Everyone understands that after five years the current Solvency II supervisory framework needs to be revised. After all, the world can change considerably in five years. The COVID pandemic, but recently also the war in Ukraine, show this all too much. Adjustments are therefore necessary.
"The revision of Solvency II can ensure that our sector, as the largest institutional investor in Europe, can play its role in the enormous investment challenges that Europe faces in the coming years," said Richard Weurding, managing director of the Dutch Association of Insurers, during the ACIS symposium at the UvA in Amsterdam.
Weurding is not only referring to the recovery from the current economic crisis. He also refers to making Europe climate neutral through the Green Deal and catching up in the field of digitization. Weurding was, in addition to Armand Schouten, director of the Insurers Supervision Division of De Nederlandsche Bank and CFO of Aegon Nederland, Boaz Magid, one of the speakers at the symposium entitled 'The 1st lustrum of Solvency II: Fête, Farce or Force Majeure?' Led by Roger Laeven, Professor of Mathematics and Economics of Risk at the UvA, the speakers shed light on the revision and where they believe the bottlenecks and points for improvement lie.
Use review as a driver for long-term investments
According to Weurding, the current revision, which he prefers to call a tour de force, can play a significant role in all the challenges facing Europe. "Provided that the European Commission (EC) actually gives insurers the opportunity to use their long-term investment power for an economically strong and more sustainable Europe," says Weurding. "That investment power cannot and will not be fully exploited if the Commission and the European Parliament stick to their proposed requirements for holding buffer capital. The increase in the current capital burden proposed by EIOPA by around EUR 60 billion reduces the investment capacity of the insurance sector by around 170 billion equity investments or 680 billion bond investments. Part of this unnecessary increase is inevitably passed on to the consumer. As a result: Higher premiums." According to Weurding, such a result is in stark contrast to what policymakers expect from insurers as the largest institutional investor in Europe. "The European Commission has adopted large parts of EIOPA's advice, but is trying, I believe and hope, to take our investment capacity into account."
No clear information on correct extrapolation from LLP to UFR
Another important point is the proposal to change the current yield curve extrapolation method. According to Weurding, the proposal makes the current system even more complicated. "And it's also not necessary because there are already mechanisms in place to ensure that insurers, even at persistently low rates, hold enough investments for very long-term liabilities."
"The biggest problem here," says Weurding, "is that there is no underlying scientific research or knowledge that can advise us on the correct extrapolation. This makes it a political subject of praise and bidding. So horse-trading. The bottom line is that the path of extrapolation from the LLP to the UFR can be very steep or very flat, and everything in between. A steep extrapolation means that the valuation of long-term liabilities is done at a higher interest rate, so that the liabilities are lower and so is the associated capital requirement. A flat extrapolation does the opposite. You can probably guess what EIOPA's proposal is and where the industry stands", with Weurding looking into the audience. "Exactly: EIOPA wants a flat extrapolation and the industry wants a more steep extrapolation. In the EIOPA draft advice of 2019, this led to a huge additional capital requirement for Dutch and German insurers in particular. We were shocked by that, but fortunately so were the supervisors. In their final opinion, EIOPA added a transitional measure, allowing for a gradual introduction over eight years. How much and whether that will ease the pain depends on the market situation at the time and the EU country concerned."
Avoid a shadow capital requirement
"What is very curious," he continues, "is the proposal that insurers should disclose what their capital ratio would be without that transitional measure. That immediately creates a higher shadow capital requirement. Of which the capital market immediately wants to know how the insurer solves that problem." In Weurding's view, this makes the transitional measure de facto meaningless. "The point that the insurance industry wants to make is that Solvency II must primarily serve the interests of policyholders. And then the first question is: is extra capital needed, or can the risk be addressed with less far-reaching resources? The current framework already takes into account the long-term interest rate risk. The interest rate to calculate the liabilities is already very low. This provides the right risk management incentives for new contracts."
Then Weurding comes to the volatility adjustment or volatility adjustment, abbreviated VA. Without VA, even an insurer is exposed to enormous artificial volatility due to market movements. Without the VA, for example, the financial crisis of 2008-2009 could have been disastrous for insurers and the euro crisis of 2011-2012 could also have caused serious problems. "That is precisely the reason that the VA was included in the directive after the financial crisis," says Weurding.
Combat artificial volatility
"The current volatility adjustment creates artificial volatility. We have to bring that back, regulators also agree with us on that." His appeal to the European Parliament: "Counter artificial fluctuations in capital ratios caused by short-term fluctuations in capital markets. This can be done by turning knobs in the formula. But then we have to turn the right knobs, and in the right direction," Weurding argues.
Risk margin based on outdated assumptions
In his story, Weurding also reflects on the risk margin that, according to him, is based on outdated assumptions. "In 2007, when the capital market interest rate was still considerably higher than today, EIOPA (without much substantiation) fixed the Cost of Capital at 6% (these are the costs that an insurer incurs to finance the discounted future capital requirements). Because the capital market interest rate is now considerably lower, we can therefore adjust the Cost of Capital considerably downwards. The Commission is coming to five percent, we are coming to a realistic three percent. "But," Weurding emphasizes, "insurers can free up much more capital for investments if the risk margin is brought in line with the current interest rate level. This leads to lower capital requirements. That is why we are critical of the current proposal of the European Commission."
Address operational complexity and compliance burdens
In addition, Weurding believes that we need to address the operational complexity and compliance burdens of Solvency II. "Make proportionality really work in practice, by also simplifying and streamlining reporting requirements. This leads to a more diversified and efficient insurance market, which is directly beneficial for European consumers."
Last but not least, Weurding also considered the treatment of mortgages under Solvency II. "We see absolutely no reason to adjust Solvency II on this point, especially if this leads in practice to an increase in the already high capital burden."
Join the live discussion on Solvency II: put 15 March in the agenda!
The European Commission's legislative proposals for the revision of the Solvency II Directive have been on the table since September 2021. Although discussions on the review between EU member states are now quite advanced, the European Parliament is still busy taking its position on many crucial questions: of ensuring financial stability and consumer protection. To strengthen the investment capacity of the sector in order to support the green transition and the economic recovery of Europe as well as possible. Het Gesamtverband der Deutschen Versicherungswirtschaft e.V. (the German Confederation) has found leading voices from the European Parliament and the European insurance industry willing to discuss the Solvency II review with each other:
- Markus Ferber, Member of the European Parliament
- Eero Heinäluoma, Member of the European Parliament
- Allegra van Hövell-Patrizi, CEO, AEGON Nederland NV
- Moderation: Jörg Asmussen, CEO, German Insurance Association
The event can be followed live via LinkedIn on Tuesday 15 March between 3-4 pm via this link: https://lnkd.in/eXTEv4Fw
Sign up and join the discussion live!
Was this article useful?