The European Insurance and Occupational Pensions Authority’s (EIOPA’s) recently-issued opinion on the harmonisation of recovery and resolution frameworks for the insurance sector is a landmark step for the insurance industry towards implementing the G20’s 2011 commitment to end “too big to fail” for financial services1. While a harmonised resolution regime has been implemented (and applied this year in a live context) for the European banking sector, insurance resolution has so far remained a national matter. Consequently, substantial differences in regime and approach currently apply across Europe.
We emphasise that this is an EIOPA opinion: a decision on what, if anything, to do with it will fall to the European Commission, Parliament and Council. Nevertheless, if implemented, the implications of EIOPA’s proposals for the EU insurance industry will be profound, involving the potential use, inter alia, of forcible transfers of assets and liabilities, including to bridge institutions, and the bail-in of creditors including, as a “last resort”, the bail-in of policyholders.
EIOPA’s earlier discussion paper on the topic shows that existing recovery and resolution frameworks vary substantially between different Member States, and that some of the powers that EIOPA has proposed are currently available to as few as three of the thirty responding supervisors. Moreover, the proposed requirements and powers, which are set out in greater detail in the annex to this blog, will go well beyond the Solvency II framework, including in the following important ways:
- The framework layers pre-emptive recovery and resolution planning and early intervention powers on top of the Solvency II ladder of intervention. In particular:
- Pre-emptive recovery planning bridges the Own Risk and Solvency Assessment (ORSA) and the recovery plan that insurers submit on an actual breach of the Solvency II Solvency Capital Requirement (SCR). The pre-emptive recovery plan considers the potential recovery measures that could be applied in severe scenarios, premised on the breach of prudential requirements, unlike the ORSA which is an assessment of continuous compliance2. The Solvency II recovery plan sets out actions to recover from a specific breach of the SCR, and hence may be informed by pre-emptive planning.
- EIOPA envisages early intervention action being appropriate before an insurer has breached its SCR, although the opinion clearly states3 that early intervention powers should not result in a new pre-defined intervention level or implicit new capital requirement. The opinion therefore rules out hard, quantitative criteria for early intervention. Nonetheless, we would expect clear guidance to be needed on when these powers should be applied.
- EIOPA has called for independent resolution authorities to be established in each national jurisdiction with comprehensive resolution powers4. These include the powers to allocate losses to policyholders and establish bridge institutions to which the assets, rights and liabilities of insurers in resolution can be transferred. Many of these powers will be new in most Member States. However, the powers mirror many of those established under the Bank Recovery and Resolution Directive (BRRD). Extending the scope of national banking resolution authorities to cover insurers is therefore a likely outcome.
- EIOPA suggests flexibility for the resolution authority to be part of, or separate from, the national supervisory authority, with safeguards to operational independence for resolution where both roles reside in the same authority5. We would expect further detailed consideration to be needed on how resolution and supervisory authorities should coordinate and interact, particularly at key decision points such as entry into resolution.
- Consistent with the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions (Key Attributes), EIOPA’s proposed resolution powers extend to the allocation of losses to policyholders, as a “last resort option”, and subject to safeguards including the “no creditor worse off than in liquidation” (NCWOL) principle6. Policyholders have in the past absorbed losses in insurer insolvencies carried out under national law. However, in our view the explicit recognition of this outcome in EIOPA’s opinion will provide an important point of reference for future insolvencies.
- EIOPA notes7 in its opinion that the existence and scope of insurance guarantee schemes (IGSs) are relevant to resolution, and that potential coverage under IGSs must be taken into account where losses are allocated to policyholders. The Key Attributes specifically provide for resolution authorities to have the flexibility to treat policyholders protected by an IGS differently from those not so protected to maximise value for creditors (including policyholders) as a whole8. EIOPA’s research to date indicates substantial differences in IGSs between Member States. Gabriel Bernardino, Chairman of EIOPA, observed in a 2015 letter to Jonathan Hill, then European Commissioner for Financial Stability, Financial Services and Capital Markets Union, that “the combination of non-harmonised recovery and resolution regimes with non-harmonised Insurance Guarantee Schemes, would make the management of a stressed situation much more difficult.” EIOPA proposes further work in this area, raising the prospect of further initiatives on the harmonisation of IGSs9.
- EIOPA has proposed that a recovery and resolution regime be applied to all Solvency II insurers, but with proportional application thresholds for various building blocks of the framework10. At face value, this goes beyond the FSB’s Key Attributes, which are envisaged as applying to any insurer that could be systemically significant or critical if it fails and, in particular, all insurers designated as Globally Systemically Important Insurers (G-SIIs)11. EIOPA’s approach recognises that, in principle, policyholder protection and systemic disruption should be of concern in any insurer resolution. The harmonised criteria that EIOPA proposes be developed to guide supervisors will be crucial to ensure that an appropriate balance is struck on application12.
Implications for Firms
As an own-initiative opinion, there is no certainty at this stage on whether the European Parliament, Council and Commission will choose to legislate to implement some or all of EIOPA’s proposed powers. However, in our view EIOPA’s proposals represent a clear strategic direction of travel for insurance regulation in the EU. Notably, EIOPA’s founding regulation provides a recovery and resolution remit13, and EIOPA’s 2017 to 2019 Single Programming Document allocates 4 FTEs to fulfilling EIOPA’s responsibilities in this area, with a sharpening focus on recovery and resolution14.
To date, a consensus on recovery and resolution for insurance has not been apparent among European supervisors, and some of what EIOPA proposes is likely to be controversial in certain jurisdictions and markets. In anticipation of this, EIOPA’s proposals may well contain some conscious “negotiating room”. Following a scrupulously even-handed coverage of the arguments for and against harmonised resolution powers in its discussion paper15, EIOPA’s opinion provides a strong endorsement of the FSB’s framework for the insurance sector. This is likely to increase the pressure on the European Commission either to start developing legislation, or to rule out doing so.
We would therefore recommend insurers pay close attention to EIOPA’s opinion and proposals. In particular:
- We expect supervisors to place increasing emphasis on pre-emptive recovery planning in their regular supervisory dialogue. In particular, we expect a still sharper focus on the severity of insurers’ stress and scenario analysis and the need for robust management action planning as part of, and in extension of, the ORSA process. In his July speech to the ABI, the PRA’s Insurance Executive Director, David Rule, highlighted the insurance sector risks that the PRA will be prioritising. These include:
- Continuing soft underwriting returns and declining premium rates in the general insurance market.
- The new skills that insurers investing in direct investments such as infrastructure and equity release mortgages will need to manage downturns in those investments.
- The potential for excessive risk concentrations to build in areas such as cyber risk and UK property, especially where risk concentrations are hidden.
The PRA also set out its expectations in its July 2017 Supervisory Statement SS5/17 for general insurers to plan proactively for their response to a market-turning event in the non-life sector. Insurers will need to demonstrate clearly to their supervisors that they are proactively considering these issues, and planning appropriately.
- As noted above, we would expect further work on recovery and resolution from EIOPA, the European Commission and national supervisors. EIOPA has called for the macroprudential framework16 for insurance to consider the specific nature of the insurance sector rather than simply extending the approach developed for other parts of the financial system to insurance17. Engagement from the insurance industry, including on recovery and resolution, will be essential to achieve this.
1As stated by the G20 in its communiqué following its 2011 summit in Cannes: “We have agreed on comprehensive measures so that no financial firm can be deemed “too big to fail” and to protect taxpayers from bearing the costs of resolution.” https://www.oecd.org/g20/summits/cannes/Cannes%20Leaders%20Communiqu%C3%A9%204%20%20November%202011.pdf
2EIOPA opinion Box 4
3EIOPA opinion paragraph 90
4EIOPA opinion paragraphs 97 to 100
5EIOPA opinion paragraphs 99 and 100
6EIOPA opinion paragraphs 111 and 117
7EIOPA opinion paragraphs 15, 16 and 25
8Key Attributes Appendix II-Annex 2 paragraph 5.2
9The European Commission proposed in a 2010 white paper to introduce a directive to ensure that IGSs with certain minimum features exist in all EU countries, although no such directive has since been produced.
10EIOPA opinion paragraphs 40 to 42
11Key Attributes Appendix II-Annex 2 paragraph 2.1
12EIOPA opinion paragraphs 50 and 70
13Regulation (EU) No 1094/2010 of the European Parliament and the Council of 24 November 2010 Articles 8(1)(i) and 25
142017 to 2019 Single Programming Document, page 52
15EIOPA discussion paper section 3.2.2
16EIOPA views recovery and resolution as both a microprudential and macroprudential tool - as set out, for example, in paragraph 80 of EIOPA’s paper on a potential macroprudential approach to the low interest rate environment in the Solvency II context.
17Response to the EC’s Consultation on the Review of the EU Macroprudential Policy Framework paragraph 17