The introduction of the Solvency II Directive with effect from 1 January 2016 includes a number of transitional measures which allow firms to move to full implementation over a period of time.
This article gives a brief description of the most important ones. The purpose of transitional measures is generally to soften the immediate impact of the new rules so that, for example, large increases in technical provisions or capital requirements can be brought in gradually, allowing firms to fund them gradually rather than all in one go.
The transitional measures are found in Articles 308b, 308c and 308d of the final version of the Directive. There are also papers on implementing technical standards which give more detail of how the transitional measures are to be applied.
Article 308b Transitional Measures
This covers a variety of items. We have highlighted a couple which are likely to be of particular importance to our readers and a list of all others is on the second page of our article.
Paragraphs 4 to 8 of the Article 308b allow for the transition in the reporting deadlines, reducing the publication date for the annual returns for a solo firm from 20 weeks to 14 weeks over a four-year period and reducing the publication date for quarterly information from 8 weeks to 5 weeks, also over a four-year period. It is this provision which means that the first deadline for quarterly reporting will be 26 May 2016 (8 weeks after 31 March 2016) and by 2019 firms will have to report the March quarterly numbers by 5 May 2019. Similarly the first annual return will be due on 20 May 2017 and the return for end 2019 is due on 7 April 2020. All firms are expected to take advantage of this measure.
Equity Transitional Measure
This measure permits, but does not require, firms to phase in the effect of the standard stress factor in the equity risk sub-module. The wording of this is complex but the Technical Standard confirms that firms can immediately apply 100% of the standard parameter if they choose to do so. If they wish to take advantage of the transitional provision they should calculate the equity adjustment in line with Article 304 and compare that with the full stress factor prescribed for the risk sub-module. The transitional period is 7 years and firms can move linearly to 100% of the full equity stress factor or move more quickly than that if they choose to do so.
This means that, for example, if the standard stress in the equity risk submodule is 45% but the calculation made in line with Article 304 gives a factor of 24% then a firm can use 24% in the first year, 27% in the second year, until it gets to 45% in year 8. This means that the capital requirement in the sub module will rise gradually rather than give a big hit in the first year.
The adjustment can only be applied to equities in the portfolio at 31 December 2015 so any trades after that date will reduce the effect of the transitional allowance and firms will have to keep records of which equities the adjustment can be applied to. If a firm has investments in collective funds then Article 173 of the Delegated Regulation includes a concession which allows these to be included in the calculation based on an estimate of the rate of turnover within the fund.
Use of this transitional measure does not require regulatory approval. Firms which are not short of capital can choose to take the full hit on capital immediately rather than make the complex calculations which will be required every year to support use of the transitional measure.
Article 308c Transitional Measure on Risk-Free Interest Rates
This allows firms a transitional period to move from the interest rate structure in force under Solvency I to that required by Solvency II. The point here is that the Rule under Solvency I (Article 20 of Directive 2008/83/EC) did not specify that a risk-free rate had to be used and only required a single rate rather than a yield curve. So, for example, the UK set rates by reference to a 15-year gilt.
The new requirement to use the risk free yield curve means that, particularly for short term cash flows, the discount rate is likely to be significantly lower under Solvency II and hence the transition allows firms to move from the current level of interest rates to the level required by Solvency II over a period of up to 15 years. This means that firms can lower the average discount rate gradually rather than all in one go.
This measure requires prior approval by the supervisory authority. This measure cannot be used in conjunction with Article 308d.
Article 308d Transitional Measure on Technical Provisions
This allows firms to apply a transitional deduction to their technical provisions. The amount is the difference between the technical provisions (net of reinsurance) under Solvency I and the technical provisions (net of reinsurance) under Solvency II. If the Solvency II provisions are higher, firms can deduct an amount equal to 100% of the difference from the Solvency II provision at 1 January 2016 but the maximum amount that can be deducted reduces linearly to 0% of the difference by 1 January 2032. This allows firms to increase their technical provisions to the level required by Solvency II at a gradual rate rather than all in one go.
This measure requires prior approval by the supervisory authority. This measure cannot be used in conjunction with Article 308c.
What is there for firms to do?
Firms need to decide whether they wish to take advantage of any of these transitional measures. The published regulatory timetables assume that all firms will take full advantage of the transitional measures on reporting deadlines. Some measures, particularly the measures on risk-free interest rates and technical provisions, require regulatory approval. In general, we think that these measures (with the exception of the reporting deadlines) will only be of limited value unless a firm has a particular issue.
Full list of Transitional Measures in Article 308b
Exemptions if in run off or administration
Paragraphs 1 to 4 of Article 308b provide for firms in run off or administration to have a limited period to settle their affairs without being subject to the main provisions of Solvency II.
Paragraphs 4 to 8 allow for the transition in the reporting deadlines reducing the publication date for the annual returns from 20 weeks to 14 weeks over a four-year period and reducing the publication date for quarterly information from 8 weeks to 5 weeks, also over a four-year period.
Paragraphs 9 and 10 permit the use of existing own fund items to be included in the calculation of basic own funds as Tier 1 or Tier 2 items for up to ten years as long as they were being used to meet existing solvency margin requirements at 31 December 2015. This is for the situation where these items would not meet the own funds criteria specified in Articles 92 and 93.
Paragraph 11 allows firms to continue to use these without meeting the requirements imposed by Article 135(2) except where new underlying exposures were added or substituted after 31 December 2014.
Concentration and Spread Risk
Paragraph 12 allows for firms which have exposures to Member States currencies which are not their domestic currency to phase in the effect of this in the concentration and spread risk sub modules over a period of four years up to January 2020.
Equity Transitional Measure
This measure permits, but does not require, firms to phase in the effect of the standard stress factor in the equity risk sub-module. The adjustment can only be applied to equities in the portfolio at 31 December 2015 so any trades after that date will reduce the effect of the transitional allowance and firms will have to keep records of which equities the adjustment can be applied to.
Paragraph 14 permits a firm which is compliant with the Solvency I Capital Requirements at 31 December 2015, but not compliant with the Solvency II Capital Requirements at 1 January 2016 a period of two years to build up its capital to the Solvency II level.
Paragraph 15 allows a transitional period for occupational pension schemes run by insurance firms to be subject to the Solvency II requirements. Paragraphs 16 and 17 make various transitional provisions for Groups.
How can OAC help?
If you have any questions about this article, or want further information, please talk to your usual OAC consultant, or contact me.
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