What has been decided?
The European Trialogue have agreed on the key details that have been holding up Omnibus II negotiations over the last few years via an 8 hour meeting held yesterday.
Agreement at the meeting between the European Parliament, European Committee and European Council paves the way for implementation of Solvency II from 1 January 2016 and provides insurers with much-needed clarity on timelines.
The key sticking points that have been holding up negotiations to date include:
- The Long-Term Guarantees package – Changes in the details of this package having significant consequences for the capital requirements of products sold with embedded guarantees (e.g. long term life products such as annuities with embedded guarantees).
- Equivalence – The rules related to non-EEA countries equivalence with Solvency II.
- Transitional arrangements – Allowing certain elements of the SII rulebook to be applied at a later date than 1st January 2016.
Do the agreements represent good or bad news for insurers?
1. The Long-Term Guarantees package
Overall our understanding of what has been agreed for the LTG package measures appear to be largely good news for insurers. Ratios applied to variables used in the assessment of liabilities result in more favourable valuations, specifically for long-term liability business:
- The ring-fencing requirements are replaced with reduced transferability of assets: we understand that the agreed text clarifies that the requirements should be understood on an economic rather than a legal basis. This alleviates the burden of setting legal arrangements for ring-fencing the affected portfolios of assets and liabilities. There appear though to be no economic benefit arising from this change.
- The floor for fundamental spread is set at 35% and 30% for corporates and government bonds respectively: insurers will be pleased with this outcome as in the LTG Assessment a floor of 75% of the long term average spread was proposed. Due to historic spikes in credit spreads the 75% was considered to be very onerous; the reduction will have a significant impact, effectively increasing the matching adjustment and lowering liabilities.
- We understand that the application ratio for the volatility adjustment is to be set at 65%. This is a significant increase from the 20% cap proposed by EIOPA in its report on the results of the Long Term Guarantee Assessment. However as the volatility adjustment cannot be applied to liabilities which are discounted using a matching adjustment or liabilities for which a transitional has been applied this may have limited impact on many insurer’s liabilities.
- Our expectation is that the agreed text will permit insurers to show the impact of the volatility adjustment through a reduction in the value of the liabilities rather than as an adjustment to own funds as recommended by EIOPA.
- It is likely that there will be no additional capital charge in respect of the volatility adjustment.
We understand that a pragmatic solution has been agreed in terms of equivalence whereby 'provisional equivalence' can be granted where a set of conditions are met – this effectively makes Group requirements (where the Group has an entity outside the EEA) less onerous as equivalence is easier to obtain and more consistently applied.
3. Transitional arrangements
We understand that the transitional arrangements have been extended up to 16 years. We expect that this will be welcomed by many as this is significant in terms of the discount rate applied for life insurers as it will allow a more phased transition to the new regime to be achieved.
What does this mean for your implementation programme?
UK insurers have generally made good progress towards meeting Solvency II requirements, particularly in relation to the modelling and system of governance, but more work is needed to comply with reporting requirements.
Some insurers have slowed down their Solvency II preparations pending this clarification. This agreement will now be a catalyst for them to speed up their implementation plans.
Deloitte’s research indicates that the shifting nature and uncertainty surrounding insurance regulation generally has made it harder for European insurers to make decisions and plan their businesses. In addition, our research on the impact of the entire regulatory agenda on EMEA-based insurers suggests these global insurers will be subject to c. 30 new regulatory reforms between 2012-2017. Insurers will need to take a coordinated approach to how they tackle these, often overlapping regulations alongside SII.
The costs of regulation for large European insurers were in the range of €214-217m for 2010-2012. Our research suggests few expect this level of spending to decrease to 2015 – driven by several regulatory reforms including SII, IFRS, SIFIs*.
In the context of the wider regulatory agenda to which large global insurers are subject, many aspects of regulation are still ‘known unknowns’. Insurers will need planning tools and techniques to help navigate the rest of the course.
*Based on research from Rethinking the response: A strategic approach to regulatory uncertainty in European Insurance.
Rick is a partner in the Risk and Regulation practice of Deloitte and is the Solvency II lead partner for the UK.
Diana is an actuary and Director in the EMEA Centre of Regulatory Strategy. Diana has more than 20 years of experience in life insurance and has assisted several companies with their Solvency II implementation programmes.