European Insurance: Solvency II (19 December 2016)

OAC Digest
EU / European Parliament / EIOPA, Financial modelling, Life insurance, Non-Life, PRA / Bank of England, Solvency II

19 December 2016

Selected recent Solvency II news items: 

The Solvency II Directive requires EIOPA to provide an annual report about the impact of the application of various articles. On 15 December, EIOPA published their "Report on long-term guarantees measures and measures on equity risk", announcing, not altogether unsurprisingly, that the "Long-Term Guarantees Measures have a significant impact on the own funds and capital requirements of insurers." (See the stress test report below.) The application of many of these measures is optional for undertakings and subject to (non-trivial) conditions laid down in the Solvency II Directive and Regulations. 

OAC Comment: The volatility adjustment (VA) is the most widely used measure - being used by 61% of undertakings (by European market share). OAC consider it would be disproportionate for smaller firms to apply for the VA. The costs of doing so are not justifiable in terms of the benefit to be gained from a reduction in best estimate liabilities. It is worth noting that at the beginning of Solvency II the transitional adjustment is 100% of the relevant difference but over the transitional period of 16 years the transitional deduction is reduced to zero. This could explain the "significant impact" in this first report but clearly those firms electing to use such measures must plan for reduced dependency.   

[Background information] The long-term guarantees measures are the extrapolation of risk-free interest rates, the matching adjustment, the volatility adjustment, the extension of the recovery period in case of non-compliance with the Solvency Capital Requirement, the transitional measure on the risk-free interest rates and the transitional measure on technical provisions. The equity risk measures are the application of a symmetric adjustment mechanism to the equity risk charge and the duration-based equity risk sub-module.     

Also on 15 December, EIOPA announced the results of its 2016 EU-wide stress test which covered 77% of the market in terms of the relevant business (life technical provisions excluding health and unit linked). The most onerous stress scenario is the “double-hit” scenario (price shocks combined with prolonged low risk-free interest rate levels). EIOPA announced that this "has a negative impact on the undertakings balance sheets of close to EUR 160 billion (-28.9% of the total excess of assets over liabilities) with more than 40% of the sample losing more than a third of their excess of assets over liabilities. In the absence of LTG and transitional measures, such impact would apply to almost 70% of the sample."

EIOPA's 2016 EIOPA Insurance Stress Test Report states "The exercise has highlighted the vulnerability of the insurance sector to the low interest rate environment" prompting a number of recommendations.         

EIOPA’s Insurance Stress Test 2016 Recommendations are addressed to the National Supervisory Authorities and the three recommendations cover the following:

  • allow for double hit as part of ORSA;
  • assess changes to risk appetite;
  • assess the viability of business models more vulnerable to the low-for-long scenario;
  • review modelled behaviour of management and policyholders;
  • assess the value of guarantees and whether the valuation of the technical provisions can be considered proportionate and prudent; and
  • assess impact at group level (with National Supervisory Authorities requested to inform EIOPA by 31 October 2017 on the impact that the results of the stress test participating undertakings would have at group level and the possible actions taken).

On the same date, the PRA published CP47/16 maintenance of the ‘transitional measure on technical provisions’ (TMTP) and CP48/16 ‘Solvency II: Matching adjustment – illiquid unrated assets and equity release mortgages’. The two papers are relevant to firms using or intending to use TMTP and holding or intending to hold restructured illiquid assets (including equity release mortgages) in an MA portfolio respectively. The former requires firms to perform an analysis of the material components and drivers of TMTP relief and document how changes to the Solvency II best estimate basis have been reflected in the Solvency I basis and make these available to supervisors. 

On 8 December, "The Companies Act 2006 (Distributions of Insurance Companies) Regulations 2016" were laid before Parliament, following the recent consultation on technical changes to the legal definition of life insurers’ distributable profits. These changes relate to proprietary companies and are a consequence of the Solvency II Directive. The regulations come into force on 30 December 2016 and set out a method for calculating realised profits and realised losses for Solvency 2 life-insurance companies by reference to the surplus or deficit in the company’s Solvency 2 balance sheet. The method for calculating this is set out in a formula in the new section 833A.

David Gray

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David Gray
Consultant Actuary

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