Need for a better balance - The Solvency II review and lessons from EIOPA's impact assessment - GDV

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Need for a better balance - The Solvency II review and lessons from EIOPA's impact assessment - GDV
Gesamtverband der Deutschen Versicherungswirtschaft e. V.

    Regulation and supervision compact

   Need for a better balance
   The Solvency II review and lessons
   from EIOPA’s impact assessment

   While the current 2020 Solvency II review is ongoing, the                         Götz Treber
                                                                               Member of the Extended
   German insurance industry has proven its stability throughout                 Management Board
   >.*  ŤǨDz 9%7)*6/'Ş./= ?7)*;4/7*=>.* *++*'>/@*7*== 8+              ǧǫǧǪǧǪǧʆǭǬǯǧ
   the current Solvency II regulatory framework. However, EIOPA’s
                                                                                    Lenka De Mauro
   holistic impact assessment shows that the draft proposals still
                                                                                Head of European and
   have room for improvement in some areas, particularly with                    International Affairs
   regard to three key aspects:                                         

   ʻ .*extrapolation method used for the risk-free rate curve should not
     be changed.

   ʻ .**++*'>/@*7*==8+>.*Volatility Adjustment should be increased,
     and the Dynamic Volatility Adjustment should be included in the
     standard model.

   ʻ .*9;898=*)'%4/&;%>/878+>.*interest rate risk should be improved.

   Addressing these topics in a consistent manner will enable and
   promote the achievement of other important EU political objec-
   tives such as the Capital Markets Union, the European Green
     *%4%7)>.**'8786/';*'8@*;C%+>*; ŤǨDzŞ
Need for a better balance - The Solvency II review and lessons from EIOPA's impact assessment - GDV
02      Need for a better balance

     Solvency II review:                                                                 listic Impact Assessment5 (HIA) to                                     This publication gives an over-
     ongoing situation                                                                   gain deeper insights into the effects                              view over the HIA’s findings so far.
     The goal of the 2020 Solvency II re-                                                of the review by analysing the com-                                The results reveal that many of the
     view1 is to better reflect the long-term                                             bined impact of changes to techni-                                 proposals currently under discussi-
     nature of the insurance business mo-                                                cal provisions, own funds and sol-                                 on would have a direct impact on
     del, thereby strengthening the status                                               vency capital requirements. The re-                                insurers’ capital requirements.
     of insurers as long-term capital pro-                                               ference date for the exercise was the
     viders. Achieving this will allow insu-                                             31 December 2019.                                                  Need for a better balance
     rers to contribute to key European                                                                                                                     – results of the Holistic
     objectives such as the Capital Mar-                                                 COVID-19 changed not                                               Impact Assessment
     kets Union2 (CMU) and the Europe-                                                   only the timetable                                                 The 2020 Solvency II review is an
     an Green Deal at their full potential.                                              Due to COVID-19 the timeline of the                                opportunity to improve the current
          The starting point of the review                                               review has been delayed by 6 months                                regulation and ensure that it re-
     was the European Commission‘s                                                       (see Chart 1). EIOPA has postponed the                             flects the business model of insu-
     „Call for Advice3„ to the European                                                  submission of its recommendations                                  rers more accurately. Due to their
     Insurance and Occupational Pen-                                                     to the European Commission until                                   liability structure, insurers are able
     sions Authority (EIOPA) on 11 Feb-                                                  the end of December 2020. The ori-                                 to hold investments until maturity.
     ruary 2019 (Directive 2009/138/EC).                                                 ginal deadline of 30 June 2020 could                               As long-term investors, insurers can
          On 15 October 2019, the EIOPA                                                  not be met, as EIOPA also wanted to                                thus provide financing to the Euro-
     published a consultation paper4 on                                                  assess the impact of the pandemic                                  pean economy and exert a stabili-
     the review of the Solvency II Direc-                                                on the financial markets and the in-                                sing and anti-cyclical effect on fi-
     tive. This paper made draft recom-                                                  surance business.                                                  nancial markets. This, in turn, en-
     mendations for a possible adaptation                                                     Thus, the next stage of the re-                               ables insurers to make a significant
     of the Solvency II Directive and the                                                view includes an update of EIO-                                    contribution to the Capital Markets
     Delegated Regulation. EIOPA will de-                                                PA’s Holistic Impact Assessment6                                   Union, Sustainable Finance and the
     liver its advice to the European Com-                                               to determine the consequences of                                   economic recovery.
     mission at end December 2020.                                                       COVID-19. In order to carry out this                                   However, the HIA reveals that
          As part of this process, early                                                 impact assessment, EIOPA has sent                                  this opportunity might not be ta-
     this year, EIOPA carried out a Ho-                                                  a complementary request for infor-                                 ken; instead, EIOPA is discussing
                                                                                         mation to the industry with the re-                                tighter rules with far-reaching con-
                                                                                         ference date of 30 June 2020.                                      sequences going against the ob-
     Ȃ 2020 Solvency II review                                                                                                                             jectives of the current review pro-
     Ȅ EU Capital Markets Union                                                         ȇ Information on the holistic impact                              cess. The impact assessment shows
     ȅ Request to EIOPA for technical advice on                                         assessment of the review
                                                                                                                                                            that the insurance market would be
     the review of the Solvency II Directive                                             Ȉ Complementary information request
     Ȇ Consultation on technical advice for the                                         on the holistic impact assessment of the                           strongly affected by these changes.
     2020 review of Solvency II                                                          Solvency II review


                        ǪǧǨDz                                                                      ǪǧǪǧ                                                                   ǪǧǪǨ
                                                                                  June:                                        Final EIOPA-
                                                                         End of Impact                                         Advice to EC
                                                                           Assessment                                                                             EC-Advice

                                                                                            July:                                  End of EC-Consultation
                                                                        - Start of Complementary
                                                                       Update Impact Assessment                          Sep:
                                                                                                                         End of Complementary
                                                                         - Start of EC-Consultation                      Impact Assessment

     8?;'*Š *;6%77=?;%7'*==8'/%>/87

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Need for a better balance - The Solvency II review and lessons from EIOPA's impact assessment - GDV
Need for a better balance                         03

What have we learnt                                                                 %4%7'*/7)%7-*;
from the HIA?                                                                       .%;>ȄƊ84@*7'C*@/*AȄȁȄȁ
The HIA reveals both lights and
shadows in the current EIOPA draft                                                                                                                                    ȂŞ B>;%984%>/87

proposals. The results show that                                                     ȂŞ /=36%;-/7                                               /-.>*7/7-=       ȄŞ Šǝ/-.>*7/7-/7
                                                                                                                                                                          the current markt
while some of the discussed changes                                                  ȄŞ Šǝ6*7)6*7>%>                                         Rewiew 2020             situation
                                                                                      ȅȂŞȂȄŞȄȁȂȌ                        Amendments
would be improvements (risk mar-                                                                                         Review 2020
                                                                                                                                                 ;%7=/>/87      ȅŞ 7>*;*=>;%>*;/=3
                                                                                     ȅŞ 7>*;*=>;%>*=ť
gin, for instance), there are a num-                                                     spread correlation
                                                                                                                                                 UFR Reduction
ber of other changes that would have                                                 ȆŞ 87-Ť>*;6*:?/>C

negative consequences.                                                                                                                            ;%7=/>/87%4=
• Especially worrying for the in-
  surance market are the results re-
  garding the extrapolation of the
  interest rate curve. German in-                                                   8?;'*Š *;6%77=?;%7'*==8'/%>/87

  surers would be strongly affected
  by a deferral of the starting point                                                 financial markets are low and lo-                   to this effect. According to EIOPA’s
  of the extrapolation or a change of                                                 wer values of the VA when spreads                  corridor method the UFR will con-
  the extrapolation method. The cur-                                                  are high. Since the VA is designed                 tinue to decrease in the coming ye-
  ve used to discount the provisions                                                  to mitigate the effects of short-                  ars. As a consequence of that, the
  of insurers is based on available                                                   term spread widenings we consi-                    long-term liabilities will be parti-
  swap data. Since reliable swap data                                                 der this a negative outcome.                       cularly affected.
  is not available for long-term matu-                                              The chart above provides an over-                  • The removal of the transitional
  rities, an extrapolation of interest                                              view of the impact of the EIOPA                      measures from Solvency I to Sol-
  rates is necessary. This leads to sta-                                            draft proposals on the Solvency II                   vency II. The current transitional
  ble and reliable long-term interest                                               Regulation.                                          measures will be phased out line-
  rates. In the HIA, EIOPA applied a                                                                                                     arly until 2031.
  new extrapolation method that ta-                                                 Challenges today
  kes non-reliable swap data into ac-                                               Even without these amendments,                     In addition, the effects of the CO-
  count and would lead to a signifi-                                                 German insurers currently face a                   VID-19 crisis on insurance compa-
  cantly lower risk free rate curve.                                                number of challenges stemming                      nies remain a challenge for the in-
  This would make companies‘ ca-                                                    from regulation that have an im-                   surance industry. German insurers
  pital resources much more su-                                                     pact on their solvency position (see               are meeting their obligations despi-
  sceptible to fluctuation, which                                                    Chart 3), for example:                             te the challenges resulting from the
  would result in undue pressure on                                                 • The IBOR transition: The instru-                 COVID-19 pandemic.
  insurers to act in a procyclical way,                                               ments from which the Solvency II
  thereby creating barriers to long-                                                  interest rate curve is derived will
  term investments by insurers.                                                       change in the next years. This is
• Another area of concern is the                                                      necessary because they currently
  treatment of the interest rate                                                      rely on IBOR reference rates who-                %7C%=9*'>=/69%'>9;*=*7>4C
  risk: Negative interest rates are                                                   se significance as reference ra-                  >.*=84@*7'C98=/>/878+/7=?;*;=
  currently not further stressed.                                                     tes is decreasing. However, these                .%;>ȅƊ?;;*7>84@*7'C=/>?%>/87
  The changes in the HIA seem to be                                                   new instruments will lead to a lo-
  justified taking into account cur-                                                   wer interest rate curve. Thus, this                                                     ;%7=/>/87
  rent market conditions. However,                                                    purely technical transition which
  we believe that technical changes                                                   is not connected to any change in                                                       UFR Reduction

  need to be adopted to mitigate the                                                  the economic situation will presu-                                                       ;%7=/>/87%4=
  negative effects.                                                                   mably increase liabilities, especial-                                                      Removal

• Volatility Adjustment (VA): EI-                                                     ly for long-term business.                                                                 ŤǨDz
  OPA applied several changes to                                                    • Ultimate Forward Rate (UFR):
  the VA with contradictory effects.                                                  Insurers discount their liabilities.
  All in all, this will result in higher                                              Since there is no long-term mar-
  values of the VA when spreads on                                                    ket data available, the UFR is used              8?;'*Š *;6%77=?;%7'*==8'/%>/87

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04      Need for a better balance

     What should be done –                                                               Interest rate risk:                                      view presents a unique opportunity
     and what shouldn’t                                                                  We think that the risk factors EIOPA                     to review the Solvency II regulatory
     German insurers have strongly ad-                                                   tested in the HIA are reasonable for                     framework in a way which facilita-
     vocated for a moderate further de-                                                  the liquid part of the curve. However,                   tes the achievement of these overar-
     velopment of Solvency II, parti-                                                    the illiquid part of the curve needs to                  ching objectives at the European le-
     cularly with regards to long-term                                                   be derived from the stressed liquid                      vel while at the same time ensuring
     guarantees.                                                                         part exactly with the usual extrapo-                     policyholder protection. This view
          Against this background, the                                                   lation method. Only this procedure                       is shared by the Report on the
     current EIOPA draft proposals are a                                                 represents the changes in the inte-                      Capital Markets Union (CMU) by
     promising development. However,                                                     rest rate curve which could occur in                     the High-Level-Forum: The review
     the overall package still represents a                                              real terms.                                              should “better consider the long-
     tightening of requirements, especi-                                                                                                          term nature of the insurance busi-
     ally when interest rates are low.                                                   Risk margin:                                             ness” and “avoid exaggerating valua-
                                                                                         The level of the cost-of-capital rate                    tion of projected long-term liabilities
     Extrapolation of the                                                                of 6% which is a key parameter in                        and reduce artificial volatility.”7
     risk-free rate curve:                                                               the calculation of the risk margin                            However, even at this early
     Starting the euro extrapolation no                                                  is inappropriately high and should                       stage of the review, it must be no-
     later than 20 years when using the                                                  be lowered significantly.                                 ted that many of EIOPA’s draft pro-
     current method is appropriate. Ho-                                                       We welcome that EIOPA pro-                          posals would counteract the EU‘s
     wever, there is no need to change the                                               posed a slight change in the design                      objectives.
     existing extrapolation method.                                                      of the risk margin by introducing a
         An extrapolation start at 15 years                                              new parameter. As a result, the risk
                                                                                                                                                  ȉ A new vision for Europe’s capital markets
     should be considered.                                                               margin for long-term liabilities will                    ť /7%4;*98;>8+>.*/-.*@*4 8;?687
                                                                                         be less volatile. However, we think                      >.*%9/>%4%;3*>=7/87ş?7*ǪǧǪǧş9ŞǬǨ
     Volatility Adjustment (VA):                                                         that the choice of this new parame-
     The industry strongly supports focu-                                                ter could be changed to improve this
     sed improvements of the VA:                                                         effect.
     • increasing the general level of the
       VA to properly reflect the ability                                                 What is at stake?
       of insurers to earn returns above                                                 The review process is linked to other
       risk-free rates,                                                                  key initiatives at the EU level. An
     • applying it to all maturities, and                                                adequate review of the regulatory
     • avoiding artificial balance sheet                                                  framework is essential to achieve
       volatility.                                                                       the objectives of political priorities
                                                                                         such as the Capital Markets Uni-
     Dynamic Volatility                                                                  on or the European Green Deal
     Adjustment (DVA):                                                                   whose importance has increased
     Applying a DVA in the standard for-                                                 in light of the economic impact of
     mula, too, would be appropriate.                                                    the corona crisis. In our view, the re-

     Publisher                                                                                                 Person responsible                             Author
     Gesamtverband der Deutschen Versicherungswirtschaft e. V.                                                  Ĭ>D;*&*;                                    Dr. Victor Cristobal
      /4.*46=>;%Ŝ*ǬǫŶǬǫ şǨǧǨǨǯ*;4/7                                                                       Member of the Extended Management Board        Cover photo credits
     8=>+%'.ǧDZǧǪǮǬşǨǧǧǧǪ*;4/7                                                                           .87*ǧǫǧǪǧǪǧʆǭǬǯǧ                            /*;7*C ť=>8'3Ş%)8&*Ş'86
     .87*ǧǫǧǪǧǪǧʆǭǧǧǧş %BǧǫǧǪǧǪǧʆǮǧǧǧ                                                                    E-Mail:
                                                                                                                                                              44*)/>/87=ŞŞŞ,                                                                                 Publication assistant                          at GDV.DE
                                                                                                               Heike Strauß
                                                                                                               Editorial deadline
                                                                                                               3. September 2020

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