerequisite to inclusion in a transitional regime.
• The main areas where the equivalence criteria would currently not be met.

To date, Australia, Chile, China, Hong Kong, Israel, Mexico, Singapore and South Africa have expressed an interest in being covered by the transitional provisions, and have received requests for information to enable EIOPA to carry out a Solvency II gap analysis. EIOPA has confirmed that its advice to the Commission will be based largely on the responses provided by these third countries to its questionnaire for equivalence gap analysis. The questionnaire was published as an annex to the paper. Following the adoption of the Omnibus II Directive, EIOPA expects to launch a call for evidence inviting any interested parties to provide input on the factors they think may be relevant to its gap analysis or professional secrecy equivalence assessment.

EIOPA stresses that its work is of a technical nature only and it will be up to the Commission to decide which third countries will be included in the equivalence transitional regime. The paper indicates that the Commission’s decisions will most likely be taken in mid-2013 under the working assumption that the Solvency II regime will be applied by EU firms from 1 January 2014.

For further information: Solvency II - Equivalence Transitionals measure

FSA publishes feedback letter and speech on Solvency II IMAP work

May 2012

On 15 May 2012, the FSA published a letter from Julian Adams, FSA Director of Insurance Supervision, sent to firms involved in the FSA’s IMAP in preparation for the implementation of Solvency II. In addition, Adams gave a speech discussing specific feedback issues from the letter.

In his speech, Adams explains that firms will shortly be moving from the ‘pre-application’ to the submission phase of IMAP, with the FSA expecting the first submissions in May 2012. Submissions will be reviewed against the FSA’s current requirements and feedback on the model provided to the firm in question. The letter sets out the FSA's feedback on firms' IMAP work to date, including observations on the following issues where the FSA has observed weaknesses in its reviews of firms' work:

• Methodology and assumptions. Models should be pitched at an appropriate level, adequately reflecting the risk a firm is exposed to but avoiding unnecessary complexity.
• Aggregation and dependency. The FSA expects firms to be able to explain and validate the choices and assumptions made in relation to the amount of diversification credit a firm seeks to take, and in particular whether it presents a capital number which is adequately reflective of risk.
• Validation. The FSA expects decisions about materiality thresholds to be clearly articulated and justified. Adams states that many of the validation policies already seen are too vague, and that the level of detail should reflect the materiality of the elements of the model.
• The use test. Firms are expected to demonstrate how the internal model has been embedded, and where it will be used within the business.

The FSA has also identified model change policy, un-modelled risk and documentation requirements for Solvency II as further areas of weakness.

The date at which the FSA can begin accepting formal applications is dependent on when it assumes formal legal powers under Solvency II, which in turn is dependant on the finalisation of the Omnibus II Directive, however, Adams suggests it will be “some time in 2013”.

For further information: 

Feedback from our IMAP work to date

Solvency II and the London Market

EIOPA opinion on external models and data used for calculating Solvency II capital requirements

May 2012

On 7 May 2012, EIOPA published an opinion, addressed to supervisors, regarding the process for approving the use by insurers of external models and data to calculate the SCR using a full or partial internal model, under the Solvency II Directive.

In the opinion, EIOPA states that an insurer should provide the specific information required to enable its supervisor to assess whether an internal model approval to calculate its SCR should be granted. The supervisor should reject an insurer’s application if it fails to provide the specific information or documentation required for a proper assessment. The opinion further provides that any insurer seeking to obtain approval of an internal model application, which includes the use of an external model or data (that is, external models or data an insurer has obtained from a third party vendor), must demonstrate to its supervisor that it has complied with all the requirements for internal model approval.

Applications which include the use of an external model or data must be assessed by the supervisor on the appropriateness of each individual application. EIOPA states that particular attention should be paid to how the external model or data has been adapted to take into consideration the insurers risk profile and specificities. In these cases, the supervisor may request additional information about either the external model or data in order to assess whether the requirements have been complied with. Again, failure to provide such information will result in the application being rejected. The opinion states that contracts between insurers and third party vendors of models or data should specify how to deal with providing information to supervisors for approving an internal model application. The contract terms cannot be used to justify an insurer's refusal to demonstrate that its external model or data fulfils the necessary requirements.

In order to address confidentiality concerns raised by some vendors of external models and data, the opinion emphasises that confidentiality provisions are already in place under Solvency I, and these provisions extend to confidential information received by supervisors during the pre-application process.

Gabriel Bernardino, EIOPA Chairman, confirmed that EIOPA intends to make use of opinions as a “tool” to promote common supervisory approaches and practices in the EU.

For further information: EIOPA opinion on external models and data

FSA publishes policy statement on RDR adviser charging and Solvency II disclosures

March 2012

On 22 March 2012, the FSA published PS12/5 Distribution of retail investments - RDR Adviser Charging and Solvency II disclosures - feedback to CP11/25 and final Adviser Charging Rules. The policy statement follows the publication of CP11/25 Distribution of retail investments - RDR Adviser Charging and Solvency II disclosures in November 2011.

The consultation paper considered the changes needed to implement the disclosures required by Article 185 of the Solvency II Directive, and included amendments to Chapters 1, 13, 14, 15 and 16 of COBS. The disclosures required by Article 185 incorporate and extend those under the current CLD and most of the additional Solvency II disclosure information is already contained in the FSA rules. Where this is the case, the FSA has replaced references to the CLD with references to the relevant provisions in Solvency II. The Solvency II disclosure rules are "near final", and will be made at the same time as the main Solvency II rules. The FSA confirms that it expects this to be at the end of the year and the rules should come into effect on 1 January 2014.

For further information: PS12/5 Distribution of retail investments - RDR Adviser Charging and Solvency II disclosures - feedback to CP11/25 and final Adviser Charging rules

Official white paper published on the transposition of the Solvency II Directive into German law

February 2012

The official white paper on the transposition of the Solvency II Directive into the VAG has just been published. After going through the legislative process, the law will come into effect on 31 October 2012. The white paper does not attempt to harmonise the VAG and the Directive. It does, however, seek to avoid the imposition of any additional requirements on top of those provided for in the Directive, unless they already exist in the VAG. The following issues will be of greatest interest:

• The risk-based capital requirements (including enhanced solvency requirements based on an integral risk analysis and new valuation rules based on market value) are transposed in line with Solvency II’s three-pillar approach.
• There will be a greater focus on group supervision. It will be enforced through the establishment of a group supervisor as well as better cooperation between the supervisory authorities of respective Member States.
• BAFin will focus more on the active review of risk profiles of insurance companies and on the quality of their risk management and governance systems. The white paper gives BaFin greater discretion regarding the application of the regulations. As BaFin will increasingly be incorporated into the European system of financial supervision, which is headed by EIOPA, the VAG will be just one of several levels of legal provisions.
• Any debt financing for insurers (outside of the permitted types of Tier-1 and Tier-2 capital) will continue to qualify as non-insurance business and will not be permitted for German regulated insurers.
• The current system of keeping a register of specific assets covering technical reserves will be maintained.
• Where a cross-border portfolio transfer within the EU leads to a change in the competent EU supervisory authority, the policyholder will be entitled to terminate their policy.
• Certain transitional provisions do exist under certain circumstances. For example, there are provisions regarding minimum capital requirements (one to two years) and disclosure requirements (five years).

The GDV has commented positively on the white paper’s clear and comprehensive structure. However, one of the main objectives was to keep the cost and effort connected with the new requirements as low as possible for the insurance industry. The GDV noted that the white paper could cause enormous practical challenges for insurance companies attempting to comply with the new requirements.

For further information, please contact Andreas Börner in Munich.

FSA publishes general and life insurance newsletters

February 2012

The FSA has published Issue 7 of both the General Insurance Newsletter and the Life Insurance Newsletter. In his introduction, Julian Adams, FSA Director of Insurance, comments that the evolving shape of regulation (both domestically and globally) is likely to continue to influence significant changes in the wider insurance market. According to Adams, Solvency II, changing accounting standards, regulatory reform, the gender ruling and the implementation of the RDR are just some of the changes ahead. These will require careful consideration and firms will require an in-depth understanding of the changes they face in order to respond with adequate strategic solutions.

On the subject of Solvency II, both newsletters contain an article providing a policy and implementation update. The article confirms that, whilst the vote by ECON has been rescheduled to 21 March 2012, the FSA has no information to suggest that the dates beyond 2014 will change. Therefore, firms should continue to work on this basis and the FSA will provide further updates as appropriate. The article also states that, owing to the complexity and lead times involved, the FSA is continuing with its preparations for accepting submissions from internal model firms from 30 March 2012. The FSA encourages firms in the pre-application phase of the internal model approval process to register for the half-day industry briefing, which is due to be held on 27 February 2012. For all other firms, the FSA will be open to receive applications from 1 January 2013, for approvals that firms will require from 1 January 2014. The FSA may, however, exercise its discretion to deal earlier with more complex issues and will continue to monitor firm readiness for the new regime through its ongoing supervisory engagement.

For further information:

General Insurance Newsletter - Issue 7

Life Insurance Newsletter - Issue 7

European Commission publishes letter on third country equivalence

February 2012

The European Commission has published a letter, dated 2 February 2012, sent by Jonathan Faull, Director General for Internal Markets and Services, to Gabriel Bernardino, Chairman of EIOPA.

The proposed Omnibus II Directive introduces the possibility for third countries (which meet defined criteria) to be included in a transitional regime for Solvency II equivalence. Whilst many of the details of the transitional regime, including the criteria for eligibility and the length of the transitional period, are yet to be agreed, the Commission understands that the co-legislators are supportive of such a regime for third country equivalence.

In his letter dated 22 November 2011, Faull asked EIOPA to carry out an analysis of the following:

• whether persons working for, or on behalf of, the supervisory authorities are bound by obligations of professional secrecy, which are equivalent to those established under Solvency II; and
• the areas where the third country’s supervisory regime does not currently meet equivalence criteria.

This technical analysis will help the Commission prepare for future discussions in relation to both full and transitional equivalence determinations under Articles 127, 227 and 260 of the Solvency II Directive. The Commission expects EIOPA to adopt a different approach to that taken when considering full equivalence assessments.

The Commission has already entered into informal discussions regarding a potential transitional regime with a number of countries, and Australia, Chile, Hong Kong, Israel, Mexico, Singapore, and South Africa have expressed an interest in being part of the regime. Faull stresses that these countries are not certain of inclusion in the transitional regime. Discussions are ongoing and a decision will not be taken by the Commission until next year.

The Commission is also engaged in discussions with Brazil, China and Turkey. Discussions are at an early stage, but the Commission understands that the countries are, in principal, interested in inclusion in a transitional regime. In addition, the JFSA indicated its interest in being included in a transitional regime for third country equivalence in relation to group solvency and supervision, under Articles 227 and 260, when EIOPA provided its assessment of the solvency regime applied to the Japanese reinsurance sector under Article 172.

In relation to the United States, representatives from the Commission and EIOPA recently met with representatives from the Federal Insurance Office and State insurance regulators to define a workplan, which is designed to lead to increased mutual understanding and cooperation in the insurance sector. Faull suggests that the outcome of this work could serve as a basis for future discussions on equivalence. However, the prudential regulation of insurance undertakings remains a State competence under US law and Faull recognises that a different approach to equivalence will be required.

For further information: Letter dated 2 February 2012

ABI publishes volume 22 of its Solvency II Bulletin

January 2012

The ABI has published volume 22 of its Solvency II Bulletin. In his introduction, Hugh Savill, ABI Director of Prudential Regulation, states that European policymakers must aim to end 2012 with full certainty on the Solvency II rules that will be binding on insurers from 1 January 2014. For their part, Savill suggests that, insurers need to use the next 11 months to enact their implementation plans to the greatest extent possible.

2011 proved to be an extremely challenging year in the development of the Solvency II Directive. However, Savill believes that it would be unkind for the year to go down in the annals as a failure. For example, the recognition of EPIFP as Tier 1 capital and the appreciation of the need for adequate solutions to the issues of pro-cyclicality and long-term insurance business were just two significant developments in a number of positive gains for the industry in the past 12 months. According to Savill, the immediate priority must now be to reach an agreement on the Omnibus II Directive.

ECON has now moved its ballot back to late March. The principal reason for the delay is that compromise amendments are still to be produced in key areas of debate. Most significantly, in relation to long-terms guarantees, which covers essential elements of the new regime such as the Matching Premium, the extrapolation methodology and the Counter-Cyclical Premium. Whilst this delay would appear to place more strain on the Solvency II implementation timeline, it appears increasingly likely that the European Parliament will seek to assess the details of the Level 2 package in parallel with Omnibus II. The aim of such a move would be to approve the Level 2 measures in as short a period of time as possible, following publication of the final Omnibus II text.

In Savill’s opinion, European policymakers are clearly aware of the need for movement. For example, EIOPA recently consulted on two Level 3 papers, having been given special dispensation to do so in order to provide the industry with some clarity. The Bulletin includes articles on both papers.

In relation to EIOPA’s consultation on the detailed features of Solvency II’s supervisory reporting and public disclosure requirements, the Bulletin notes the presence of two key topics in the paper. Namely: (i) reporting processes; and (ii) pre-defined events that would trigger public or private reporting by insurers outside of their regular reporting cycle (for example, in the case of relevant merger or acquisition activity involving the insurer in question). In its response to the consultation, the ABI emphasised the importance of the principles of proportionality and materiality by insurers when constructing their reports. In particular, the guidelines on the SFCR are considered to be excessively detailed for the purposes of public disclosure. Given the wide-audience that such reports will address, the ABI states that, it is of utmost importance that the content of the SFCR should be easily understandable and its content carefully explained by insurers.

The consultation on the ORSA was also welcomed by the industry and provided some useful clarifications. However, the ABI believes that there are still some areas in the consultation where feedback suggests that the European body should issue more information. In particular, whilst the consultation notes that the internal report on the ORSA produced by an insurer could be used as the basis for the ORSA report to supervisors, the potential for duplication of documentation is not alleviated to the same degree when referring to the ORSA policy and the record of each ORSA process.

For further information: Solvency II Bulletin volume 22

EIOPA publishes report on the calibration of premium and reserve risk factors in the standard formula

December 2011

On 12 December 2011, EIOPA published Calibration of the Premium and Reserve Risk Factors in the Standard Formula of Solvency II: Report of the Joint Working Group on Non-Life and Health NSLT Calibration.

When delivering its advice on the Level 2 measures, EIOPA agreed to carry out a comprehensive revision of the calibration of the premium and reserve risk factors in the NSLT underwriting risk module of the SCR standard formula. To this end, EIOPA established a Joint Working Group consisting of representatives from AMICE, Groupe Consultatif, the CEA and CRO Forum, as well as observers from the European Commission. The working group was tasked with discussing the most appropriate calibration methods and deriving recommendations for the premium and reserve risk factors. The report summarises the findings and recommendations of the working group.

The methodology used to carry out the calibrations took as its starting point the methodology previously applied by EIOPA’s predecessor, CEIOPS, in deriving its technical advice on the setting of premium and reserve risk factors for non-life underwriting risks in QIS5. Building on this, the report contends that, discussions in the working group led to significant improvements in the methodology, including a more systemic approach to the underlying statistical framework as well as the development of a comprehensive set of validation tools.

In the analysis undertaken, two broad options emerged for the setting of factors. Namely, a pan-European approach (favoured by EIOPA) and an averaging approach (favoured by the industry). Under the pan-European approach, the factors are set on the basis of a pooled European data set. Whereas, the averaging approach initially requires factors to be set at a regional level. The final Europe-wide factor is then determined by averaging across the regional factors.

The working group has, therefore, recommended the use of a combined approach (which combines the advantages of the two options described above) as a methodological basis for the calibration of the premium and reserve risk factors. The combined approach offers the advantage of taking into account the heterogeneity of the non-life risks in the individual markets for the setting of the European factors. At the same time, it ensures that the final factors are reflective of the average size of portfolios of insurers in the European markets to which they are applied.

For further information: Calibration of the Premium and Reserve Risk Factors in the Standard Formula of Solvency II: Report of the Joint Working Group on Non-Life and Health NSLT Calibration

HM Treasury publishes consultation paper on Solvency II

November 2011

On 23 November 2011, HM Treasury published a consultation paper inviting views on the changes the Government is making to UK legislation in order to transpose the Solvency II Directive. The Government accepts that there is still a level of uncertainty as to the detailed practical effect of implementing Solvency II, as Omnibus II is still under discussion (and will not be adopted until this consultation is complete) and the Level 2 implementing measures cannot be formally published by the European Commission until Omnibus II has been adopted by the European Council and European Parliament. However, the Government believes that discussions have reached a stage at which it is clear that the policy set out by Solvency II, and the legislation that needs to be transposed into UK law, is sufficiently stable to allow for the necessary transposition. The Government has therefore decided to consult at this juncture in order to give (re)insurance undertakings as much certainty and clarity as possible and to provide adequate time to prepare for the implementation of Solvency II.

To facilitate the full implementation of Solvency II, the Government needs to make changes to UK legislation and the FSA will amend its Handbook rules. The Statutory Instrument (available in Annex B of the consultation paper) contains provisions amending FSMA (as amended by the forthcoming Financial Services Bill which is due to be introduced into Parliament in early 2012). The required legislative changes fall into four broad categories:

• The amendments necessary to set out the conditions under which undertakings may be authorised and de-authorised to carry out (re)insurance business.
• New powers for the PRA, aimed mostly at enabling the PRA to provide the support and supervision required to enable (re)insurance undertakings to calculate their solvency position on a Solvency II basis.
• New duties for the PRA aimed at mandating its participation in the new European supervisory framework.
• Amendments to align UK terms and definitions with those set out in Solvency II.

The number of changes required to primary legislation is relatively small (as the majority of Solvency II requirements will be contained in the FSA Handbook) and the scope of the consultation is limited to amendments the Government intends to make to FSMA. To this end, the consultation does not cover the Level 2 implementing measures (which provide the technical details and processes through which Solvency II will take effect) as the Commission has indicated that these measures will be made by Regulation, once finalised, and will not require transposition into UK law.

The consultation period will run for 12 weeks and the closing date for responses is 15 February 2012.

For further information: HM Treasury: Consultation on Solvency II

FSA publishes consultation paper on the distribution of retail investments and Solvency II disclosures

November 2011

On 10 November 2011, the FSA published CP11/25 Distribution of retail investments RDR Adviser Charging and Solvency II disclosures. Amongst other things, the consultation paper sets out minor changes to the disclosure requirements in chapters 13 to 16 of COBS to implement Solvency II requirements.

Solvency II includes disclosure requirements, which incorporate and extend those required by the Consolidated Life Directive. The consultation considers how the FSA will incorporate these changes. It does not, however, cover changes to COBS 20 (with-profits) or COBS 21 (permitted links), which will be consulted on separately. The general application of Solvency II disclosure requirements is the same as for the Consolidated Life Directive, and for the most part the FSA proposes simply to replace the references to the Consolidated Life Directive in COBS 1 Annex 1 with references to the relevant provisions in Solvency II. In addition, most of the additional disclosure information set down in Article 185 of Solvency II is already required by FSA rules.

The consultation period ends on 10 January 2011 and the FSA plans to publish a policy statement in the first quarter of 2012.

For further information: CP11/25 Distribution of retail investments RDR Adviser Charging and Solvency II disclosures

EIOPA publishes report on cross-border cooperation mechanisms between insurance guarantee schemes in the EU

October 2011

On 5 October 2011, EIOPA published a report summarising the findings of a mapping exercise on the existing mechanisms for cross-border cooperation between IGSs of Member States and national supervisory authorities. The report has been prepared in accordance with the work programme specified in the mandate of the EIOPA task force on IGSs and provides general recommendations to the European Commission.

In conducting the mapping exercise, the task force developed a questionnaire which collected relevant data from Member States about the motor insurance regime and banking sector deposit guarantee scheme in the EU, and the US insurance guarantee regime. The responses were then compared in order to identify any lessons that could be of benefit. For example, by considering the motor insurance regime in the EU, the task force concluded that a future IGS directive should aim at aligning the scope and principles of IGSs to avoid contradictory positions being adopted between national IGSs and to create legal certainty in areas in which cross-border cooperation is expected.

The report summarises the conclusions and proposals reached by the task force following completion of the mapping exercise. In the report, the task force advocates:

• Clear cooperation procedures for consumer protection.

Effective cooperation between home and host state IGSs and between IGSs and supervisors will help to ensure that policyholders are protected when an insurance undertaking fails. The proposed IGS directive needs to set out a framework for cooperation. It should also ensure that IGSs have effective cooperation arrangements in place.

• Exchange of information by IGSs as a prerequisite for effective policyholder protection.

IGSs will require access to information from supervisors, both during the handling of an insolvency situation and on an ongoing basis, to enable the IGS to prepare for its involvement in potential cases. IGSs should, on a regular basis, provide general information about their own schemes, such as any coverage offered beyond the minimum stipulated by the proposed IGS directive, any material changes to the coverage, and contact details, so that in the event of a failure, all IGSs already hold this basic information.

• Provision of legal certainty for the purpose of confidentiality

The proposed IGS directive should include specific requirements relating to the exchange of information by supervisors and IGSs prior to, and during a winding-up procedure or other insolvency event. It should explicitly relieve the parties from their general duty to protect information. Supervisors and IGSs should be able to provide sensitive information without fear of breaching professional secrecy rules.

• Provision of infrastructure for exchange of information

Colleges of supervisors should discuss, in conjunction with IGSs, how cooperation arrangements should work, both in normal times and in the event of failure.

• Need for a mechanism to solve disputes

Parties should take all necessary steps to reach an agreement on how best to deal with an undertaking in financial difficulties. Nevertheless, disagreements may arise and the proposed IGS directive should provide a mechanism to settle such disputes. The task force suggests that the use of EIOPA’s mediation regime could be considered.

For further information: Report on the cross-border cooperation mechanisms between Insurance Guarantee Schemes in the EU

European Parliament publishes report on insurance guarantee schemes

September 2011

The European Parliament has published a report, produced by ECON, on IGSs. The report explains that IGSs are designed to reduce the risk to policyholders in the event of the failure of an insurer. Essentially these schemes are a policyholder’s last resort when insurers are no longer able to meet their commitments. The issue is complex as there are already a number of IGSs in place throughout Europe (for example, the UK operates the Financial Services Compensation Scheme) and there is an interplay with other issues currently under consideration at EU level, most notably the Solvency II Directive. According to the report, an EU dimension is necessary in order to ensure:

• consumer protection in the event of the bankruptcy of an insurer;
• equal consumer protection regardless of the home state of the insurer;
• consumer protection in the event of fraud or mis-selling; and
• tax payer protection in the event of the failure of an IGS.

The report suggests that these goals can be met by a minimum harmonisation directive that ensures the same level of consumer protection regardless of the location of the insurer writing the policy and limits the exposure of tax payers in a market where the size of one or a number of insurers vis-à-vis the overall market is such that the failure would imperil the ability of an IGS to meet the claims of policyholders. Within these boundaries the design of the scheme will be a matter of subsidiarity (i.e. beyond the minimum requirements of the directive, individual Member States will be responsible for designing the scheme). Furthermore, the report does not support the introduction of a compulsory ex-ante scheme. In a situation where the failure of one or a number of insurers could place significant strain on the ability of an IGS to absorb all claims made, it is suggested that the home state regulator should ensure that the additional risk posed is accounted for through further supervisory standards. Given the implications of the failure of an IGS, national supervisors in cooperation with EIOPA should conduct market specific and Europe-wide stress testing to ensure that schemes are capable of withstanding the failure of one or more insurers.

ECON also believes that the geographical scope of an IGS should be decided on the basis of the home country principle. Ultimately the failure of an insurer will be linked to the inadequacy of supervision by the home supervisor. Therefore, the burden of compensating policyholders affected by that failure should be borne by the home IGS. The report considers a number of other key features and suggests that IGSs should fully cover valid policy claims across all forms of insurance, the claims compensation process should be consistent for all consumers and that IGSs should only cover natural persons at this stage (although national schemes may choose to include legal persons). Finally, the report calls on the European Commission to rapidly put forward its proposal for a directive on IGSs to complement the Deposit Guarantees Scheme Directive, the Investor Compensation Schemes Directive and the Solvency II Directive.

For further information: Report on Insurance Guarantee Schemes - Committee on Economic and Monetary Affairs

European Commission publishes a summary of responses to the consultation on the Level 2 implementing measures for Solvency II

May 2011

On 24 November 2010, the European Commission invited submissions from stakeholders and other interested parties on the Level 2 implementing measures for Solvency II. The Commission received 68 responses to the public consultation and has now published a document summarising these contributions.

The Commission reports that, by virtue of the nature and volume of the comments received, the consultation identified a small number of key issues that were of particular concern to stakeholders.

The impact on long-term products

A large number of respondents were concerned about the effect of the Level 2 implementing measures on long-term products, particularly those with guarantees. QIS5 suggested that it will no longer be viable for insurers to continue to offer these products. The problem is caused by the volatility of the value of assets and liabilities under a market consistent valuation framework and the measurement of specific risks that undertakings offering these products are exposed to. As a result of these comments, the Commission has established a working party which is currently analysing these issues. The Commission states that necessary measures will be taken to ensure that the characteristics and risks of long-term products are adequately reflected in the implementing measures.

Volatility and pro-cyclicality

Respondents also highlighted the need for mechanisms designed to address pro-cyclicality to work effectively and not create artificial volatility. The merits of the illiquidity premium as an anti-cyclicality measure were also observed and respondents suggested that a similar mechanism should be used to address distortions in the government bond market.

Proportionality and limiting the reporting burden

Many respondents cited the need for the concrete application of the proportionality principle in relation to Pillar III requirements, for example through exempting certain undertakings from quarterly reporting based on the size, nature and complexity of the risks in their business. Furthermore, respondents stressed the need to apply the proportionality principle across all three of the Solvency II pillars.

Transitional measures

The consultation highlighted the need for transitional measures in certain areas to ensure a smooth transition to the new Solvency II regime and to avoid market disruption. The areas in which transitional measures were deemed necessary include own funds, reporting requirements and third country equivalence.

EIOPA

Finally, the respondents made reference to the new European supervisory architecture and the importance of EIOPA in ensuring a harmonised application of the requirements. The need for a harmonised approach between supervisors was specifically mentioned in relation to capital add-ons, supervisory reporting and the actuarial function.

EIOPA announces the results of QIS5

March 2011

On 14 March 2011, EIOPA published the results of QIS5. QIS5 assessed the practicability, implications and impact of specified approaches to (re)insurers’ valuation of assets and liabilities as well as capital settings under Solvency II.

In comparison to QIS4, which was conducted in 2008, there was a marked increase in the participation of insurers. EIOPA reported that almost 70 per cent of all insurance and reinsurance companies falling under the scope of Solvency II participated (an increase of 33 per cent).

QIS5 revealed that the financial position of the European insurance and reinsurance sector, assessed against the SCR set down in Solvency II, remains sound. At present, the insurance companies that participated hold €395 billion and €676 billion of excess capital to meet their SCR and MCR respectively. EIOPA feels that this highlights the strong position of the sector as the capital surplus was achieved despite a difficult market situation.

For insurance and reinsurance groups, QIS5 showed a reduction in their capital surplus. When compared to the calculation under Solvency I, insurance groups have €86 billion less surplus capital available. However, QIS5 demonstrated that this reduction could be largely absorbed if insurance groups apply internal models and transitional measures to calculate their capital requirements under Solvency II.

QIS5 also examined the calibrations within Solvency II. While these are generally accepted as appropriate, EIOPA reports that it is already performing additional work to improve the calibrations, especially in regards to the areas of non-life and catastrophe modules. As QIS5 was designed to encourage insurance companies and supervisors to prepare for Solvency II, EIOPA has been able to use the exercise to identify areas where further guidance is necessary and where the feasibility and complexity of the proposals should be addressed to facilitate proper implementation by all undertakings. EIOPA cites various examples including the design of the non-life and health catastrophe risk sub-modules, the definition of contract boundaries and related valuation of deferred taxes, and expected profits in future premium.

Similarly, QIS5 identified areas, which were not tested in this exercise, that require further attention from the industry in the preparation for Solvency II. These areas are governance, risk management and reporting requirements.

To summarise, QIS5 showed that a prudent framework has to be based upon sound capital requirements, with particular attention paid to the quality of capital. EIOPA concludes that transitional measures are needed to ensure a smooth transition from Solvency I to Solvency II but stresses that an important balance needs to be struck. Transitional measures should be limited and not extended excessively due to a potential adverse effect on competition and the incentive for the insurance sector to implement Solvency II, nor should they be too short a duration so as to limit their effectiveness.

European Commission publishes the long-awaited Omnibus II Directive Proposal

January 2011

On 19 January 2011, the European Commission published the long-awaited proposal for the Omnibus II Directive (Omnibus II). Omnibus II will make changes to existing legislation to enable supervisory convergence under the new European regulatory architecture. Omnibus II sets out the scope of how the new ESAs will exercise their powers, including their capacity to develop draft technical standards and settle disagreements between national supervisors. Omnibus II will also make a series of amendments to the Level I Solvency II Directive, including moving the implementation date back by a couple of months.

The ESAs will replace the former Lamfalussy level 3 Committees CESR , CEBS and CEIOPS , which had only advisory powers. In contrast, the ESAs have been given enhanced powers including the power to develop technical standards, draw up specific rules for national authorities and financial institutions, take action in emergency situations (for example banning certain products) and settle disputes between national supervisors. The new ESAs are EIOPA, EBA and ESMA.

The amendments made by Omnibus II will fall broadly into the following categories:

• Definition of the appropriate scope in which the ESAs will be able to propose technical standards as an additional tool for supervisory convergence and with a view to developing a single European rule book.
• Detail of how the ESAs will settle disagreements in those areas where common decision making processes already exist in sectoral legislation.
• General amendments which are necessary for the existing directives in the financial services sector to operate in the context of the ESAs, for example, renaming the level 3 committees as the ESAs and ensuring that the appropriate gateways for the exchange of information are present.

The legislative proposal contains a limited set of amendments to Solvency II. These include the provision of more specific tasks for EIOPA, such as ensuring harmonised technical approaches on the use of ratings in relation to Solvency Capital Requirements, and extending the implementation date by two months (to 31 December 2012) to ensure better alignment with the end of the financial year for the majority of insurance and reinsurance undertakings. The amendments will also allow the Commission to specify transitional measures in certain areas if deemed necessary to avoid market disruption and to allow a smooth transaction to the new regime.

The proposal will now be sent to the European Parliament and the Council of the European Union for consideration. The European Parliament has announced an indicative date of 15 November 2011 for its plenary session on Omnibus II.

For further information:
Omnibus II Directive Proposal
Financial services: additional legislative proposal to complete the framework for financial supervision in Europe (Press Release)

Solvency II will radically change the supervision of insurers and reinsurers across Europe. Under the Solvency II Framework Directive, existing insurance directives will be amended and recast into the new regime which aims to introduce a consistent, risk-based, solvency regime which better reflects modern solvency and reporting requirements.

The Solvency II Framework Directive, which was adopted by the European Council on 10 November 2009, requires the provisions of the new regime to be in force by the end of December 2012.

This blog will provide regular updates on Solvency II related developments.