Report of the meeting held at the offices of EBF, Brussels
Dr. Thomas Steffen, Vice-chairman of the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS), highlighted the vital role which supervision plays in promoting financial stability when he spoke to GrahamBishop.com’s European Finance Forum.
“A failure of a major bank or insurance company could have a tremendously negative impact on financial stability, and in the case of an insurance company or pension fund, on policyholders or beneficiaries,” he said, explaining the fundamental rationale behind CEIOPS role. CEIOPS is one of the three ‘Level Three’ financial market supervisory committees set up under the Lamfalussy legislative process, all of whom were represented at the ECOFIN Council on October 11th.
Dr. Steffen said that, at that meeting, the ministers had encouraged supervisors to adopt a more risk-based supervisory methodology, which is the foundation of the Basle II banking capital adequacy regime and also of the new Capital Requirements Directive. ECOFIN had also, he said, encouraged the Committees to try and streamline their supervisory processes, including moving towards more cross-border co-operation through, for example, joint supervisory inspections and trying to move towards a common reporting methodology in so far as this is possible.
He described the planned Solvency II insurance directive as the equivalent, for insurance companies, of Basel II and the CRD for banks, based on the four-level Lamfalussy Process model. The top level is the Framework Directive, underpinned by technical implementing measures coupled with the “call-back” and “sunset” provisions designed to protect in particular the European Parliament’s prerogatives. Finally, the new supervisory framework is built on the principle of more intensive consultation with the financial sectors affected. He added in parentheses that, still to be decided is whether a fourth Lamfalussy Committee, for financial conglomerates should be created or whether the supervision of conglomerates will be dealt with through the creation of a joint committee of CEIOPS and the Committee of European Banking Supervisors (CEBS).
Describing CEIOPS objectives, Dr. Steffen said that legally it is just a technical body advising the European Commission. However, insurance supervisors have been working on this for 40 years since the first meeting of European Insurance Supervisors in Paris. On cross-border supervision, Dr. Steffen said that under the Helsinki Protocol, the question of how to coordinate cross border supervision is being tackled by meetings of a coordinating committee (Co-Co), analogous to the co-ordinating supervisor envisaged by the CRD for banks.
Alongside offering formal technical advice to the Commission, the application of voluntary co-operation on supervisory standards and guidelines is expected, with peer pressure being subtly exerted to achieve this. Joint cross-border inspections could, he suggested, expose any weaknesses in supervisory techniques.
· Intense activity is underway on Solvency II, at level one and two of the Lamfalussy process.
· IORPS - Work is underway at level three on how to implement the “Pensions” Directive – which came into force in September. Dr. Steffen suggested that pension fund regulation and supervision was a difficult area for supervisors to work together in. “It is particularly challenging because some supervisors think it should not be part of the insurance business,” he said, explaining that in some member states pension law is seen primarily as part of labour, tax and social security law.
· Insurance mediation questions are complicated by the vastly different insurance broker systems in different member states. He pointed out that in Germany there are 4-500,000 insurance agents and brokers - far too big a number for a tightly staffed regulatory agency to supervise, regulate and train. Some supervisory practitioners see the EU law in this field as “pure overregulation which the Commission should review, ” he said.
· Additionally, there are issues relating to financial accounting for insurance companies and financial stability. The Solvency II directive for insurance companies could not be drafted without paying close attention to the impact of International Financial Reporting Standards.
· Another field of activity relates to EU/US insurance supervision structures, and particularly the issue of the collateral which US states require to be posted by foreign insurers.
Solvency II
Turning to the planned Solvency II Directive itself, Dr. Steffen explained what are the factors driving the new capital regime for insurers and why is it necessary. He argued that it is part of a global solvency approach which incorporates enhanced risk sensitivity, bases this on internal risk assessment by company managements which is being encouraged, aims at increasing cross-border convergence of capital adequacy regimes and improved transparency.
LikeBasle II for banks, Solvency II aims at covering all risks: market, underwriting, operational and risk. He then outlined the “three waves” of consultation which are underway. However, “waves” may be a bit of an understatement, given in particular the timescale which aims at having Solvency II up and running by 2010. They are more like “tsunamis,” he said. The first started in July 2004, and the second in December 2004. The third consultation would address the issue of how best to calculate technical provisions for life as opposed to non-life insurance firms, a tricky issue given that life companies have very long tail liabilities stretching twenty or thirty years into the future.
There is a debate he said, about what technical provisions are needed given thatthere is also shareholders’ capital backing the fund. He suggested that the solution might be to provide a “safety margin”, and a key question is how this might impact on capital requirements. Concerning quantitative requirements for assets it will be necessary to find a compromise between member states who see no need for quantitative restrictions because of capital backing, and those that say you do.
As for the calculation of capital adequacy, he said that this monthCEIOPS would launch a first Quantitative Impact Study (Basle II is already on its fourth QIS).
As for supervisory structures for large, cross border groups, he said that at least in Germany there is support for the lead supervisor model to reduce supervisory burdens.
Moving on to what he called “Pillar Two” of the risk management system, he said that this would deal with the qualitative as opposed to the quantitative characteristics of the new regime. The ‘Titanic’ sank, he argued, because of poor risk management systems, not because of the iceberg, therefore it is important that supervisors make sure firms have “proper risk management and control procedures.”
On the timing of Solvency II, he said that the current aim is to a have a draft framework directive by 2007. He could not predict when it would come into force. This is a political question to be resolved by the Parliament, the Council and the Commission. But he hoped by 2010 or 2011.
Graham Bishop said that he was struck by the scale of what is being undertaken, in particular the tight timetable. He suggested that the timetable might prove too ambitious given that there will have to be a series of level 2 consultations and companies cannot start planning for risk management systems until these are finished since they have to write computer programmes for them. If there are several rounds of QIS, then it is difficult to see how the level 2 measures can be concluded until the QIS process is finished.
Paul Barrett of the Association of British Insurers (ABI), in his response to Dr. Steffen, said that the ABI believes that the new approach of Solvency II is essential. He stressed however that the Directive should concentrate on high-level standards and principles and that the details needed to be worked out in very close consultation with the industry. “This cannot be done behind closed doors, you need to be in touch with the markets,” he said. He stressed too that one of the fundamental motivations behind the Lamfalussy process was to allow legislation to adjust to changing markets and to keep pace with developments in them. Lamfalussy tries to overcome excessive proscription and the complicated comitology structures needed to amend legislation. “CEIOPS is not just a committee to interpret legislation, it is also there to make a reality of the single market…it has to make regulation work,” he said, adding that part of this is avoiding “gold plating,” or excessively detailed regulation.
He also stressed that while it was important to protect consumers, this should not amount to “supporting any (failing) firm at any cost. The Titanic was seen as an “unsinkable” ship, but what is the point of a Solvency II Directive if we have a system creating unsinkable financial institutions,” he asked, adding that a balance has got to be struck between incentives for firms and regulation. CEIOPS, he went on, is a body which is effectively settingregulations, not just implementing them in a commercial environment in which, for big groups, there is still not a “level playing field” within the EU.
The top goals for CEIOPS, he said, should be well informed and coherentregulation across borders coupled with more timely and consistent regulatory implementation. This has to be coupled with an ability to respond to feedback and adopt changes.
On the issue of cross border supervision, Mr. Barrett said that this will require more than politicians just paying lip service to the idea, it will require formal and informal support.
Solvency II, he said, represents a enormous challenge, moving insurance industry regulation into the modern era in which computers and financial market innovation have transformed the landscape since the first Insurance Directive in 1973.
To achieve this CEIOPS will have to embrace micro-economic principles and capture in its regulations the true economic value of assets and liabilities, drawing upon the modern derivatives markets. Old measures of solvencymargins were no longer adequate or relevant, something more sophisticated is needed.
As for the qualitative, as opposed to the quantitative rules, scenario building and stress-testing methodologies will be needed but it will be important to get behind the models and understand the markets they are based on. “Without a deep understanding of the models, the regulators will be flying blind,” he said.
For companies and consumers, Mr. Barrett said, a new solvency regime should reduce the cost of capital and produce a stronger, more diverse and more internationally competitive insurance industry, getting capital levels closer to underlying risks and offering better cross-border value to consumers.
Dr. Steffen replied that he agreed with much of what had been said, in particular that the new regime could not be conducted behind closed doors. He agreed too that there should be “no unsinkable insurance companies.” But he favours a slim, harmonised guarantee scheme, particularly to prevent consumers being hit by a failure in the life/pensions sector. On cross border supervision, he said that “this is where the regulator meets reality.”
Graham Bishop said that he expected the question of guarantee schemes to be “a big issue.” Chris Verhaegen of the EFRP said that in continental Europe there is no tradition of pensions supervision, adding that it would be a mistake to fill gaps with insurance models where inappropriate capital adequacy standards might be imposed. Moreover, the consultation panel is not really working.
Dr. Steffen said that there is an intense debate underway about these issues and how they relate to International Financial Reporting Standards (IFRS). Some countries feel that there is a need to add “prudential filters” to accounting standards, so that in the social security sector it is not just a question of market value but of “prudent provision,” since liabilities are so long term. Some countries are saying “stick to IFRS,” however.
He added for the pension fund field a consultative panel had been started eighteen months ago by CEIOPS, covering insurance companies and consumers as well as the pension fund industry.He pointed out that the European landscape is complicated by the fact that each country does not have the same supervisory structure. In the UK for example, the integrated financial sector supervisor, the Financial Services Authority, does not, in fact, cover the pensions sector which is covered by The Pensions Regulator. This could make dialogues between responsible supervisors more difficult. As for the commercial side, the fact is that if you want to sell products across borders you have to follow local labour, social and tax policies. In Germany, he said, supervisors had drafted a sixty page document setting out what these regulations, including labour law rules, are. For some entrants, this might represent quite an obstacle to doing business.
Peter Skinner, MEP, focussed his comments on the comitolgy issues and argued that the famous Prodi statement to Parliament in 2002 gave Parliament its call-back right – but only in terms of practical politics. However, the right has not yet had to be used so the political realities remained un-tested. He made it clear that Parliament means to “stick to its guns” but that does not mean acting in a way that might be seen as irresponsible. There were those who argued that the CRD should be “taken hostage” but, in the end, a suitable compromise had been reached – for the moment.
As the Market Abuse Directive sunset clause comes into operation in only 18 months, it is important to keep the process alive and President Borrell will be sending a letter to Council shortly – expecting a suitable reply by mid-2006. However, the representative of a Member State commented that there is a strong body of opinion that the current Treaty does not give Parliament the possibility of a call-back power.
In the meantime, Parliament is requesting observer status on the level 2 committees so that it gets advance warning of contentious issues, rather than only being informed at a relatively late stage – even when the Lamfalussy Process is fully implemented.
Date of next meeting: provisionally set for 8th December
The meeting closed by thanking the European Banking Federation for their kind hospitality.
© Graham Bishop