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Reviewing Solvency II: Keeping the regime fit for purpose


Publication date
22 February 2022


Contribution to the Eurofi Magazine - February 2022

The Solvency II Directive came into effect in Europe on 1 January 2016 and was a true milestone, resulting in real progress in terms of risk management and the harmonisation of prudential standards in the European Economic Area. The insurance industry now uses a risk based approach to assess and mitigate risks. It also has better aligned capital to the risks it runs. Insurers have significantly strengthened their governance models and their risk management capacity. Solvency II is definitely an effective framework. 

When the Solvency II Directive was introduced, revisions had already been planned to update the method of calculating capital requirements under the standard approach in 2018 and to assess the application of the long-term guarantees measures and measures on equity risks in 2020. At the request of the European Commission, the scope of EIOPA’s Opinion on the 2020 review of Solvency II is wider than that provided by the Directive. 

EIOPA’ Opinion on the Solvency II review aims in particular at keeping the regime fit for purpose by introducing a balanced update of the regulatory framework and reflecting better the economic situation, while completing the regulatory toolbox. 

From a prudential perspective EIOPA is of the view that overall the Solvency II framework has been working well and no fundamental changes are needed, but a number of amendments are required to ensure that the regulatory framework continues to be a well-functioning risk based regime. This is the reason why EIOPA has advised in 2020 an evolution to this prudential framework. More specifically on the aspects of the review of Solvency II that relate to quantitative requirements, EIOPA’s Opinion proposes amendments on the long-term guarantee measures and measures on equity risk, technical provisions, Solvency Capital Requirement standard formula and Minimum Capital Requirement. The following does not intend to cover all quantitative aspects.

From the perspective of the economic situation, there are areas of concern, which the review should address. Subdued economic growth has led to extensive monetary easing, which was further intensified by the Covid-19 pandemic. Also, in the last two years, the euro swap curve moved to negative territory.

EIOPA’s advice is that it is essential to recognise this economic picture in Solvency II. In its 2018 review of the Solvency Capital Requirement, EIOPA has proposed changes to the treatment of the interest rate risks to avoid that the capital held against it is underestimated. EIOPA considers that changes are necessary and suggests to reflect the low and negative rates recently experienced. In addition, EIOPA recommends changes to the interest rate curves used by insurers to value liabilities, especially in respect of the extrapolation. The changes to the extrapolation method increase market consistency and recognizes the changes that happened in the market since the current framework was developed in 2014.

Having said that, EIOPA also recognizes that, due to their long term liabilities, insurers are particularly well suited to long term investments. EIOPA’s advice is that there can be a more favourable, prudent, treatment of insurers with long term liabilities. This is reflected in the EIOPA’s suggestions of refinements to the volatility adjustment.

More favourable but prudent treatment is also recommended for the long term equity investment, held against long term illiquid liabilities. EIOPA proposes to revise the eligibility criteria, to make them more prudentially sound, practicable and recognizing the long term character.

With respect to the risk margin, EIOPA proposes to introduce adjustments to account for the time dependency of risks. The effect of such change is a progressive reduction of the risk margin, which increases with the duration of the liabilities. Moreover, the volatility of the risk margin will be reduced through this change especially for long term liabilities.

The proposals of the European Commission published in October 2021 largely share EIOPA’s approach and follow the objectives set in EIOPA’s Opinion on the 2020 review of Solvency II.

Nevertheless, some important aspects have been modified and result in a reduction of the level of prudence with regard to policyholders. Prudence is an important element of Solvency II to avoid harmful situation for policyholders. EIOPA’s advice recommended a more favourable but prudent treatment of illiquid liabilities as well as a balanced update overall. In EIOPA’s view the removal of illiquidity considerations for the purpose of volatility adjustment calculations on the one hand and relaxations regarding the calibration on the risk margin and interest risk capital charge on the other, pose potential risks.

Thanks to Ornella Lombardi and Maxime Louardi for their contribution to this article.