The document, ‘Solvency II: an update on implementation', released on July 25, lays out the PRA's interpretation of Solvency II rules on the admissibility of group own-funds items. Own funds are the capital used to satisfy Solvency II regulatory requirements.

 

The document states that capital instruments issued by group members in a country granted equivalence under Solvency II will only be eligible as own funds at a group level if their terms and conditions align with Solvency II rules. Some capital that firms assumed would be classified as group own funds might not be permitted under this interpretation of the directive.

 

David Stevenson, Edinburgh-based actuary in Standard Life's UK capital and risk management team, explains: "For the purposes of assessing whether an item of own funds of a third-country undertaking is available to the group and therefore can count towards group solvency under Solvency II, that item also has to meet Solvency II rules. For example, if the third-country insurer had issued subordinated debt, which qualified as a capital resource under local regulations, then in order to count that sub-debt as a capital resource at group level, it would also have to satisfy Solvency II requirements for the group."

 

Consultants say this requirement may take some insurers by surprise. "One principle of Solvency II is that if you're a group with an insurer in an equivalent country, you can apply to bring it into the group solvency calculation using the deduction and aggregation method, allowing the assets and liabilities and solvency requirement to be assessed under local rules. What this note says is that is not the end of the story. Any capital instrument issued by such a subsidiary will need to meet the Solvency II own funds criteria in order to be eligible for the group capital requirement," says Janine Hawes, director at KPMG in London.

 

Solvency II lays out specific criteria that capital instruments must fulfil to be counted as own funds. For example, according to the June 2 consultation paper on guidelines for Pillar I requirements issued by the European Insurance and Occupational Pensions Authority (Eiopa), for a debt instrument to count as Tier II own funds it cannot include any call option prior to five years from the date of issuance or provisions for the suspension of repayments and/or redemption in the event the insurer breaches the SCR. Capital issued by third-country subsidiaries would have to comply with these rules and others in order to count as group own funds under Solvency II.

 

"If the third-country undertaking of a European insurance group wants to issue subordinated debt, they have to make sure the market understands that the instrument has these two levels of loss absorbency – one relating to domestic rules and another relating to Solvency II. That could affect investor appetite and pricing, among other things," says Hawes.

 

The implementation note also specifies that for own funds to be considered available at group level, groups must show that the funds can be made available to the group within a maximum of nine months. In a recent letter sent to the PRA by the Association of British Insurers (ABI), the UK industry took the stance that own funds of regulated insurers should be automatically considered transferable. The PRA's response suggests that no own funds can be considered transferable without "robust" evidence.

 

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Solvency II Update (PRA document)