01 July 2020

Insurance Europe: Views on EIOPA’s Solvency II holistic impact assessment

This paper sets out Insurance Europe’s views on EIOPA’s Holistic Impact Assessment exercise, undertaken between March and June 2020. Insurance Europe looks forward to continued engagement with the EC, EIOPA and all other stakeholders on the 2020 Review of Solvency II and would welcome the opportunity to discuss the views raised below in more detail.
Key messages

EIOPA seeks to achieve a “balanced outcome” 1 and has committed to delivering technical advice which, except for the interest rate risk submodule, aims to not increase the aggregate capital requirements for European insurers. However, EIOPA has not provided evidence that a balanced outcome is appropriate, and it should, in any case, achieve its target for a balanced outcome at national as well as European level.

On the contrary, Insurance Europe considers Solvency II to be unnecessarily conservative and that a net reduction in aggregate capital levels is justified.

Policy measures not being tested in the HIA, such as those for groups, should be included as part of the balanced outcome. Similarly, the impact of the IBOR transition should also be considered, although such a transition should not have a negative impact in the first place.

EIOPA’s attempt, through the second HIA, to test potential changes under market conditions impacted by COVID-19 is welcome. However, due to the recovery on the financial markets since March this may not, in practice, provide a significantly different data set compared to the previous exercise. In its final recommendations to the EC, EIOPA should ensure that its proposals do indeed work under a wide range of economic conditions, for example by assessing the impact of the proposals under market conditions similar to those experienced in the 2008 or 2011 crises.

Comments on specific proposals:
Extrapolation of RFR: Insurance Europe continues to support the existing extrapolation methodology and parameters. The Matching Criterion and Residual Bond Criterion are key elements of the risk-free rate framework. These two criteria must remain anchor points for any extrapolation approach.
Volatility Adjustment: It is disappointing that EIOPA continues to pursue damaging and uneconomic changes to the VA.
There is not sufficient justification to change the risk correction. The existing methodology is already conservative enough to cover any concerns about the level of losses from defaults which may arise after a crisis. EIOPA’s small tweak to its original proposal does not address the industry’s strong and credible concerns about the risk correction being set as a proportion of the prevailing spread. In addition, this proposal increases procyclicality in the framework.
The revised liquidity application ratio criteria remain flawed and therefore strongly opposed by the industry. Liquidity should be dealt with in Pillar II and Pillar III, not Pillar I.
However, some of the proposed changes to the VA are welcome as steps in the right direction, as they reflect the industry’s positions that the VA is too low and does not sufficiently address artificial balance sheet volatility. This includes the inclusion of a “rescale factor”, recognition that the 65% for the GAR is too low and the enhanced country component (Option 7).
Risk Margin: EIOPA’s proposal to include a lambda factor is a step in the right direction, yet more work is needed to ensure the calibration of this scalar is appropriate. EIOPA’s proposal for the Risk Margin does not go far enough to address its excessive size and volatility; the value of 0.975 for lambda is too high, and the proposed floor of 0.5 has not been adequately justified.

EIOPA should improve the Risk Margin by:

Recalibrating the lambda parameter and its proposed floor to better reflect the impact of risk dependence over time.
Allowing for diversification between life and non-life business within the same entity, or between different entities within a group.
Lowering the Cost of Capital rate to 3%, in line with evidence provided by the industry.
Interest Rate Risk SCR: EIOPA’s proposal is overly punitive and uneconomic. The standard formula interest rate risk requirements must properly reflect the effective lower bound for interest rates and calculate the illiquid part of the stressed curves using the standard extrapolation methodology.
The two “optional” configurations on which data is requested are also insufficient to resolve the industry concerns. In particular, the level of the interest rate floor proposed by EIOPA is ineffective and does not reflect the lower bound for interest rates.
Dynamic Volatility Adjustment: Insurance Europe welcomes the recognition of the DVA as a valid tool within internal models and the testing of the standard formula DVA.
For internal models, the industry is concerned that the enhancement of the DVA prudency principle could create additional unjustified calculation burden and unstable cliff effects.
For the standard formula, the proposed approach is overly conservative and excludes unrated bonds, which would be detrimental in respect of the EC’s CMU objectives.
Long-term equity (LTE): EIOPA’s revised LTE proposals are not expected to extend the scope of the LTE submodule and therefore are of limited value.
For life insurers, the flawed liquidity criteria and excessive duration requirements will restrict the application to only a few long-term pension products.
For non-life, the binary application approach and the restricted HQLA assessment will unnecessarily restrict its use.
Own funds buffer: The inclusion of an additional discretionary buffer to be applied when credit spreads are excessively compressed is unnecessary and would effectively create additional capital add-ons to deal with systemic risk. Insurance Europe strongly opposes this.
Non-proportional reinsurance: Insurance Europe welcomes the testing of an alternative approach to recognise non-proportional reinsurance in non-life premium risk. However, several technical challenges remain which need to be overcome to make this a viable solution.

1 See G. Bernardino Key Speech: Insurance and Pension: Leading the Future, 19 November 2019

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