EUROPEAN COMMISSION

Brussels, 22.9.2021

SWD(2021) 260 final

COMMISSION STAFF WORKING DOCUMENT

IMPACT ASSESSMENT REPORT

Accompanying the documents

Proposal for a Directive of the European Parliament and of the Council

amending Directive 2009/138/EC as regards proportionality, quality of supervision, reporting, long-term guarantee measures, macro-prudential tools, sustainability risks, group and cross-border supervision

and

Proposal for a Directive of the European Parliament and of the Council establishing a framework for the recovery and resolution of insurance and reinsurance undertakings and amending Directives 2002/47/EC, 2004/25/EC, 2009/138/EC, (EU) 2017/1132 and Regulations (EU) No 1094/2010 and (EU) No 648/2012

{COM(2021) 581 final} - {SEC(2021) 620 final} - {SWD(2021) 261 final}

Table of contents

1.Introduction

1.1.Political and legal context

1.2.High-level overview of the main issues that the Solvency II review will aim to address

2.Problem definition

2.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy

2.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies

2.3.Insufficient proportionality of the current prudential rules generating unnecessary and unjustified administrative compliance costs for small and less complex insurers

2.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

2.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector

2.6.How will the problems evolve if not addressed?

3.Why should the EU act?

3.1.Legal basis

3.2.Necessity and Added Value of EU action

4.Objectives: What is to be achieved?

4.1.General objectives

4.2.Specific objectives

5.What are the available policy options?

5.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy

5.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies

5.3.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers

5.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

5.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector

6.What are the impacts of the policy options and how do they compare?

6.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy

6.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies

6.3.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers

6.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

6.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector

7.Preferred combination of options

7.1.General impacts

7.2.Impact on SMEs

7.3.REFIT (simplification and improved efficiency)

8.How will actual impacts be monitored and evaluated?

Annex 1: Procedural information

1.Lead DG, Decide Planning/CWP references

2.Organisation and timing

3.Consultation of the RSB

4.Evidence, sources and quality

Annex 2: Stakeholder consultation

1.Introduction

2.Consultation strategy

3.Conference on Solvency II

4.Inception impact assessment

4.1.Priorities of the Solvency II Review

4.2.Long termism and sustainability

4.3.Volatility and proportionality

4.4.Recovery, resolution, IGS, group supervision and cross-border supervision

5.Public consultation

5.1.Long-termism and sustainability of insurers’ activities and priorities of the European framework

5.2.Proportionality of the European framework and transparency towards the public

5.3.Improving trust and deepening the Single Market in insurance services

5.4.New emerging risks and opportunities

5.5.Additional or late feedback to the consultation

6.Targeted consultations of Member States

Annex 3: Who is affected and how?

1.Practical implications of the initiative

2.Summary of costs and benefits of the combined set of options

3.Summary of costs and benefits per problem

3.1.Problem 1: Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy

3.2.Problem 2: Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of insurers’ solvency position

3.3.Problem 3: Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs

3.4.Problem 4: Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

3.5.Problem 5: Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector

Annex 4: Proportionality and simplification measures

Annex 5: Discussion on the technical design of the minimum harmonising rules in relation to insurance guarantee schemes (IGSs)

1.Background

2.Introduction

2.1.A fragmented landscape

2.2.The failure of insurance companies

2.3.The default likelihood of insurers

2.4.Estimates of potential losses associated with the failures of insurance companies

2.5.Objectives of an EU action

3.Analysis of policy options

3.1.The need for harmonisation of national IGSs in the European Union

3.2.The harmonisation of the design of national IGSs

4.Are there alternative to specific EU action on IGS?

5.Conclusions

Annex 6: Analytical methods

Annex 7: Impact assessment of technical topics that were not explicitly covered by the main body of the impact assessment

1.Safeguards in the use of internal models

1.1.Problem definition

1.2.What are the available policy options?

1.3.What are the impacts of the options and how do they compare?

2.Reporting and disclosure requirements

2.1.Background and problem definition

2.2.What are the available policy options?

2.3.What are the impacts of the options and how do they compare?

Annex 8: “Zooming” on some issues covered in the impact assessment

1.Strengthening “pillar 2” requirements in relation to climate change and sustainability risks

2.Reducing undue volatility in Solvency II

2.1.Revising the volatility adjustment.

2.2.Revising the symmetric adjustment on equity risk

3.Balancing the cumulative impact of the review on capital requirements

3.1.Achieving the balance partly through phasing-in periods

3.2.Achieving the balance partly through “compensating measures”

4.Enhancing group supervision

4.1.Strengthening and harmonising supervisory powers towards groups

4.2.Clarifying prudential rules on capital requirements

5.Enhancing supervision of cross-border insurance companies

5.1.Ensuring more efficient information gathering/exchange during the authorisation process and ongoing supervision

5.2.Improving cooperation between Home and Host supervisory authorities, under the coordination/mediation of EIOPA

6.Incorporating a macro-prudential dimension in Solvency II

Annex 9: Other initiatives that will have a material impact on the insurance sector

Annex 10: Evaluation of the Solvency II framework

Glossary

The three “pillars” of Solvency II

Solvency II constitutes a three-pillar framework (capital requirements, governance, transparency), which is risk-based and market-based.

The “Pillar 1” sets out quantitative requirements, including the market-based rules to value assets and liabilities, the general design of capital requirements. The capital requirements are risk-based, forward-looking and economic, i.e. tailored to the specific risks borne by each insurer and taking into account risk diversification benefits, allowing an optimal allocation of capital across the EU. 

The framework is designed in such a way that an insurer complying with its requirements is supposed to be able to cope with an extreme adverse event, whose probability of occurrence is only 1 in every 200 years. In other words, the insurer is then supposed to be able to meet its obligations to policyholders and beneficiaries over the 12 following months, with a 99.5% probability. Hence, where the insurer complies with these risk management rules, the risk of an insurance failure over the following year should reach a very low probability (even though not null).

The “Pillar 2” consists of requirements for the governance and risk management of insurers, as well as the details of the effective supervisory process with competent authorities. A key Pillar 2 requirement is the “own risk and solvency assessment” (ORSA). It aims at supporting insurers to get a holistic view of its risk profile and understand how risks affect the future solvency situation. It requires that the insurer undertakes its own “stress testing”, integrating all foreseeable risks such as a volatile and uncertain economic outlook. It also implies that insurers, when defining their own “risk appetite”, may (shall) look beyond the “purely quantitative” solvency requirements, and set level of “reserve”/available capital that are also forward-looking, as an additional cushion beyond the minimum regulatory quantitative requirements.

Finally, the “Pillar 3” focuses on reporting to supervisory authorities and disclosure to the public, thereby enhancing market discipline and increasing comparability.

1.Introduction

1.1.Political and legal context

The economic and social importance of insurance is such that intervention by public authorities, in the form of prudential supervision, is generally accepted to be necessary. Not only do insurers provide protection against future events that may result in a loss, they also channel household savings into the financial markets and into the real economy. With trillions of assets under management, the insurance sector remains a mainstay of the European financial industry.

The rationale for EU insurance legislation 1 is to facilitate the development of a Single Market in insurance services, whilst at the same time securing an adequate level of consumer protection.

The Directive on the taking-up and pursuit of the business of insurance and reinsurance (Directive 2009/138/EC) is also known as the Solvency II Directive. The Solvency II Directive, as amended by the Omnibus II Directive (Directive 2014/51/EU), has entered into application in 2016. The supplementing Delegated Regulation (EU) 2015/35 was intended to further specify a range of aspects of the Solvency II Directive, with the aim to facilitate a consistent implementation throughout the European Union. Those two levels of legislation form the ‘Solvency II framework’, or regime. The Solvency II regime replaces fourteen existing directives commonly known as 'Solvency I'.

The European Commission has a legal mandate to conduct a comprehensive review of the pivotal components of the Solvency II Directive by the end of 2020. This review is an opportunity to draw the lessons learned from five years of implementation of the Solvency II framework, including in crisis situations such as the one triggered by the Covid-19 outbreak, and to take into account the feedback received from insurers, consumers and public authorities. In order to appropriately take stock of the potential shortcomings in prudential rules, which have been highlighted by the pandemic crisis, the timeline of the review had to be extended by six months.

Finally, the review of the framework needs to be coherent with the political priorities of the European Union. In particular, both the renewed Capital Markets Union (CMU) Action Plan and the communication on the European Green Deal explicitly refer to insurers as key institutional investors whose role will be instrumental to the so-called “re-equitisation” in the corporate sector and the greening of the European economy.

The European Parliament and the European Council also identify the Solvency II Review as a pivotal initiative to support the objectives of the CMU. The European Parliament’s report on further development of the CMU of 16 September 2020 requests the Commission to assess, on the basis of an impact assessment, the potential benefits and prudential justification of adjusting capital requirements for investments in businesses, notably of small and medium-sized enterprises (SMEs) to ensure that capital requirements for insurers do not discourage long-term investments. The Council Conclusions of 2 December 2020 on the Commission’s CMU Action Plan urges the Commission, to prioritise and to accelerate its work in parallel on strengthening the role of insurers as long term investors and assessing ways to incentivise long-term investments in corporates and particularly SMEs without endangering financial stability or investor protection and ensuring risk adequate regulatory treatment of long term investments.

At this stage, the Commission is pursuing several initiatives to increase private financing of the transition to a carbon-neutral economy and to ensure that climate and environmental risks are managed by the financial system. Those initiatives, which are listed in Annex 9, will have a significant impact on the insurance sector.

Other horizontal EU political priorities are being tackled in parallel, without having yet identified the need for a legislative change. For instance, the recently adopted Digital Finance Strategy has defined the main priorities for the EU and these priorities are also relevant for insurers and reinsurers. In that context, the Commission invited the European Supervisory Authorities (ESas), including EIOPA, to provide technical advice on digital finance. If necessary, Commission services will propose targeted amendments to the financial services acquis, including the Solvency II framework (possibly via a cross-sectoral proposal).

Following a formal request for advice that was sent by the European Commission to the European Insurance and Occupational Pensions Authority (EIOPA) in February 2019, EIOPA conducted three technical consultations covering the 19 topics of the Solvency II review that were identified by the European Commission. It also conducted two data collection exercises in order to quantify the cumulative impact of all policy proposals. EIOPA’s final Opinion on the Solvency II review, and the associated background analysis and holistic impact assessment , were published on 17 December 2020. The Commission services’ impact assessment largely leverage on the technical work and analysis conducted by EIOPA.

1.2.High-level overview of the main issues that the Solvency II review will aim to address

Since 2016 when it entered into application, the Solvency II Directive has provided a harmonised and sound prudential framework for insurance and reinsurance companies in the EU, as evidenced in the Evaluation Annex. Based on the risk profile of individual firms, it promotes comparability, transparency and competitiveness. Solvency II has significantly enhanced the protection of policyholders and beneficiaries, by limiting the likelihood that their insurer fails. It has also provided strong incentives for insurers to better measure and manage their risks, and to improve their internal governance. Under the coordination of the European Insurance and Occupational Pensions Authority (EIOPA), Solvency II has also facilitated supervisory convergence within the Union and contributed to the integration of the Single Market for insurance services.

Also thanks to Solvency II, the European insurance industry remained robust overall. With average levels of capital resources that remain more than twice as high as what is required by the legislation, insurers’ solvency position has so far proved to be sufficiently solid to weather the economic and financial consequences of the Covid-19 outbreak 2 . However, due to the high level of uncertainty in the economic and financial outlook, regulators and supervisors still have to closely monitor future market developments.

The primary objective of Solvency II is the protection of policyholders. Achieving this objective requires that insurance companies are subject to effective solvency requirements based on the actual risks they are facing (“risk-based” framework). The framework is defined in such a way that the risk of an insurance failure over the following year, even though not null, is of very low probability, as an insurer complying with its requirements is supposed to be able to cope with an extreme adverse event whose probability of occurrence is only 1 in every 200 years. The framework also relies on full market-based valuation of insurers’ assets and liabilities, which allows monitoring the impact of economic and financial conditions on insurers’ solvency in real time and on an ongoing basis.

However, the market value and risk-based principles also raise some challenges.

First, with regard to market risks faced by insurers, the risk-based approach implies that the definition of capital requirements on investments only depends on the relative riskiness of each asset over a one-year time horizon. Therefore, prudential rules do not take into account the instrumental role of insurers in financing long-term sustainable growth in the Union and in the economic recovery in the aftermath of the Covid-19 crisis. Both the European Green Deal and the Capital Markets Union Action Plan make this observation.

While Solvency II is not the main driver of insurers’ investments, the framework may still provide disincentives to invest in assets such as equity, as insurance firms have to set aside more capital when holding such assets whose prices are generally more volatile than fixed-income securities. In addition, current rules do not capture the lower long-term risk of environmentally sustainable (“green”) activities/assets (all else equal). Hence, it should be explored whether barriers to long-term sustainable investments are unjustified and could be eliminated so as to facilitate insurers’ contribution to the financing of long-term sustainable growth, while preserving an appropriate level of policyholder protection.

Second, in order to be effective in protecting policyholders, the framework needs to be regularly updated, so that it appropriately captures all risks that insurers are facing due to structural changes in financial markets. At this stage, Solvency II provisions and parameters may prove to be outdated, as they do not reflect key trends, such as the protracted low – and even negative – interest rates environment, and its consequences.

Finally, reliance on market values can generate high volatility in the solvency position of insurers. Such volatility may unduly foster procyclical behaviours and short-termism in their underwriting and investment activities, although insurers are supposedly “long-term oriented” by nature. In particular, it can provide disincentives to the supply of (life) insurance products with guarantees, which are still highly sought by EU citizens, in particular for their pensions.

In addition to the issues stemming from market valuation and risk-based rules, the review of Solvency II should aim to address other challenges.

Solvency II is a highly sophisticated framework, which provides strong incentives for robust risk management by insurers. However, the framework can prove to be very complex, and its implementation generates significant compliance costs, in particular for smaller insurers. Solvency II embeds an overarching principle of proportionality, which supposedly ensures that both the requirements imposed to companies and the intensity of supervisory activities by public authorities are commensurate to the “nature, scale and complexity” of the risks of each firm. However, in practice, this overarching principle is abstract and results in legal uncertainties and insufficient visibility for both national supervisory authorities (NSAs) and companies, as the framework neither specifies what the proportionate measures are nor clarifies the scope of firms that are eligible for such proportionality. Hence, at this stage, the implementation of proportionality is insufficient to effectively reduce the regulatory burden for smaller insurers.

Solvency II has facilitated the integration of the Single Market for insurance services by improving the level-playing field and supervisory convergence. However, recent failures of insurance companies, which operated mainly outside the Member State where they were initially granted authorisation, highlighted shortcomings and deficiencies in the quality and coordination of insurance supervision, including of cross-border insurance groups. In addition, it also confirmed that policyholders are not consistently protected across the European Union in the event that their insurer fails, in particular in a cross-border context. Indeed, national resolution regimes are mostly incomplete and uncoordinated, and the patchwork of national insurance guarantee schemes (IGSs), which are expected to act as a safety net to pay policyholders’ claims in the event of their insurer’s insolvency, can leave some policyholders without any protection.

Finally, while policyholder protection is the primary objective of Solvency II, regulators and supervisors also have to preserve financial stability according to the Directive. To this end, supervising insurers on an individual basis (“micro-prudential supervision”) may not allow addressing systemic risks in the insurance sector, since it does not really take into account their interconnections with other market participants and common risky (herding) behaviours among insurers. While some regulatory tools embedded in Solvency II already contribute to this objective, they may be insufficient and too narrow in terms of scope to effectively prevent the build-up of systemic risk in the insurance sector.

2.Problem definition

The need for amending the Solvency II framework in order to either introduce new provisions or to review the existing ones has emerged as a result of both the conclusions of the evaluation of the Solvency II Directive (see Annex 10), and the outcome of the public consultation that was conducted between 1 July and 21 October 2020 (see Annex 2).

This section presents the most important problems addressed by this impact assessment. Those problems are further identified and assessed as part of the Evaluation Annex. Please also refer to Annex 7 for specific discussions on internal models and on reporting and public disclosure, which fall under the broader issue of quality of supervision (See 2.4) but will not be assessed as such in the core part of the Impact assessment due to size limitations.

Figure 1 summarizes the problems and problems drivers as well as their related consequences. Regarding the links between problems and consequences, the solid arrows correspond to the primary links whereas the dotted arrows correspond to the secondary links.

Figure 1: Problem tree

2.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy 

The main focus of Solvency II is policyholder protection and financial stability. To that end, Based on quantitative data (e.g. historical price and volatility behaviour of financial assets), it defines capital requirements, i.e. the amount of capital resources that insurers have to set aside in order for them to be able to cope with very extreme adverse events (1-year duration shocks whose probability of occurrence is only once in 200 years). Higher capital requirements on investments are therefore applied to assets, which are more volatile and/or more risky, for instance equity. However, since Solvency II was adopted, the European Commission set additional political objectives, notably the need to build-up a Capital Markets Union which can channel more funding to businesses and the European Green Deal to achieve a transition to carbon-neutrality. The capital requirements of Solvency II do not take into account the positive externalities of some investments in strengthening long-term sustainable growth and the economic recovery in the aftermath of the Covid-19 crisis and the limitation of the negative impact of climate change.

Limited incentives for insurers to contribute to the long-term financing of the economy

For the purpose of this impact assessment, the objective of fostering long-term investments will be actually related to the equity asset class only, since insurers are already largely investing in long-maturity bonds, as discussed in Sub-section 6.1.4 of the Evaluation Annex.

In addition, the concept of long-term investment has no commonly agreed definition. It cannot be restricted to “buy-and-hold” strategies. For the purpose of this impact assessment, a long-term investment will be deemed an investment in an asset class (and not individual assets) with a long-term perspective (the Solvency II Delegated Regulation refers to a 5-year time horizon for long-term equity investments), including under stressed conditions. In other words, an insurer is deemed to make a long-term investment in equity if it can have a long-term perspective to hold a certain share of its investment portfolio in equities (listed, unlisted, private equity, etc.), even if it does some arbitrage operations from time to time (i.e. realising gains on certain equities and investing in other ones). From a prudential perspective, a long-term perspective encompasses the possibility for insurers to avoid forced selling under stressed market conditions.

The Capital Markets Union Action Plan underlined the instrumental role that insurers can play in the “re-equitisation” and long-term financing of the European economy. Insurers can hence support the economic recovery in the aftermath of the Covid-19 crisis. As shown in the Evaluation Annex, Solvency II, which only entered into application in 2016, is not the main driver of insurers’ investments, since the downward trend in equity investments dates back to the beginning of the 21st century. The Commission made several amendments to the Solvency II Delegated Regulation to help insurers contribute to the long-term financing of the European economy, in particular by introducing a preferential treatment for long-term investments in equity, subject to some criteria 3 . However, those amendments are not sufficiently effective and the framework still includes disincentives to investments in assets such as equity, as insurance firms have to set aside more capital when investing in more volatile assets. To achieve the political objective of facilitating insurers’ role in sustaining the economic recovery, prudential rules should be reviewed to facilitate long-term equity investments, while at the same time ensuring that such changes do not harm policyholder protection and financial stability. For further evidence, please refer to Sub-section 6.1.4 of the Evaluation Annex.

Insurers could contribute more to the greening of the economy

In relation to the European Green Deal, the Commission’s Communication states that climate and environmental risks should be managed and integrated into the financial system. As regards insurers, the objective concerns both how insurers invest their money and how they take into account sustainability risks in their risk management concerning investments and underwriting of insurance risks. With respect to the former, insurers can play a role in closing the investment gap for environmental-friendly assets and activities. However, EIOPA estimates that only up to 5 % of the total asset value held by insurers may be eligible investments in sustainable assets (as identified by the taxonomy 4 ), and therefore contribute to the climate objectives of the European Green Deal. This seems too low to achieve the Union’s objective of a climate-neutral continent.

A first issue is probably the lack of available investable assets that are aligned with the taxonomy 5 . While the review of Solvency II will not address the need to foster the supply of sustainable assets, there is currently no explicit prudential incentive for insurers to invest in such assets. Indeed, the rules on capital requirements do not distinguish between sustainable and other investments, and do not capture the possibly lower (respectively higher) level of risks over the long term of some categories of “green” (respectively “brown”) assets, all else equal. Also, the positive (respectively negative) externalities of investing in such assets are not captured.

Furthermore, insurers are exposed to climate and environmental risks through their assets and liabilities towards policyholders. While Solvency II contains a general requirement on insurers to take into account all risks in their risk management, the Directive does also name particular risk categories explicitly. However, climate and environmental risks are not part of those risk categories and it would often materialise through other risk categories, e.g. market or underwriting risk. This may result in a lack of clarity as regards whether and where insurers are expected to reflect climate and environmental risks and, as a consequence, in insufficient management of those risks by insurers. For instance, only a small proportion of all insurance companies reflects climate change risks in their own risk and solvency assessment (ORSA). In 2020, EIOPA analysed a sample of ORSA reports from 1682 companies representing more than 80% of the EU insurance market. Only 13% of the analysed ORSA reports made a reference to climate change risk scenarios 6 .

In conclusion, the prudential framework requires the same capital to be held for sustainable investment as for investment that do not qualify as sustainable. However, the financial risks of some categories of sustainable investments may already be lower or, notably with respect to transition risks, could be lower over a longer term. To achieve the political objective of private investments in the green transition, prudential rules should be reviewed to ensure that capital requirements on green assets are not higher than necessary to avoid harm to policyholder protection and financial stability. Furthermore, there is no clear obligation to manage and reflect climate and environmental risks. However, given their clear importance going forward, from both an economic and risk perspective, there may be room for appropriate regulatory adjustments in this area.

2.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies 

The economic and financial conditions faced by insurers over the recent years and months (in particular in relation to interest rate risks and market volatility) significantly differ from those present when the Solvency II framework was adopted 7 . Therefore, the Directive may contain outdated parameters and provisions, possibly resulting in an insufficient risk sensitivity and excessive volatility in some areas of the framework. The below subsections provide a few examples of such shortcomings.

Insufficient reflection of the low interest-rate environment in the Solvency II framework

As insurers are large investors in fixed-income securities (i.e. debt instruments that pay a regular fixed amount of coupon interest), it is commonly accepted that the current low – and sometimes even negative – interest rate environment is one of the main risks that EU insurers have been facing over the recent years. This is because they earn only low returns (or even make losses) which impact their profitability and solvency. This limits them in their ability to provide adequate insurance products for their customers. As shown in Sub-section 6.3.2 of the Evaluation Annex, between 2018 and 2020, the level of interest rates (for the euro) has significantly decreased, with a material adverse impact of both insurers’ solvency position and profitability.

In this regard, the underlying assumptions based on which the Solvency II capital requirements under the standard formula are designed are outdated, as they do not envisage the possibility for interest rates to move in negative territory, or when rates are already negative, to further decrease. Therefore, the prudential framework, which leads to an underestimation of the interest rate risk to which insurers are exposed, has not provided clear obligations to insurers for having capital to buffer for the risk of negative interest rates over a recent years, which has now materialised. If not addressed, this underestimation of the real risks to which insurers are exposed could become detrimental to policyholder protection, as insurers may not at some point have sufficient capital to absorb losses if the downward trend in interest rates continues in the future. Already in 2018, EIOPA estimated that this underestimation of interest rate risk represented on average 14 percentage points of solvency ratios at European level 8 .

Sub-section 6.1.1 of the Evaluation Annex also shows that the current low interest rate environment raises doubts about the appropriateness of the stipulated regulatory interest rate curves that have to be used by insurance companies when valuing their long-term liabilities towards policyholders. As an illustration, the yield at issuance on a 100-year Austrian government bond (AA-rated) was lower than the 33-year regulatory risk-free interest rate in June 2020. An underestimation of the value of insurers’ liabilities would lead to an overestimation of their solvency position, and may limit prudential incentives for insurers to establish robust asset-liability management strategies, with detrimental side effects on policyholder protection.

Insufficient ability of the framework to mitigate the impact of financial market turmoil on the solvency position of insurers.

In addition to being risk based, Solvency II relies on the pivotal principle of market-consistent valuation of assets and liabilities, which means that insurers have to rely as much as possible on market data when establishing their balance sheet. By nature, such characteristics imply high short-term volatility in insurers’ assets (the value of which evolves with financial market movements) and liabilities (for instance, when asset values and asset returns collapse, the cost for an insurer of providing a high guaranteed rate on a life insurance product increases significantly). Those fluctuations in asset and liability values lead to a high volatility in the level of insurers’ capital resources and more generally in their solvency position.

Solvency II also includes several regulatory mechanisms (so-called "long-term guarantee measures and the measures on equity risk" 9 ) which are aimed at mitigating the impact of short-term market turmoil on insurers solvency position.

However, as evidenced in Sub-section 6.1.1 of the Evaluation Annex, those measures have proved to be insufficiently effective at mitigating excessive short-term volatility in the solvency position of insurers, in particular during market turmoil such as during March 2020 in the context of the Covid-19 outbreak. When the short-term volatility in insurers’ solvency ratios becomes excessively high, it fosters short-termism in insurers’ underwriting and investment activities. In particular, it may unduly incentivise life insurers to reduce their supply of long-term insurance products with guaranteed minimum returns, to shift a large part of the risk to policyholders (via the distribution of unit- or index-linked products), and to divest from real assets supporting the long-term financing of the European economy. Also, if the treatment of long-term insurance products is unduly penalising for EU insurers, they may be put at a disadvantage compared to their non-EU competitors and will have less stable surplus capital (capital minus capital requirements) to expand internationally. Therefore, excessive volatility is also impeding international competitiveness of the European industry 10 .

The Evaluation Annex also shows that the current parameters of the “long-term guarantee measures” sometimes give rise to unexpected improvements in the solvency position of some insurers, during crises such as the Covid-19 outbreak. Such unintended situations (called “over-shooting effect”) raise supervisory challenges, because the existing regulatory framework may not result in appropriate risk measurement under stressed situations.

2.3.Insufficient proportionality of the current prudential rules generating unnecessary and unjustified administrative compliance costs for small and less complex insurers

Outdated thresholds of exclusion from the Solvency II framework

The Solvency II Directive already provides that very small insurers are excluded from the application of the Directive if they meet a series of cumulative criteria, including limited revenues (lower than EUR 5 million) and risk volume (insurers’ liabilities towards policyholders of less than EUR 25 million).

As outlined in Sub-section 6.2.2 of the Evaluation Annex, the thresholds for exclusion have not been amended since the adoption of the Solvency II Directive in 2009. Therefore, those thresholds may be considered as outdated, although they will have to be updated to reflect inflation every five years, provided that the inflation since the last update is greater than 5%. The first update will therefore take place in 2021 11 . Still, the lack of reassessment of the appropriateness of thresholds may imply high compliance costs for small companies in the scope of Solvency II, which may not compensate the benefit of being subject to Solvency II.

Insufficient application of proportionate rules in Solvency II

The Solvency II framework broadly embeds the principle of proportionality, insofar as it requires ensuring that not only the requirements imposed to insurance companies, but also the intensity of the supervisory review process, are commensurate to the “nature, scale and complexity” of each company which is subject to Solvency II. Therefore, the application of the proportionality principle does not depend on the size of the companies but on the risks that they are facing. The framework as a whole is formulated in a modular manner, such that insurance and reinsurance companies must only apply those requirements, which are relevant to the risks they incur.

As Solvency II does not clearly define which firms can be subject to proportionality and which measures can be implemented in a proportionate way, the current framework results in legal uncertainty and lack of predictability for both insurers and NSAs. There is no report on the effective application of proportionality under Solvency II. However, Sub-section 6.2.2 of the Evaluation Annex concludes that the current framework results in a limited implementation in practice of the proportionality principle. If not implemented in a proportionate way, Solvency II requirements become very challenging to comply with for smaller and less complex insurers, as their limited riskiness is not appropriately accounted for in supervisory review processes. This implies that the intensity of regulatory requirements is not sufficiently modulated so that they do not generate a disproportionate burden for small and non-complex insurers.

The issue of proportionality concerns all three pillars of Solvency II. However, the lack of proportionality in the implementation of prudential issues is particularly acute in relation to reporting and disclosure requirements by insurance companies (“pillar 3”). In this regard, Sub-section 6.2.1 of the Evaluation Annex shows that the information that must be publicly disclosed to policyholders proves to be too complex and too detailed, lacking a high-level simple overview. As regards data collection and reporting to NSAs, the Evaluation Annex underlines that the number and frequency of submission of the quantitative templates for regular reporting (often on quarterly basis) generates costs to both insurers and supervisors.

2.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

Inconsistent and insufficiently coordinated supervision of insurance companies and groups, including in relation to cross-border activities

Solvency II has facilitated the integration of the Single Market for insurance services by improving the level-playing field and supervisory convergence.

However, as shown in Sub-section 6.1.3 of the Evaluation Annex, recent failures of insurance companies, which operated mainly outside the country where they initially obtained their license, highlighted shortcomings and deficiencies in the quality and coordination of insurance supervision including in relation to cross-border activities. It also shows the insufficient prioritisation of some NSAs on the supervision of cross-border business 12 . EIOPA’s coordination role, although reinforced in the context of the review of the Regulation (EU) 2019/2175 establishing the European Supervisory Authorities, proves to be insufficient in ensuring a high-quality convergent supervision across Member States. In addition, the lack of data sharing between NSAs may hinder the effective supervision of insurers operating on a cross-border basis.

Furthermore, the Evaluation Annex shows in the same Sub-section that due to legal uncertainties, several areas of the framework may not be sufficient for a harmonised implementation of the rules by insurers and NSAs, including in relation to the supervision of insurance groups. In particular, challenges arise from the supervision of groups that are headquartered or active in non-EEA countries, and of mixed financial groups combining banking and insurance activities (financial conglomerates).

Insufficient supervisory toolkit to intervene when firms are in financial distress

Although the Solvency II framework aims to minimise the likelihood of insurance failures, such likelihood is not brought to zero either. Recent failures, in particular of cross-border insurers, demonstrated that this risk remains not sufficiently addressed early, partly due to deficiencies in prudential supervision by some public authorities.

However, experience has also shown that, despite the existing Solvency II arrangements, the efforts to recover an insurer in financial distress are sometimes inefficient or run into legal or operational difficulties for a lack of proper and timely preparation of recovery options. Likewise, public authorities may fall short of options that could effectively avoid the winding-up of the insurer as they have not looked at failure scenarios and have not anticipated possible impediments to deploying alternative measures.

Furthermore, public authorities do not always have sufficient tools to avert the failure of insurers. As reported by EIOPA 13 , one third of NSAs identified gaps and shortcomings in their range of recovery and resolution powers. Likewise, public authorities often lack alternatives to insolvency for failing insurers. Even traditional tools for an orderly wind-up such as run-off (i.e. a ban on writing new business while fulfilling existing obligations) and transfer of portfolios are either unavailable or subject to restrictions in some Member States. Other important powers to stabilise a failing insurer, such as stays on early termination rights, are only available in a small minority of Member States. Even in the few Member States equipped with the necessary tools, resolution approaches remain tailored to national objectives and constraints and could therefore differ widely (i.e. legal frameworks, scope of powers and tools, conditions for exercising these powers).

Finally, despite general cross-border coordination mechanisms for supervision, there is no clear framework for coordination and cooperation between authorities to prepare and manage a (near) failure of an insurance company operating across borders. As illustrated by EIOPA 14 , this can result in conflicts of interest and a misalignment between the national accountability and mandate of supervisors (protecting the interest of policyholders at national level) and the cross-border nature of the insurance industry that is not coherent with the objectives of the Single Market. Cross-border cooperation and coordination is however essential to support recovery, eliminate impediments to an orderly resolution process and reduce suboptimal outcomes at the EU level. For further details, see Sub-section 6.1.3 of the Evaluation Annex.

Inadequate / insufficient protection of policyholders in case of failure

Currently, 17 Member States (and Norway) operate one or more IGS(s). This means that a significant share of gross written premiums are not covered by any IGS and that losses stemming from the failure of insurance companies can still be passed onto EU policyholders or taxpayers.

The current patchwork of national guarantee schemes means that policyholders across the EU are not equally protected. Gaps, but also overlaps 15 , in the protection of policyholders can stem from substantial differences in the design features of existing national IGSs, notably in terms of geographical coverage. Therefore, for the same type of insurance policy, policyholders might benefit from a different level of IGS protection or no protection at all, depending on where they live and on where they have contracted the policy. 16 For further details, see Annex 5 and Sub-section 6.1.3 of the Evaluation Annex.

Insurers in the EU may therefore face different costs and incentive structures, which can lead to an uneven level-playing field and add to the regulatory arbitrage previously described. 17  

2.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector 

While policyholder protection is the primary objective of Solvency II, regulators and supervisors also have to preserve financial stability. To this end, supervising insurers and reinsurers on an individual basis without taking into account their interconnections with other market participants and common risky (herding) behaviours may not be sufficient to preserve financial stability.

Most rules of the Solvency II Directive are targeted to individual insurers (so-called “micro-prudential supervision”). Those provisions, for instance risk-based capital requirements, can help preventing systemic risk as they provide disincentives for excessive risk-taking. There are also several regulatory tools embedded in Solvency II that more directly contribute to preventing systemic risk, for instance by avoiding forced-sales of assets during market turmoil, which could amplify negative market movements.

However, according to EIOPA and ESRB, there are several shortcomings in the existing framework, which may limit public authorities’ ability to preserve financial stability, and to address risks generated by the insurance sector itself. In particular, as further detailed in the Sub-section 6.3.2 of the Evaluation Annex, the current set of rules may not appropriately address issues of search-for-yield behaviours, high concentration of investment portfolios in certain assets and sectors, potential liquidity strains and insufficient coordination of macro-prudential measures, as illustrated during the Covid-19 crisis.

2.6.How will the problems evolve if not addressed?

For the purpose of this impact assessment, the baseline scenario will be to “do nothing” (this “baseline scenario” will be “Option 1” for each problem).

Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy

Doing nothing would generate opportunity costs for the wider economy in the form of lost output and overall welfare, by possibly preventing insurers from providing capital injections to businesses, notably SMEs, and from financing the transition to a carbon-neutral economy. This would not be coherent with the objectives of the CMU and the European Green Deal. It could also affect international competitiveness. Still, it can be argued that the higher risk of investing in equity justifies higher capital requirements, and that such an approach actually makes insurers’ solvency more resilient to financial shocks in the long- run. Similarly, insurers that have already invested in sustainable assets may have less “free capital” which may affect competitiveness and the ability to offer products with guarantees to consumers. For further evidence on those different issues, please refer to Sub-sections 6.1.4 and 6.3.3 of the Evaluation Annex.

Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies

Not addressing the issue of insufficient risk sensitivity of the framework would have detrimental effect on the overall level of policyholder protection, and could foster risk-taking activities by insurers, with potential negative side effects on financial stability risks.

While volatility had been very low in recent years, it has sharply moved upwards as the Covid-19 crisis became virulent, and higher volatility seems to remain entrenched in the financial system. In consequence, without policy action, insurers might tend to reduce their investment time horizon and aim to shift market risks to policyholders (via the supply of unit-linked products) in a higher volatility environment. Finally, excessive volatility can generate procyclical behaviours, and therefore raise financial stability risks. Doing nothing would not be coherent with the renewed Action Plan on the CMU where it is acknowledged that volatility mitigation is key to help insurers provide long-term (capital) financing to the EU economy.

For further evidence on those different issues, please refer to Sub-sections 6.1.1 and 6.3.2 of the Evaluation Annex.

2.6.1.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers

The high compliance cost of Solvency II 18 (3.18% of total operating costs, the highest one-off costs among the financial services frameworks 19 ), could be a barrier to the entry and growth of new competitors in the Single Market, with undesirable effects in the offer of insurance products and/or in their price for policyholders 20 (higher fees). Therefore, doing nothing on proportionality may progressively lead to a less diversified landscape of insurers in terms of size and more concentration. The reduced competition in the sector could be detrimental to consumers.

In addition, as the conditions to apply the principle of proportionality are not clearly defined, insurers with a similar risk profile, could be subject to different rules depending on the Member State in which they are located, which is detrimental to the level-playing field in the EU.

Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

Doing nothing would leave unaddressed the inconsistencies and gaps identified in the Solvency II framework on the quality of supervision. Only relying on EIOPA’s soft (non-binding) tools to ensure convergence in supervision is of limited effectiveness as supervisory authorities have no legal obligation to comply with those principles. Similarly, the problem drivers identified in Sub-section 6.1.3 of the Evaluation Annex and in the problem definition on policyholder protection in case of insurers’ (near-)failures would remain, with the risk of late and not sufficiently prepared measures by insurers and/or public authorities in case of an insurer’s distress. This could have a negative impact on policyholder protection and level-playing field as further Member States would probably establish national recovery and resolution frameworks to implement international guidance. Finally, doing nothing on IGSs would mean that Member States continue to take different approaches to IGS, including a total absence of IGS in some Member States. Uneven and insufficient levels of protection could undermine consumers’ trust in the Single Market for insurance services.

For further details, see Annex 5 and Sub-section 6.1.3 of the Evaluation Annex.

Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector

The baseline scenario would not impose new requirements on insurers and reinsurers, and therefore would allow avoiding additional compliance costs for them. In addition, the absence on new rules on investments or quantitative requirements (capital surcharge for systemic risk, concentration limits, etc.) would ensure that EU insurers’ short-term competitiveness 21 is not affected. 

However, doing nothing would not guarantee that supervisors have the powers to address systemic risk, which is not coherent with one of the main objectives of Solvency II (preserving financial stability). Furthermore, a lack of sufficient supervisory tools to prevent financial instability risks originating from the insurance sector would be negative for policyholders in the long term, since insurance failures may require public intervention and indirect costs for taxpayers. Furthermore, the economic and financial consequences of a crisis on social welfare go far beyond the sole insurance sector, and may concern the wider economy. It should be noted that the “holistic framework” for systemic risk, adopted by the Insurance Association of Insurance Supervisors and the Financial Stability board in November 2019, provides that supervisory authorities should have the power and mandate to identify, monitor and address, where necessary, the build-up and transmission of systemic risk in the insurance sector. 22

3.Why should the EU act?

3.1.Legal basis

The Solvency II Directive provides for a comprehensive regulatory framework regarding the taking up and the pursuit of insurance and reinsurance (hereafter “insurance”) business within the Union. The principle of regulating the taking-up and pursuit of the business of insurance is long established at European level, and leaving this matter to the discretion of Member States would highly hinder the right of establishment and the freedom to provide services which European insurance companies benefit from to date. The legal bases of the current Directive are Articles 53(1) and 62 of the Treaty on the Functioning of the European Union. This would also be the legal basis for the envisaged introduction of a new minimum harmonised framework for insurance guarantee schemes. In order to continue to harmonise the rules at stake, or introduce these new harmonised rules, EU action in accordance with these Articles is needed.

On the envisaged harmonised framework for recovery and resolution of (re)insurers, which aims at ensuring a minimum level of harmonisation across the EU, the legal basis is Article 114 of the Treaty on the Functioning of the European Union.

Necessity and Added Value of EU action

The review aims to amend certain provisions of the Solvency II Directive, in particular those on capital requirements, on valuation of insurance liabilities towards policyholders, on cross-border supervision and on preventive recovery planning. It also aims at providing necessary clarifications and changes to the principle of proportionality. With regard to these particular issues, only EU action to clarify these provisions will ensure that going forward, these regulatory provisions are applied uniformly and guarantee the existence of the well-established regulatory framework regarding the taking up and the pursuit of insurance and business, which are essential for the Single Market.

In addition to amendments of existing rules, the review will consider the introduction of new dimensions in Solvency II, notably in relation to climate change and environmental risks, to the harmonisation of national frameworks for resolution, and to macro-prudential tools. In addition, the impact assessment will contemplate putting forward a stand-alone proposal for a minimum harmonisation framework for insurance guarantee schemes. The necessity and added value of EU action on those areas is justified in the next paragraphs.

Climate change and environmental risks: The limited incentives for insurers to contribute to the greening of the economy could possibly be addressed through individual actions by Member States. In fact, given the commitments to environmental and climate policy goals, both at international (e.g. Paris Agreement) and at Union level, it is very likely that more Member States and NSAs will explore options of ensuring a contribution by the insurance sector. The lack of clarity on the relevance of sustainability risks in current prudential rules could however be exacerbated by parallel and uncoordinated attempts by Member States in that field which would undermine the Single Market for insurance services. Thus, such clarification needs to be provided at Union level so that insurance companies operating in several Member States comply with rules within a single framework and for supervisory authorities to coordinate and align actions within that framework (instead of segmenting the market via different actions and rules).

Resolution: A minimum harmonised resolution framework for insurers, aiming to address situations where an insurer is no longer viable or likely to be no longer viable 23 , would ensure a common approach to address and mitigate the consequences of an insurer’s failure across the EU, thereby fostering cross-border cooperation and coordination. If applied in a proportionate manner, this could improve the functioning of the Single Market, ensure that the overall framework is suitable to maintain a high level of protection for policyholders and beneficiaries and contribute to preserving financial stability in the EU.

Insurance guarantee schemes: Currently, in the event an insurer fails, a patchwork of national schemes is in place across the Member States, which can step in. These guarantee schemes offer different levels of protection, cover a different scope of insurance products and have different geographical scopes. Solvency II does not contain substantive provisions on IGS. It only contains a provision providing that host Member States may require non-life insurers from other Member States selling insurance products on their territories through branches or cross-border sales to join and participate in their IGS. Combined with the increasing share of cross-border activities within the EU Single Market and the absence of adequate cross-border mechanisms for compensation, the current situation results in an inefficient and incomplete protection for policyholders and other beneficiaries. Establishing mechanisms that would address these issues would not be possible without EU action. Only an EU action can ensure consistently that all policyholders and beneficiaries acquiring insurance policies in the EU benefit from a minimum level of protection in the event that their insurer fails, and in particular in cross-border situations. EU action would also be necessary to create an appropriate and consistent incentive structure across the EU that is conducive of market discipline by involving the insurance industry in the financial consequences of an insurance failure 24 .

Macro-prudential supervision: Solvency II is at this stage mainly focused on micro-prudential supervision (i.e. the supervision of individual insurers) with the aim of protecting policyholders, but the Directive also mandates supervisors to preserve financial stability. Under certain (and so far limited) circumstances, insurance activities can indeed originate or amplify systemic risk. An action at EU level to integrate (targeted) macro-prudential elements within the Solvency II Directive would ensure uniform application of the new provisions. As financial stability does not have national borders (in particular since insurance companies and groups largely operate on a cross-border basis), an EU action (aiming to ensure that public authorities are granted sufficient powers allowing them to adopt appropriate and coordinated supervisory responses to systemic risks in all Member States) would contribute to the financial stability in the whole Union. This would also be consistent with the approach followed by banking regulation where macro-prudential supervision is framed at EU level. Finally, the scope of the amendments would have to be sufficiently targeted in order to ensure consistency with the existing instruments that have been designed as micro-prudential but may also have a macro-prudential relevance (e.g. the ORSA, which is the process by insurers to assess their exposures to all quantitative and qualitative risks, or the prudent person principle which requires insurers to monitor risks related to their investment activities,).

4.Objectives: What is to be achieved?

General objectives

The review of Solvency II will aim to achieve the following general objectives:

·Increase insurers’ contribution to the long-term and sustainable financing of the economy;

·Enhance the protection of policyholders;

·Contribute to financial stability;

·Preserve the international competitiveness of the European insurance industry and improving the efficiency of the EU insurance industry.

Specific objectives

The impact assessment will consider the following five specific objectives:

·Provide incentives for insurers to long-term sustainable financing of the economy (hereafter “LT green financing”)

·Improve risk-sensitivity (hereafter “risk sensitivity”)

·Mitigate excessive short-term volatility in insurers’ solvency position (hereafter “volatility”);

·Increase proportionality of prudential rules aiming to remove unnecessary and unjustified administrative burden and compliance costs (hereafter “proportionality”) 25 ;

·Enhance quality, consistency and coordination of insurance supervision across the EU, and improve the protection of policyholders and beneficiaries, including when their insurer fails (hereafter “supervision / protection against failure”);

·Better address the potential build-up of systemic risk in the insurance sector (hereafter “financial stability”).

Figure 2: links between general and specific objectives

5.What are the available policy options?

5.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy 

The “preferred policy option” may be a combination of one option in relation to the long-term financing of the European economy (among Options 2 or 3) and another one in relation to the greening of the European economy (among Options 4 and 5).

Options discarded at an early stage

A complement to Option 5 could have been an option where additional disclosure requirements in relation to climate change and environmental risks are introduced in Solvency II, so that external stakeholders are fully informed about the sustainability of insurers’ activities. However, the communication on the European Green Deal underlined that the Commission intends to review the Non-Financial Reporting Directive (NFRD) the scope of which goes beyond the insurance sector, in order to extend “green” disclosure requirements to all types of financial market participants through one single piece of legislation. Therefore, in order to avoid overlapping disclosure requirements for insurers in different Directives, the option of introducing specific green disclosure requirements for insurers is not assessed in the context of this initiative. However, should gaps in the disclosure requirement for the insurance sector remain after the review of NFRD, amendments to Solvency II rules on disclosures could be considered.

In relation to amendments of quantitative requirements, an alternative or a complement to Option 5 could have been to amend quantitative rules so that all else equal, insurers investing in environmentally harmful (“brown”) assets would have a lower solvency position than other insurers (i.e. prudential rules would penalise “brown investments”). However, contrary to green assets, there is no commonly accepted European definition of “brown” investments. Without such a definition, it would be very challenging (if not impossible) to define penalising factors for brown investments and to assess the quantitative impact of such an option. Therefore, such an option has been discarded at this stage, but could be reconsidered if a taxonomy for “brown assets” were to be developed. In addition, a standalone approach for the insurance sector which would not be consistent with other financial market participants is not deemed appropriate.

5.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies 

No option was discarded at an early stage.

5.3.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers

In order to avoid excessive compliance costs, two elements can be combined: first, a further extension of the thresholds of the Directive (see Article 4) which would directly exclude from its mandatory scope a higher number of small insurers; second, new measures to reduce and simplify prudential rules for those insurers that would continue being in the scope of Solvency II. While the first element would address the problem of lack of proportionality for the smallest firms, only the second element would improve the application of the proportionality principle for the rest of firms, by not relying only on size. Therefore, only a combination of elements would allow an optimal solution.

Options discarded at an early stage

Alternative options could have been different exclusion thresholds that are lower than the changes proposed in Options 2 and 3. However, in view of the limited impact of such lower changes, those options, which were also tested by EIOPA, were discarded. Similarly, one could have envisaged a further increase in thresholds than the one proposed by EIOPA (as reflected in Option 2). However, in view of the downsides of Option 2 which are specified in the next section, this alternative option, which was also discarded by EIOPA, has not been considered in this impact assessment.

5.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

For the purpose of analysing this problem, different policy options will be considered in order to address the issues of:

I.Inconsistent and insufficiently coordinated supervision of insurance companies and groups, including in relation to cross-border activities

II.Insufficient supervisory and resolution toolkit to address insurers’ distress

III.Inadequate protection of policyholders in case of failure.

Note that due to size constraints, the policy options do not explicitly refer to topics of internal models, and reporting and disclosure, although those aspects fall under the issue of quality of supervision. The dedicated impact assessment of each of those topics is presented in Annex 7. In addition, Annex 5 provides a further technical analysis of the different features of the design of harmonised rules on insurance guarantee schemes.

Options discarded at an early stage

Further options which could have been considered include an EU-centralisation of supervision and resolution. However, in view of the outcome of the ESAs review, the integration of micro-prudential supervision and of resolution is not deemed politically mature at this stage. Similarly, a further option for policyholder protection in cases of failure would be the creation of a single IGS for the entire EU. This would increase the insurance effect of mutualisation and would thus require lower resources from the insurance industry. However, a single EU-wide IGS would not be consistent with the existing national micro-prudential supervisory framework.

5.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector 

Options discarded at an early stage

An additional consideration could have been to fully centralise macro-prudential supervision at European level (e.g. at the level of EIOPA or the ESRB). While such an approach could be effective in addressing European-wide systemic risks (as systemic risks do not have borders and coordination of national responses is probably needed to effectively preserve financial stability in the Union), this idea has been discarded as too far-reaching. Indeed, the macro-prudential dimension in Solvency II remains limited at this stage according to some stakeholders. It is therefore needed, as a first step, to contemplate enhancements of the current set of rules (where deemed justified) before considering significant changes to institutional/governance arrangements on the use and implementation of such new tools. In addition, in light of the limited success of the Commission’s attempt to strengthen the centralisation of micro-prudential supervision by EIOPA 32 , it would be unlikely that the centralisation of macro-prudential supervision would receive meaningful political support from Member States, before agreeing on the necessity to embed a macro-prudential dimension in Solvency II.

6.What are the impacts of the policy options and how do they compare?

In this section, each policy option considered (other than Option 1 – “No change”) will be assessed against the specific objectives presented in Section 4. The baseline scenario (“Option 1 – no change” of each problem) will not be assessed in this section. The consequences of doing nothing are outlined in Section 2 of this impact assessment.

6.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy 

6.1.1.Option 2: Facilitate long-term investments in equity

Under this option, the eligibility criteria for benefiting from the preferential treatment applicable to “long-term equity” assets would be loosened, with the aim of expanding the share of equity investments that can fall under this regulatory asset class. This is the general approach recommended by EIOPA in its advice. The revised criteria would still rely on the principle that an insurer may only benefit from a preferential treatment if it is able to avoid forced selling under stressed conditions. Other criteria would ensure that insurers have a long-term perspective when making equity investments which they want to classify as long-term equities.

Benefits

Option 2 would positively contribute to remedying the lack of incentives for insurers to contribute to the long-term and sustainable financing of the European economy. As demonstrated in Sub-section 6.1.4 of the Evaluation Annex, although Solvency II is not the main driver of equity investments, the prudential framework can also bias insurers’ investment behaviours. By relaxing some of the eligibility criteria for long-term investments in equity (while still ensuring that insurers’ policies incorporate the long-term perspective in their investment decisions), insurers would be able to apply the preferential treatment to a wider scope of equities and therefore to increase the amount of equity investments. In other words, facilitating long-term investments in equity would imply increasing insurers’ equity exposures. More capital could hence be injected in businesses, in particular SMEs. In addition, as the greening of the economy also requires stable financing, a facilitated preferential treatment for long-term investments in equity could also contribute to financing sustainable activities (indeed, criteria for long-term equities leverage on the objective of long-term investing time horizon). EIOPA has asked the industry to quantify the impact of one set of criteria, but its final advice goes further than what was tested, notably by allowing for more flexibility in the way life insurers may demonstrate their ability to stick to their investments. Therefore, EIOPA’s impact assessment (related to the initial set of criteria) provides a lower bound estimate of the impact of its final advice 33 . Therefore, based on those figures, Option 2 could thus result at least in a doubling of the number of insurance firms which are willing to use the long-term equity asset class, and a multiplication by almost six of the amount of equities eligible to a preferential treatment (from € 4.2 billion to € 26 billion). This implies that at least € 3 billion in capital would become available for covering capital requirements for further investments in equity (assuming insurers are willing to maintain their solvency ratio constant).

Option 2 would also have a moderately positive impact on international competitiveness. Indeed, if insurers are required to establish lower buffers when investing in equity, they would have more free capital surplus (i.e. excess capital resources over capital requirements) to expand internationally. The likely beneficiaries would be the shareholders of insurance companies.

Finally, Option 2 would also allow improving supervisory convergence and level-playing field by providing more clear-cut and unambiguous criteria to the eligibility of equities for the preferential treatment.

Costs

EIOPA’s analysis suggests that the existing calibrations for equity are appropriate and that financial data do not support the preferential treatment on long-term equity investments which was introduced by the Commission in 2019. However, EIOPA did not recommend removing the long-term equity category, but concluded on the contrary that policyholder protection and risk sensitivity would remain at a very high level if the revised eligibility criteria remain sufficiently robust and clear. Therefore, Option 2 would have a moderate negative impact on the risk-sensitivity of the framework (i.e. only in relation to equity investments). While Option 2 is not aimed at addressing the issue of volatility, one may note that since equity can prove to be more volatile than other asset classes, more investments in equity (stemming from the further use of the long-term equity asset class) could lead to further volatility in insurers’ assets. On the other hand, those additional (long-term) equity investments would be possible to the extent that the insurer is able to stick to its investments, including under stressed conditions, and is therefore not exposed to short term volatility in stock markets. Option 2 could also have a limited but negative impact on financial stability. Indeed, insurers would have more incentives to invest in equity, and therefore to hold on average assets with higher risks of material loss in market value in a short period of time (i.e. more volatile assets). On the other hand, the prudential criteria would be defined in such way that supervisors have the assurance that insurers would not be subject to forced-selling of equities at deteriorated price under stressed conditions 34 . Therefore, the revised eligibility criteria would be such that insurers would not be likely to amplify the negative externalities of an exogenous shock on stock markets, as they could weather the drop in equity prices due to the long-term nature of their investments. On balance, it is thus expected that this option would not generate material systemic risk.

In terms of implementation costs, based on a survey conducted by EIOPA, there would be significant one-off implementation cost of applying Option 2 in the view of about 20% of participants to the holistic impact assessment. A similar share (24%) are of the view that there would be material increase in on-going compliance costs. Those costs are associated with updating IT systems to comply with updated requirements and trainings to ensure staff is aware of regulatory changes. However, as the criteria are assumed to be clearer than under current framework, those costs are expected to decrease relatively quickly over time.

Overall assessment

Effectiveness, efficiency and coherence: Option 2 would contribute to removing barriers to equity investments. Hence, it would enlarge the productive capacity of the economy 35 and thus generate welfare. It would also have a positive impact on international competitiveness as evoked above. Option 2 would generate limited implementation costs and have limited negative impact on policyholder protection and financial stability, since the preferential treatment would only be possible if insurers meet a set of robust eligibility criteria. It is also coherent with the CMU objectives which explicitly refer to the need to facilitate insurers’ contribution to the “re-equitisation” of the European economy, and overall does not materially affect the risk-based nature of Solvency II (limited negative effect). Finally, it generates a necessary condition for enabling the European Green Deal, as “green” assets and activities require long-term funding including in equity investments, although it must be understood that there is no guarantee that all insurers’ long term investments are “green”.

Winners and losers: Policyholders would be “winners” to a certain extent. Indeed, despite limited negative impact on policyholder protection, they may benefit from the moderate increase in risk-taking by insurers by receiving higher returns on their life insurance policies as insurance companies would generate higher returns on their investments 36 . By being allowed to take additional risks, insurance companies can generate a higher return to their shareholders at limited additional costs. The impact of supervisors would also be positive, as the new criteria would be clearer than the existing ones, making it less complex to supervise insurers’ compliance with regulatory requirements. Finally, businesses, in particular SMEs and those conducting green activities, would benefit from easier access to equity funding by insurance companies.

Stakeholder views: In the context of the Commission’s public consultation, among those stakeholders who expressed a view on equity financing, more than 50% of stakeholders consider that the current framework still includes obstacles to long-term investments. This is particularly the case for insurance companies (66%) and public authorities (75%). Only 30% of citizens/consumers/NGOs share this view, but the remaining 70% expressed no opinion on this question. In the context of EIOPA’s technical consultations on the review, the vast majority of insurance stakeholders support an alleviation of the criteria on long-term equity, although they may disagree on the very specific criteria that should be retained.

6.1.2.Option 3: Reduce capital requirements on all equity investments

Under this option, all capital charges on equity would be reduced 37 . Therefore, the average cost of investing in equity would be reduced for all insurers, without any criteria, and regardless of whether the investment is “long-term” or not. This option, which has been put forward by a few stakeholders, including public authorities in different Member States, would be justified by the choice of giving priority to the political objective of facilitating insurers’ capital financing of the economy, in accordance with the objectives of the Capital Markets Union Action Plan, even if the lack of evidence to justify such an approach would be in conflict with the primary objectives of Solvency II, namely policyholder protection and financial stability.

Benefits

Option 3 would be more effective than Options 1 and 2 in addressing the insufficient incentives for insurers to contribute to the long-term and sustainable financing of the European economy. By proceeding to a general decrease in capital requirements on equity regardless as to whether the investment is intended to be held for the long term or not, the prudential cost of investing in equity would be materially reduced, which implies a larger amount of additional “free capital” which may be invested in equity 38 . EIOPA did not conduct any impact assessment of this option. However, on the basis of the quantitative data submitted by insurers to NSAs, and based on simplified assumptions, one can estimate that a 3 percentage point decrease in capital charges on equity frees about € 5 billion of capital (which could potentially be used to invest in equity) 39 . In principle, this additional capital could also be invested in “green” assets and therefore contribute to the objectives of the European Green Deal. However, as no conditionality would apply, there is no guarantee that capital be invested in climate-friendly activities, or even in equity more broadly. Option 3 would also be more effective than the previous options in improving EU insurers’ competitiveness at international level and thus benefitting insurers and their shareholders. Option 3 would free-up more capital than under Option 2, which could be used to expand internationally and thus generate additional profit for insurance companies.

Finally, depending on the way this option is implemented, Option 3 could have a positive impact on the simplification of the framework. Indeed, if capital requirements on all equity investments were lowered to the same level regardless of their nature, this would materially simplify the framework by removing the existing patchwork of regulatory asset classes of equity investments (currently, they are at least eight different classes of equity investments in Solvency II).

Costs

Option 3 would materially reduce the risk-sensitivity of the framework. EIOPA notes that calibrations of capital charges on equity investments are already lower than what it advised when finalising the Solvency II framework before 2016. Therefore, a further general decrease in capital requirements on equity investments would not be justified based on available evidence. In addition, a general decrease of capital requirements in equity investments regardless of their nature (listed or unlisted equity, strategic or not strategic, etc.) would undermine the risk-based nature of the framework. This would also affect policyholder protection, by incentivising insurers to take much more risks, with a greater likelihood of insurance failure.

While not aiming at affecting volatility, the expected effect of Option 3 is to dramatically increase insurers’ exposure to equity. As equity investments prove to be relatively more volatile than other asset classes, a significant increase in equity exposures would probably make insurers’ assets, and therefore solvency positions, materially more volatile.

Option 3 would imply a deviation from the risk-based approach whereby capital requirements are calibrated using evidence on their riskiness. This may cause supervisory authorities to pursue other tools to address the potential underestimation of the risk in the calculation of capital requirements, such as intensified supervisory monitoring, or even a capital add-on or requests by the supervisory authority to calculate capital requirements with an internal model that models equity risk in a fully risk-based manner. In such a scenario, the tools chosen by supervisory authorities are likely to differ and the option would therefore be detrimental to the consistency and coordination of supervisory practices and thus undermine the Single Market for insurance services. On the other hand, Option 3 would simplify the prudential framework for equity investments compared to the current situation where criteria for long-term equities are subject to interpretation 40 . Therefore, the Option 3 would allow simplifying the framework, but at the cost of materially increasing risk exposure by insurers.

Option 3 would have a potential very negative impact on financial stability. By proceeding to a general decrease in capital requirements which would not be supported by quantitative evidence (but would be justified by the priority given to achieving the CMU objectives over the primary objectives of the Solvency II Directive), Option 3 would provide wrong risk-management and investment incentives to insurance companies. The risk of excessive risk-taking (search for higher return) could generate bubbles and would expose insurers to sudden trend reversals in stock markets. In addition, Option 3 could imply windfall effects by generating an immediate broad increase in free capital, which could be simply used by insurers to make more dividend distributions to shareholders or share buy-backs instead of providing additional funding to the real economy. This risk is material. Option 3 would allow reducing capital requirements without any change in insurers’ behaviours. This would imply that without any change in the risk profile, the average solvency ratio could be maintained constant despite the level of capital resources would be reduced due to opportunistic higher dividend distributions. In comparison, this risk would be deemed minor in Option 2 because in order to benefit from a capital relief, insurers would still have to revise their internal investment policies and change their approach to equity investments so as to embed long-termism in their investment decisions. They would also have to document their ability to stick to their investments under stressed situations (which implies that their solvency ratio would be sufficiently high to not be subject to forced selling of equities with the aim to de-risk their investment portfolio and reduce capital requirements). Therefore, opportunistic dividend distributions would be less likely or would make it more difficult for insurers to demonstrate their intention and ability to invest for the long term.

As regards implementation costs, although there is no available data, as this option could simplify the framework, it is expected that the one-off implementation cost would be lower than in Option 2 (need to update IT systems) and the on-going implementation costs would be almost null (simplified approach compared to today).

Overall assessment

Effectiveness, efficiency and coherence: Option 3 would probably be the most effective in removing barriers to equity investments, and improving insurers’ international competitiveness, but at the cost of materially deteriorated policyholder protection and risk sensitivity and higher financial stability risks. There would also be a lack of coherence with the primary objective of Solvency II (policyholder protection). Also, the CMU Action Plan highlights that the facilitation of insurers’ long-term sustainable financing of the economy should not be to the detriment of financial stability.

Winners and losers: In the short term, policyholders would probably benefit from the increased risk-taking by insurers by receiving higher returns on their life insurance policies as insurance companies would generate higher returns on their investments. However, in the long run, they would be the losers due to the higher risk of failure of their insurer. Insurers and their shareholders would be the winners as insurance companies would have more free capital to invest (and therefore higher return to pay to shareholder) with no conditionality. On the other hand, it is clear that in the long run, if excessive risk taking in equity leads to an insurance failure, this would be detrimental to shareholders. For supervisory authorities, while this approach would probably simplify the supervision of compliance with regulatory requirements, this would also require more active supervisory dialogue with insurers in order to compensate the higher risk of failure stemming from potential excessive risk-taking. This would also entail the need for a more active macro-prudential supervision.

Stakeholder views: The same remarks as in Option 2 apply as regards the need to bring changes to the prudential framework on equity. The principles embedded in Option 3 have not been formally consulted by EIOPA. However, while it can be expected that a majority of insurance stakeholders would support Option 3, only a minority of supervisory authorities expressed interest in such an option. In addition, in the context of the Commission’s consultation, several stakeholders, including citizens/consumers/NGOs, highlighted the need to ensure that the changes brought to Solvency II do not generate financial stability risks (which may imply dismissing Option 3).

6.1.3.Option 4: Strengthen “Pillar 2” requirements in relation to climate change and sustainability risks

Under this option, qualitative requirements on risk-management would be strengthened in order to ensure that insurers appropriately monitor, manage and mitigate climate change and sustainability risks as indicated by EIOPA in an opinion. While earlier initiatives already require insurers to take into account sustainability risk in their disclosures and risk management, those initiatives do not ensure that the sustainability risks are taken into account in insurers’ business strategy. Option 4 would imply integrating longer-term scenario analysis in relation to climate change in the own risk and solvency assessment. The own risk and solvency assessment aims, among others, to address risk that are not well reflected in the calculation of capital requirements and more generally risks that are hard to quantify, like risks related to climate change. By clarifying the relevance of climate change risks in the own risk and solvency assessment, Option 4 would ensure that those risks are taken into account in insurers’ business strategy. The option would also aim to ensure insurers put in place internal procedures to avoid overreliance on data from past events with respect to climate change-related risks. Further details are provided in Section 1 of Annex 8. However, no changes would be made to capital requirements for sustainable investments. Instead, EIOPA would for the first time receive a legal mandate similar to the European Banking Authority’s mandate in Regulation (EU) 575/2013, Article 501c, point (c). In particular, EIOPA would be asked to monitor the evidence on the riskiness of sustainable investments and, where justified, propose changes to Solvency II capital requirements.

Benefits

Option 4 would have a positive impact on policyholder protection and some positive impact on funding for the sustainable recovery of the EU. Stronger qualitative requirements on the management of climate and environmental risks would set incentives to reduce exposure to such risks on the asset and liability side of the balance sheet. As regards the asset side, a reduction to sustainable risks can be achieved by a shift to “green” investments. Furthermore, EIOPA’s work under a new mandate may provide evidence on lower riskiness of some or all sustainable investments. In that case, the Commission would be in a position to use existing empowerments for delegated acts to amend Solvency II capital requirements accordingly. Option 4 would also have limited (but possibly positive) impact on the consistency and quality of supervision. The lack of references to sustainability risks in the Solvency II Directive may result in varying approaches by supervisors to sustainability risks in the own risk and solvency assessment, in particular since sustainability risks can materialise via more traditional financial risk. Further clarification of the qualitative rules could achieve better harmonisation.

Finally, as indicated in Sub-Section 6.3.3 of the Evaluation Annex, EIOPA’s insurance stress test from 2018 suggested that there is currently only a small likelihood of systemic impact of natural catastrophes on the insurance sector. However, climate change may lead to such risk becoming systemic in the future. Likewise, the materialisation of transition risks and assets exposures to entire sectors of the economy possibly “stranded” assets may translate in systemic impacts on the insurance industry. The longer-term scenario analysis required under Option 4 would lead to an earlier identification of assets that could become stranded and a reduction of transition risks for the insurance sector. Option 4 would therefore have a positive impact on financial stability.

Costs

In terms of implementation costs, insurers would have to build up the capacity to comply with new qualitative requirements on sustainable risks without the ability to benefit from lower capital requirements. This might also result in higher costs of compliance with Solvency II rules, which could be passed on to consumers by increasing insurance premiums. In the context of previous initiatives, the costs of ESG integration for small entities was estimated to range from EUR 80 000 to EUR 200 000 per year (for buying external data, doing additional internal research, engagement with companies etc.) 41 . However, insurers already need to build up such or similar capacities to comply with other legal acts, notably the disclosure requirements under Regulation (EU) 2019/2088 and amendments to the delegated acts under the Solvency II Directive 42 . The additional cost of Option 4 is therefore estimated to be significantly below that range and thus overall limited.

Option 4 would have no or very limited impact on risk sensitivity, volatility and proportionality.

Overall assessment

Effectiveness, efficiency and coherence: Option 4 would improve the incentives for sustainable investment and the management of environmental and climate risks. Option 4 is the most effective in the harmonisation of supervisory practices in the context of sustainability risks. It is of course coherent with the objectives of the European Green Deal.

Winners and losers: Policyholders would benefit from a higher level of protection due to better management of environmental and climate risks under this option. Supervisors and insurance companies would be given a clearer set of rules to ensure the integration of environmental and climate risks.

Stakeholder views: During the Commission’s public consultation, respondents chose a contribution to the European Green Deal as the overall third most desirable objective for this initiative among a list of eight possible objectives. To that end, more than 70% of NGOs and public authorities supported strengthening “Pillar 2 requirements” in relation to sustainability risks.

6.1.4.Option 5: Strengthen “Pillar 2”requirements and incorporate climate change and sustainability risks in quantitative rules

Under this option, the changes to qualitative requirements as under Option 4 would be combined with lower capital requirement for green assets. In an analysis conducted in 2019, EIOPA concluded that the available evidence is not sufficient to conclude that sustainable investments are less risky than other investments 43 . Under this option, capital requirements would therefore not be fully reflective of risk characteristics, but depend on the “green” nature of investments. With all else being equal, insurers investing more in “green” assets would have a better solvency position than those with a lower share of green assets.

This option has been put forward by a few stakeholders and would be justified by the priority given to the political objective of the European Green Deal. More specifically, the option would aim to facilitate insurers’ financing of the transition to carbon-neutrality even though the lack of evidence to justify such an approach would be in conflict with the primary objectives of Solvency II, namely policyholder protection and financial stability.

Benefits

Option 5 would be more effective than Options 4 (as well as the baseline) in incentivising sustainable investments by insurers. By proceeding to a decrease in capital requirements, the prudential cost of sustainable investments would be materially reduced. As described under Option 3, insurers would be able to hold a larger volume of sustainable investments with the same amount of regulatory capital. But insurers could also maintain their asset allocation and use capital no longer tied up otherwise. Similarly to Option 3, Option 5 would also contribute to improving EU insurers’ competitiveness at international level. Option 5 would free-up more capital than under Option 4, which could be used, among others, to expand internationally and benefit insurers and their shareholders.

Costs

As mentioned above, such changes to capital requirements might not reflect the risk characteristics of such investments and have a very negative impact on the risk-sensitivity of the framework. This would also affect policyholder protection, by incentivising insurers to take much more risk, with a greater likelihood of failures of those companies. In addition, Option 5 would imply a deviation from the risk based approach whereby capital requirements are calibrated using evidence on their riskiness. This may cause supervisory authorities to pursue other tools to address the potential underestimation of the risk in the calculation of capital requirements. In such a scenario, the tools chosen by supervisory authorities are likely to differ and the option would therefore be detrimental to the consistency and coordination of supervisory practices and thus undermine the Single Market for insurance services.

Option 5 would also have a negative impact on financial stability. Changes to capital requirements which are neither evidence-based nor risk-based, provide wrong risk-management and investment incentives. Therefore, the option could result in too high overconfidence by investors and generate bubbles with respect to sustainable investments.

Implementation costs are expected to be limited. Although there is no available data, Option 5 would require updating IT systems so that they reflect the new risk factors for green investments, which represents a limited one-off cost. The ongoing cost would be limited as the granularity of information required for computing capital requirements would be consistent with that required for green disclosures under other EU legislations.

Finally, Option 5 would have a potential deadweight effect, as it would lead to a decrease in capital requirements with no conditionality. As such, there is no guarantee that the additional “free capital” would be used to provide further investments to the economy, and it may be an opportunity for insurers to make higher dividend distributions.

Overall assessment

Effectiveness, efficiency and coherence: Option 5 would be as effective as option 4 on the management of environmental and climate risks and it would be the most effective in incentivising sustainable investment. Moreover, changes in capital requirements could have a more immediate impact on incentivising sustainable investments than a sole reliance on the incentives stemming from rules on the own risk and solvency assessment under option 4. However, beyond investment incentives, Option 5 might result in negative impacts related to lower policyholder protection and increased financial stability risks. This option may therefore lead to economic welfare losses and contradict the two main objectives of Solvency II. Furthermore, it has to be noted that the European Green Deal states the objective of integrating climate and environmental risks into the EU prudential framework whereas it leaves open the outcome of the assessment of the suitability for green assets of capital requirements.

Winners and losers: Under Option 5, policyholders and supervisors would be losers. Although in the short run policyholders may benefit from higher return on their policies if insures take more risks, they would suffer in the long run from a lower level of protection. Supervisors would be confronted with having to address a potential underestimation of actual risk in the calculation of capital requirements. Insurers would benefit from lower capital requirements for sustainable investments – and their shareholders may hence benefit from higher dividend distributions – but also need to integrate environmental and climate risks in their own risk and solvency assessment.

Stakeholder views: In the Commission’s public consultation, many more respondents objected lower capital requirements for sustainable investments (around 44%) than those that expressed support (around 29%). The share of objecting responses is particularly high among the insurance industry (around 51% objecting vs. 29% supporting) and public authorities (75% objecting vs. 13% supporting).

6.1.5.Choice of preferred options

The below tables provide a high-level summary of how the previously described options compare (note that for the sake of readability of the tables, the labels of the options have been shortened).

In relation to long-term equity financing, Option 2 appears to be the most suitable option. While Option 3 would be more effective in fostering long-term financing of the economy, it would be at the cost of material reductions in policyholder protection, risk sensitivity and of higher risks to financial stability. On the contrary, Option 2 would have a lower impact on investment behaviour but generate limited side effects on policyholder protection and financial stability, while having a meaningful impact 45 .

In relation to the greening and the sustainable financing of the economy, while Option 5 seems to be the most effective in achieving the objective, it would have similar negative side effects on policyholder protection, risk sensitivity and financial stability. On the contrary, Option 4, while providing less incentives, would improve the way insurers incorporate sustainability and climate change risks in their underwriting and investment activities. In addition, it would have either a positive or a neutral impact on all specific objectives of this review.

The combination of Option 2 and Option 4 allows addressing the problems without generating undue costs or redundancies. Indeed, Option 2 would provide positive incentives for insurers to have a longer-term perspective when making equity investments, while Option 4 would ensure that climate change and sustainability considerations are fully incorporated in insurers’ processes. Therefore, the combination of the two options would facilitate insurers’ contribution to the long-term and sustainable financing of the economy. Each option taken individually would however not be sufficient. Indeed, even if Option 2 can contribute to the greening of the economy, asset classes other than equity can be “green investments” but would not benefit from Option 2. Reciprocally, incorporating climate change risks in investment decisions neither guarantees that insurers refrain from making shorter-term investments (and therefore from not providing sufficiently stable funding to the real economy), nor removes obstacles to equity investments generated by prudential rules. In particular, some studies suggest that capital financing is more effective than debt financing in achieving a reduction of greenhouse gas emissions 46 . The combination of Options 2 and 4 would ensure that insurers face no prudential obstacles to the provision of long-term funding to SMEs and that they appropriately value the long-term added value of investing in green assets.

6.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies 

6.2.1.Option 2: Fix all technical flaws in relation to risk sensitivity and volatility

Under this option, all changes that are technically justified and aiming to address the lack of risk-sensitivity and the excessive volatility would be adopted:

·In relation to risk sensitivity, in line with EIOPA’s advice, Solvency II would be amended to ensure that the protracted low interest rate environment is appropriately reflected in capital requirements (allowance for interest rates to become negative in quantitative rules) and in the valuation of long-term insurance liabilities.

·In relation to volatility, the long-term guarantee measures (in particular, the volatility adjustment) would be amended so as to ensure that short-term volatility in credit spreads which does not reflect economic fundamentals (i.e. the part of volatility corresponding to “irrational” market movements) 47 does not result in excessive volatility in solvency ratios, but also that there is no “over-shooting effect” (i.e. that the adjustments do not result in the insurer being “better off” during crises than under normal conditions).

Benefits

Option 2 would by nature significantly improve risk-sensitivity of the framework and reduce its volatility. The integration of negative interest rates in standard formula capital requirements would imply that insurers have to address a risk, which amounts approximately € 20 billion 48 . This additional risk sensitivity would therefore improve policyholder protection. Option 2 could also be very efficient in enhancing the volatility-mitigating effect of the long-term guarantee measures for insurers located in Southern countries with higher spreads. As explained in Sub-section 6.1.1 of the Evaluation Annex, insurers’ bond portfolio is subject to a Home Bias, i.e. they mainly invest in bonds of their Home Member State. When such a Member State is subject to more volatile spread movements that the rest of the Euro Areas, the sole “currency volatility adjustment” (i.e. the one applicable to all euro-denominated liabilities) is not be sufficient in mitigating spread volatility. Actually, EIOPA’s proposals would allow triggering more frequently a “country-specific” adjustment, which aims to capture spread crises arising in certain Member states and not in the whole Euro area. According to EIOPA’s assessment, applying retroactively the proposed amendments during the period from 2007 to 2019, insurers would have resulted in a more frequent and more significant adjustment than under current rules:

Option 2 would also achieve reducing “overshooting effects” described in the same Sub-section of the Evaluation Annex, i.e. the fact that in some cases, under crisis situations, the volatility adjustment “over-compensates” the negative effect of increases in credit spreads, leading to an undue improvement in insurers’ solvency position under stressed environments. Following EIOPA’s advice, Option 2 would reduce that risk, by decreasing the level of the volatility adjustment where such risks are most likely to occur 49 . For instance, a reduction factor of 56% would be applied on average to the volatility adjustment in Netherlands to prevent this risk.

Option 2 would have a positive impact on financial stability for two reasons. First, by better reflecting the risk of low interest rates, it would reduce incentives for excessive search-for-yield behaviours and ensure that there is no widespread underestimation of insurers’ liabilities towards policyholders. Indeed, insurers would have to set aside more capital in case of risky asset-liability management (i.e. if there is a significant duration mismatch) and the level of their liabilities towards policyholders would better reflect the low-yield environment so that there is no overestimation of insurers’ own funds. In addition, by ensuring a lower volatility of the framework, Option 2 would reduce the risk of procyclical behaviours (e.g. the risk of wide-spread fire-sale of risky assets at depressed prices during down cycles).

Costs

Option 2 would overall have a negative effect on the ability of insurers to provide long-term and sustainable financing to the European economy. Although it would reduce volatility, Option 2 would also lead to an immediate material increase in capital requirements. According to Commission services’ calculations based on EIOPA’s impact assessment report:

-If applied at the end of 2019, Option 2 would lead to a decrease in solvency ratios by 13 percentage points (from 247% to 234%). This still represents a decrease in “free surplus capital” of €15 billion for the sample of insurers which participated to the data collection exercise (decrease of approximately 5% in the surplus). If scaled up to the whole market, EIOPA estimates that the impact would be a decrease in capital surplus of EUR 18 billion.

-If applied at the end of the second quarter of 2020, when interest rates were even lower, the decrease in solvency ratio would be of 22 percentage points (from 226% to 204%), but 35 percentage points for life insurers (from 223% to 188%). This represents a decrease in available surplus for insurers which participated to the data collection exercises by EIOPA of approximately EUR 40 billion (approximately -11%), largely concentrated on life insurers. If scaled up to the whole market, EIOPA estimates that the impact would be a decrease in capital surplus of EUR 55 billion. The situation widely varies between Member state: Some countries overall benefit from the technical changes (e.g. Cyprus, Spain, Malta and Latvia), but others are materially affected (with more than 25 percentage points decrease in solvency ratios in Austria, Germany, Netherlands, and Norway).

Indeed, despite the revision of the features of the volatility adjustment, which allows improving free capital in mid-2020 by € 13 billion, as well as other technical changes improving solvency ratios 50 , the reflection of negative interest rates in capital requirements and the valuation of insurance liabilities towards policyholders generates a € 81 billion decrease in available capital surplus at EEA level.

One could argue that a more stable solvency ratio could still facilitate insurers’ long-term investments by allowing for more stability and foreseeability. However, the material reduction in free excess capital to make additional investments is such that it would overall be detrimental to achieving the objective of long-term sustainable financing of the European economy. This deterioration in solvency ratios would amplify the deterioration stemming from the ongoing Covid-19 crisis. Option 2 would also be detrimental to the international competitiveness of the European insurance industry as a lower amount of available capital offers less opportunities for insurers to expand their business internationally.

Similarly, lower volatility would on its own have a positive impact on insurers’ ability to make long-term investments and to offer products with long-term guarantees. However, the material increase in capital requirements that would also stem from Option 2 would imply that insurers have a lower ability to offer life and pension insurance products with guarantees, which are still highly appreciated by insurers, as such products generate more capital requirements. Insurers would be incentivised to shift risks to policyholders (via unit-linked products) and as such would act more as asset managers rather than as “risk managers”.

Overall, Option 2 would make the framework more complex for all insurers in the scope of Solvency II. For instance, the level of the volatility adjustment is currently determined centrally by the Commission, based on inputs provided by EIOPA. Under EIOPA’s revised approach, the level of the adjustment would depend on insurers’ characteristics (for instance, insurers would have to quantify the sensitivity of their assets and liabilities to changes in spread levels). EIOPA’s proposals also imply that each insurer would have to establish a typology of insurance liabilities in order to determine the level of the volatility adjustment. This additional burden generates disincentives for insurers to apply this adjustment, which is easy to use under current rules, and this could have a negative effect on the volatility of their solvency ratios if they are deterred from applying the new volatility adjustment. The introduction of a new method for the valuation of insurers’ long-term liabilities could also increase complexity.

However, based on EIOPA’s survey, depending on the specific change considered within Option 2, implementation costs seem to be moderate. Indeed, between 11% and 39% of respondents consider that there would be a significant one-off implementation cost, and between 7% and 33% think that there would be significant on-going costs. However, one has to note that this survey covered the largest insurers in each national market, possibly biasing the answers. Almost half of supervisory authorities estimate that they would also face significant one-off cost stemming from Option 2 (according to a survey included in EIOPA’s impact assessment), and 43% of them consider that the ongoing costs would remain significantly higher than under current rules.

Option 2 would have limited (but possibly negative) impact in improving the consistency of supervision. The increased complexity of the framework may require more supervisory discretion and expert judgement, with possible divergences in the application of the rules. This would require EIOPA to use its “soft convergence tools” to ensure a harmonised implementation of the rules. Ability of supervisors to ensure compliance with new rules would require more on-site inspections, and the effectiveness of the supervision of new rules would therefore depend on public authorities’ resources to allocate to such on-site activities.

Overall assessment

Effectiveness, efficiency and coherence: Option 2 would be effective in improving the risk sensitivity and mitigating the volatility of the framework. It would also materially improve the level of policyholder protection and financial stability, by ensuring that the solvency position of insurers appropriately takes into account all risks that they are facing, and reflect the new low-yield environment. However, Option 2 would imply high capital cost as insurers would be subject to significantly higher capital requirements. Lower free capital available for insurers implies a lower ability to contribute to the long-term financing of the economy and makes it more challenging to offer insurance products that meet consumers’ demand (in particular, long-term life and pension insurance products with a certain level of guarantees). While insurers’ average solvency ratio would remain largely above what is required by quantitative rules (above 200% even if we apply Option 2) 51 , they may still be under pressure by financial markets participants to issue new capital and debt instruments (for instance in order to maintain their credit rating). At this stage, and due to the low-yield environment, access to capital markets can be done at low cost, but there is no guarantee that such favourable conditions would persist in the long run. Option 2 would also make the framework more complex. By deteriorating the international competitiveness of the EU insurance industry, this would also contradict the objectives set out in the CMU Action Plan of a balanced review. Therefore, while Option 2 is fully coherent with the primary objectives of Solvency II (policyholder protection and financial stability), it conflicts with other political objectives of the Union.

Winners and losers: The effect on policyholders is unclear: They would benefit from an improved level of policyholder protection, but, as explained above, would experience the negative impact of reduced access to insurance products that meet consumers’ demand. In particular, insurers would be incentivized to further shift risks to policyholders, which implies that they depart from their role of “risk managers” and behave more as asset managers. Insurers would be materially affected due to the material deterioration in their solvency ratios, despite the reduced volatility of the framework stemming from Option 2. Their ability to generate return to shareholders and to expand internationally would be reduced. Finally, the situation is mixed for supervisors, which would have more comfort in the ability of the framework to protect policyholders and prevent systemic risk, but at the cost of more complexity (therefore more difficulties in ensuring an appropriate and harmonized supervision of compliance with regulatory requirement).

Stakeholder views: If we exclude those who did not express an opinion, 78% of participants to the Commission’s public consultation believe that the framework does not appropriately mitigate volatility and 64% that it generates procyclical behaviours. This is the majority view among insurance stakeholders and citizens/consumers/NGOs. Views are more split among supervisory authorities where only 50% of respondents indicate that the framework does not appropriately address volatility and 38% that it generates procyclical behaviours. As regards risk sensitivity, EIOPA’s technical consultations confirm that a vast majority of (insurance) stakeholders concur with the view that the current framework does not appropriately reflect the risk of negative interest rates in capital requirements, although views are more split regarding the technical approach to address this issue. Most stakeholders also believe that the review of Solvency II should lead to a balanced outcome in terms of quantitative requirements. Therefore, as Option 2 addresses the identified issues, but at the cost of significantly higher capital requirements, such an option would receive very limited if not hardly any support from stakeholders.

6.2.2.Option 3: Address issues of risk sensitivity and volatility while balancing the cumulative effect of the changes

Under Option 3, the changes envisaged under Option 2 would be phased in over a certain period of time, to limit their immediate negative impact on quantitative requirements. In particular, changes on interest rates would be only progressively introduced over a period of at least 5 years. In addition, some additional measures (notably in relation to the so-called “risk margin”) and small modifications to the design of the volatility adjustment (in order to slightly increase its level and simplify its functioning 52 ) would be taken in order to mitigate (part of) the long-term increase in capital requirements resulting from those changes. While the final outcome depends on the effective calibration of the different parameters 53 , the working assumption under this approach is that the average level of quantitative requirements at EEA level would be materially reduced in the short term (as the changes with a positive impact would be implemented immediately whereas those with a negative impact would only gradually apply). In the longer run, the level of quantitative requirements at EEA level would remain lower than under current rules, although the framework would allow for a better risk attribution. The extent of this decrease depends on market conditions.

Benefits

Option 3 would have a positive impact on the ability of insurers to provide long-term and sustainable financing to the European economy over time. The reduced volatility of the framework would incentivise long-termism in underwriting and investment decisions by insurers. In addition, as the overall impact of the review in terms of quantitative requirements would be more than balanced at EU level (insurers’ own funds in excess of capital requirements would increase 54 ), there would be limited impact on insurers’ ability invest in the real economy, and this limited impact would in any case not offset the positive effect of reduced volatility 55 . In addition, the progressive implementation of the changes with very negative impact would actually lead in the short term to a very significant improvement in the solvency position of insurers, which releases capital (up to € 90 billion of additional capital resources in excess of capital requirements) to provide financing to the economic recovery of the EU. However, there is no guarantee that such capital relief is not used by insurers to reduce their level of capital by making additional dividend distributions or proceeding to share buy-backs.

Option 3 would by nature significantly mitigate undue volatility. It would also improve risk sensitivity, but only in the long term, in view of the phasing-in approach to the implementation of the changes. Therefore, in the short term, the improvement in risk-sensitivity would remain very limited. Moreover, the additional “counterbalancing” measures (e.g. revision of some parameters underlying the risk margin calculation) that would be taken in order to mitigate the negative impact from the other changes aimed to improve risk sensitivity would lead to a slightly lower level of prudence compared to Option 2. In other words, Option 3 would be less conservative than Option 2 in very targeted areas. Those changes would be justified by the greater emphasis on the objective of preserving international competitiveness of the European insurance industry than in Option 2 58 , even if that leads to a slightly lower level of policyholder protection in comparison with Option 2. Still, the revised calibrations would remain justified to a certain extent by quantitative evidence 59 , although the limited robustness of that evidence could also have justified not lowering some parameters. In addition, it should be underlined that Option 3 is a clear improvement in policyholder protection and risk sensitivity in comparison with the baseline scenario. While the overall level capital requirements would decrease compared to the baseline, Option 3 allows for a better risk attribution by acknowledging the materiality of risks in relation to interest rates, while adapting other components of the framework where it could be argued that the current set of rules is overly prudent.

Finally, Option 3 would have a positive impact on financial stability, although less immediate and less material than in Option 2. Indeed, the choice of making “compensating changes” to counterbalance the negative impact of the amendments stemming from Option 2 would make the disincentives against excessive risk taking less effective than under the previous option, while still having a positive impact compared to the status quo (baseline – Option 1). In addition, the phasing-in of the changes on risk sensitivity implies that financial stability risks remain until the amendments are fully implemented (possibility to understate the impact of the low-yield environment in the short term). Still, in the long run, the preservation of financial stability would be improved, all the more that the reduction in the volatility of the framework would avoid procyclical behaviours.

In summary, the below table provides the comparative impacts of Options 2 and 3, for the sample of insurers which participated to the data collection exercise by EIOPA. Note that the previous blue box provided the estimated cumulative impact of all changes for the whole market.

Based on those figures, we can note that on average, there would be no immediate need for capital increases by insurers. While the quantitative impact would remain contained, Option 3 would lead to a material improvement compared to the baseline, by allowing for a better risk attribution (i.e. by laying more emphasis on interest rate risk, like in Option 2). The “compensating measures”, which are further explained in Section 3 of Annex 8, are not materially affecting risk sensitivity or financial stability, as they can be technically justified to a certain extent and imply removing layers of prudence in other areas of the current framework, which may be deemed excessive. The Commission services have not considered changes, which would not be justified by any quantitative evidence, as this would go against the primary objective of improving risk sensitivity. In conclusion, the difference with Option 2 in terms of improved risk sensitivity and financial stability is deemed limited in the long run (once the full impact of the changes are implemented).

Costs

Like Option 2, Option 3 would make the framework more complex for all insurers. However, as the volatility adjustment would be simplified in comparison with Option 2, Option 3 would have a less negative impact than Option 2. The “compensating” measures introduced in Option 3 may also slightly increase implementation costs compared to Option 2, although the difference is expected to be minimal. Indeed, the approach during the transitional period would be similar to the one during the permanent regime (e.g. instead of taking the full impact of the negative interest rates in the first year, insurers would only take one fifth of that impact; the next year insurers would take two fifths, and so on). Finally, the phasing-in period implies updating information system every year until the fully-fledged changes are made. Therefore Option 3 would generate moderate implementation costs.

Like Option 2, Option 3 would have limited (but possibly negative) impact in improving the consistency of supervision, due to the increased complexity of the changes introduced and the need to maintain consistency as regards the timing of the gradual adjustments. As Option 3 would also streamline some of the technical adjustments (which are deemed too burdensome while bringing limited added value from a technical standpoint 60 ), it would be slightly less complex than Option 2, and the risk of diverging supervisory practices would be slightly lower.

Finally, as explained above, Option 3 postpones to the medium term the appropriate improvement on risk sensitivity and financial stability as the amendments with a negative impact would only be gradually implemented. Therefore, in the short term, the ability of Option 3 to address the problem of insufficient risk sensitivity is limited. In addition, the moderate but negative effect of Option 3 on long-term solvency ratios is more than offset by the benefits in terms of reduced volatility. Therefore, overall, Option 3 does not have a negative effect on long-term financing and on international competitiveness.

Overall assessment

Effectiveness, efficiency and coherence: Option 3 would be effective in improving the risk sensitivity and in mitigating the volatility of the framework. It would be also more efficient than Option 2, by avoiding significantly negative impact on insurers’ competitiveness and on financial stability, and by smoothing any remaining negative impact over time. While policyholder protection would be slightly lower than in Option 2, it would be much improved compared to the baseline. In addition, the identified adaptations compared to Option 2 would still have a technical basis as modifications that could not be backed by any quantitative evidence have been discarded. As such, Option 3 is broadly coherent with the primary objectives of Solvency II (policyholder protection and financial stability) and would not hinder – and actually would even contribute to – other policy objectives such as facilitating the long-term and sustainable financing of the European economy.

Winners and losers: Policyholder protection would be improved. While the level of policyholder protection would be slightly lower than in Option 2, Option 3 would largely preserve insurers’ ability to supply insurance products with guarantees that meet consumer demands. Therefore, the benefits for consumers has to be weighed against the slight reduction in policyholder protection compared to Option 2. Insurers would benefit from with mitigated volatility and greater ability to make long-term decisions, despite the tighter rules on interest rates (which are however largely counterbalanced by other adaptations). Still, they would have to cope with a more complex framework. The potential moderate increase in overall requirements may also reduce insurers’ ability to make dividend distributions, although insurers’ solvency ratios would remain on average above 200% under Option 3. Finally, the supervision of compliance with regulatory requirements would be more complex than under current rules, also taking into account that during the “transitional phase” the actual risks may still not be fully measures in quantitative rules with limited ability to intervene in case of concern.

Stakeholder views: As already explained when discussing Option 2, a majority of stakeholders would support an approach aiming to mitigate volatility and to improve risk sensitivity, while avoiding material increases in capital requirements. Therefore, among the three options, Option 3 would probably receive greatest support from stakeholders. Note that insurers would call for more radical changes to the framework to reduce the level of capital requirements and improve their competitiveness. However, this would go against the primary objective of policyholder protection, and such changes would not be justified. Supervisory authorities would have to cope with a more robust but more complex framework, and they would have less assurance than in Option 2 that the framework is achieving an appropriate level of policyholder protection. Still, most supervisors support the principle of a “phasing-in” although they would not support a too long transitional period. The “accommodating measures” (compared to Option 2) are consistent with various stakeholders’ requests (insurance industry, several public authorities, etc.), although they have not been put forward by EIOPA in its final opinion.

6.2.3.Choice of the preferred option

The below tables provides a high-level summary of how the previously described options compare (note that for the sake of readability of the tables, the labels of the Options have been shortened).

Option 2 would be the most effective in addressing issues related to insufficient risk sensitivity and excessive volatility. The benefits in terms of policyholder protection and financial stability would however be compensated by the highly negative impact on insurers’ competitiveness and ability to provide long-term sustainable financing to the economy. Therefore, there is a trade-off to be made between Option 2 that achieves policyholder protection and Option 3, which, while being less effective in policyholder protection than Option 2, would not materially harm any other specific objective. In view of the high political priority of the review to facilitate insurers’ contributions to the completion of the CMU and the European Green Deal, Option 3 is deemed more appropriate in achieving the right balance between technical robustness, policyholder protection, and the preservation of insurers’ ability to finance the economic recovery.

6.3.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers

6.3.1.Option 2: Exclude a significant number of firms from Solvency II and enhance the proportionality principle within Solvency II

This option follows EIOPA’s advice, which proposes a significant increase in the size thresholds below which insurers are excluded from the scope of mandatory application of Solvency II. Therefore, a number of insurers currently in the scope of the European framework would no longer be subject to this regime, but instead to national-specific regimes. More precisely, Option 2 would imply:

·doubling the threshold on insurers’ liabilities towards policyholders: from € 25 million to € 50 million;

·leaving the discretion for Member States to set the threshold on gross written premiums between € 5 million (current threshold) and € 25 million 62 .

The rationale behind EIOPA’s approach is to consider that insurers’ liabilities towards policyholders are a first line of defense of policyholder protection. Therefore, a change in the threshold in this area needs to be carefully considered. On the contrary, EIOPA is of the view that there is less risk in granting more flexibility to Member States in relation to business revenues (gross-written premiums) which is not a measurement of risk exposure.

Furthermore, EOPA advises to set up a preferential treatment, in terms of proportionality, for firms complying with a list of criteria defined in the framework. Based on seven criteria 63 (only one of them related to size), “low-risk profile” insurers would benefit from automatic application of several Solvency II proportionality measures, which would be clearly specified in the legislation. Additional simplifications would also apply to certain types of insurers, notably insurance captives (i.e. insurance companies established by an industrial or commercial group to provide coverage for itself).

Finally, Option 2 would mandate EIOPA to publish an annual report on the application of the proportionality principle across the EU.

Benefits

By reducing the mandatory scope of application of Solvency II, Option 2 would result in a material reduction in compliance and capital costs for insurers that are newly excluded, as it is expected that national rules are less stringent in terms of reporting rules 64 . Based on EIOPA’s impact assessment, 228 out of 2525 EEA insurance companies (i.e. 9% of all insurers that are currently in the scope of Solvency II) would be excluded from the scope of the European framework under Option 2. It should be noted that as the threshold related to revenues is subject to national discretion up to € 25 million, Member States, would be able to retain a lower limit (or even apply Solvency II to all insurers, as it is currently the case in thirteen Member States). Assuming that Member States that currently apply Solvency II to all insurers do not change their approach, only up to 180 companies (i.e. 7% of all EEA insurers that are currently subject to Solvency II) would actually be excluded in accordance with Option 2. The wider discretion given to Member States in relation to the scope of Solvency II allows taking into account national specificities, notably the relative size of each national market.

EIOPA’s impact assessment also suggests that the criteria to define “low-risk profile” insurers would allow capturing 407 companies, which represent 16% of EEA insurers (0.5% of the life market share in terms of insurers’ liabilities and 1.8% of the non-life market share in terms of gross written premiums). However, those estimates do not take into account the reduction in the number of firms subject to Solvency II due to the increase in the thresholds of exclusions from the scope of mandatory application of the Directive. Assuming that the 228 firms that would be excluded from Solvency II would also be low-risk profile, the minimum number of insurers, which would meet the criteria to be considered as “low-risk profile” would be 179 (instead of 407), representing 7% of current total Solvency II insurers.

For those insurers that are deemed “low-risk profile”, the regulatory burden would be lower, notably, in terms of governance and reporting requirements (lower frequency of submission of the ORSA report – two years instead of one –, frequency of submission of regular supervisory report by default set at three years). In addition, given the difficulties to capture all features of “low-risk profile” insurers through seven criteria only, EIOPA proposes that other insurers, not compliant with those criteria, could still be granted identical benefits in terms of proportionality when they get an ad-hoc authorisation from their NSAs. Finally, EIOPA proposes to introduce some further simplifications in relation to quantitative requirements, notably the possibility to reduce the frequency of calculation of capital requirements in relation to risks that are deemed immaterial. Therefore the implementation of Option 2 would certainly increase the proportionality of prudential rules in order to remove unnecessary and unjustified administrative burden and compliance costs, notably for low-risk profile insurers and those other companies whose nature, scale and complexity of the undertaken risks are deemed limited.

The enhancement of the proportionality principle and the associated reduction of undue administrative and compliance costs would improve EU insurers’ competitiveness. Indeed, proportionality would not only depend on size but on the nature, scale and complexity of the risks of each insurer. Therefore, even larger insurers, which conduct international business may benefit from some proportionality measures and from the associated reduction in compliance costs.

Specific proportionality measures in relation to captive insurers would also be introduced. Captive insurance is an alternative to self-insurance in which a corporate group establishes an insurance company to provide coverage for itself. The main purpose of establishing a captive insurer is to avoid relying on traditional commercial insurance companies, which may have volatile pricing and may not meet the specific needs of the corporate group. By creating its own insurance company, the corporate group can reduce its risk management costs, insure difficult risks, have direct access to reinsurance markets, and increase cash flows. Implementing more proportionate rules in relation to captive insurance would facilitate – and therefore incentivise – businesses to establish such firms. This might allow a more efficient risk management by industrial and commercial groups, and improve the resilience of economic activities against systemic events, which may not always be appropriately covered by private insurers' product offering (for instance, captives may be used as a risk management tool against pandemic events if private insurers’ supply against such events proves to be insufficient).

It is not possible to have a clear assessment as to whether Option 2 would have a positive impact on the long-term financing and the greening of the European economy. The conclusion actually depends on the national framework to which insurers excluded from Solvency II would be subject. If the national framework is close to the former Solvency I regime, then it is expected that insurers are not subject to capital requirements on their investments, and would therefore have less constraints when taking investment risks. However, national frameworks may also include limits on investments in certain asset classes, which could then have a negative effect on insurers’ ability to invest in the real economy. As for those insurers, which would remain in the scope of Solvency II, the reduced compliance costs would improve the long-term profitability and capital resources. Higher levels of own funds may facilitate more risk taking (and therefore more ability to invest in riskier asset classes, such as equities).

Costs

Insurers that would be newly excluded from Solvency II would possibly face material one-off costs due to the need to change all reporting and IT systems. In any case, insurers may always choose to continue being subject to Solvency II, so switching costs could always be avoided. This may also imply sunk costs as those small companies, which would be newly excluded from the framework have probably incurred significant costs to comply with Solvency II requirements. However, as explained above, in the longer run, they would probably face lower ongoing compliance costs. Insurers that are not in the scope of mandatory application of Solvency II (i.e. those below the exclusion thresholds) may still request licensing under Solvency II, which is needed in order to operate cross-border. For those insurers, the extension of thresholds would have no direct financial or economic impact.

Nevertheless, a negative indirect impact on the competitiveness of the small and medium sized insurers that continue under the Solvency II scope cannot be ruled out. The considerable extension in revenues thresholds would make it more likely that insurers may have to compete in another Member State with other European companies of larger size but which are excluded from the application of Solvency II. For example, let us assume that a country A sets the exclusion threshold at € 25 million whereas country B keeps it at the current € 5 million. An insurer of country B with € 6 million gross written premiums would be subject to Solvency II, and if it is operating in country A, would have to compete with local insurers that may be up to four times as big as itself but which would still not face the compliance costs of Solvency II. This disadvantage, in terms of competitiveness, for the cross border insurers in country A may became a barrier to the entrance of other European providers to the Member State with higher thresholds in revenues, leading to unintended effects in the global competitiveness of the insurance sector.

For those insurers, which remain in the scope of Solvency II but are eligible to be recognized as low-risk profile, there would be some one-off implementation costs related to the submission of the application to benefit from the automatic proportionality measures 65 . The likely high number of applications would generate significant implementation costs for public authorities in the short term, as they would have to assess the validity of all applications.

However, the numerous companies that would be excluded from Solvency II (up to 9% of all insurers currently in the scope of Solvency II) would no longer submit data to EIOPA. Therefore, the latter would have less possibilities to monitor on a sector-wide basis the trends and potential build-up of systemic risk in the insurance sector. Hence, Option 2 may slightly deteriorate the ability of the framework to prevent systemic risk, which would more heavily depend on the quality of national supervision and the robustness of the national prudential regimes.

Finally, Option 2 would have a negative impact on the level of policyholder protection, in terms of both quantitative requirements and transparency. National quantitative rules are expected to be less stringent than EU ones, and this implies a higher risk of insurance failures. Similarly, public disclosure under national rules may be less strict than under Solvency II, and policyholders of insurers which would be newly excluded from Solvency II would no longer benefit from the high quality and granularity of information contained in the annual reports by insurers on their solvency and financial condition (SFCR). The extension of the scope of insurers, which would be subject to the patchwork of national regimes would result in an overall decrease in risk sensitivity (for instance, Solvency I which is applied in six Member States to insurers excluded from Solvency II is not a risk-based framework). It would also automatically have a negative effect on the consistency and coordination of insurance supervision across the EU.

Overall assessment

Effectiveness, efficiency and coherence: Option 2 would result in a clear reduction of compliance costs for insurers and would achieve a significant simplification of the framework. The Commission services have requested some industry stakeholders to assess the extent of the reduction of compliance costs stemming from EIOPA’s advice. Due to the time constraints, stakeholders could only provide partial information. Thus, some of the proportionality measures envisaged in Option 2 (namely the reduced frequency of the ORSA report, the reduced frequency of mandatory review of internal written policies and the possibility for the same person to cumulate several “key functions” in a firm) could allow saving up to one FTE 66 .

The annual report to be published by EIOPA on proportionality would foster transparency on the state of play and would enhance peer pressure so that all public authorities would have to effectively implement the proportionality principle. Therefore, Option 2, would materially reduce the administrative burden and the cost of compliance for the vast majority of small and medium companies in scope of the European framework, improving the efficiency of many insurers and therefore, contributing to preserving the competitiveness of the European insurance industry. However, due to a very significant increase in exclusion thresholds, Option 2 would largely achieve proportionality by reducing the scope of the European framework, with potential negative impact on the level-playing field in the European market. Option 2 would also be coherent with the Better Regulation agenda to reduce undue administrative costs.

Winners and losers: The insurance sector would take advantage from clearer rules on the application of the principle of proportionality, as it would not only apply to the smallest insurers, but also to those that are larger but have a low-risk profile (because they either meet the criteria or are granted ad hoc approval by their supervisory authority). Notably, small and less risky companies would face lower administrative burden either because they are excluded from the scope of the Directive or because they are deemed “low-risk profile” insurers. Losers would be the policyholders of those insurers that are no longer subject to Solvency II, as the level of protection could be lower and consumers would probably benefit from less transparency. Supervisory authorities would also be losers to a certain extent, as they would no longer have the wide margin of discretion that they currently have in applying the rules. The new proportionality measures would also imply for them less information submitted through narrative reporting. In addition, the wider scope of insurers subject to national regimes would imply that supervisors would face more difficulties in comparing financial data based on two different sets of risk metrics (due to the coexistence of a European and a national regime). At European level, EIOPA would also see a reduction of the data collected and in the numbers of firms under its remit. Also, there would be a certain fragmentation of the Single Market for insurance firms.

Stakeholder views: As part of EIOPA’s consultation activities, insurance stakeholders largely welcomed the proposed extension of the exclusion thresholds as envisaged in Option 2, although some national insurance associations expressed concerns for the level-playing field. In relation to proportionality within Solvency II, stakeholders were of the view that EIOPA’s proposal fell short of expectation, notably in relation to reporting and disclosure.

6.3.2.Option 3: Give priority to enhancing the proportionality principle within to Solvency II and make a smaller change to the exclusion thresholds

Option 3 would follow a similar approach as Option 2, but with the following differences (deviations from EIOPA’s advice):

-In relation to the scope of Solvency II, the increase in exclusion thresholds related to gross written premiums would be lower (multiplication by three instead of five)

-In relation to proportionality within Solvency II, the eligibility criteria to be classified as low-risk profile insurer would be slightly streamlined compared to Option 2 67 , and those insurers would benefit from additional proportionality measures in relation to public disclosure. Notably, a full SFCR would only be required every other three years, whereas only a simplified report with limited “narrative” parts would have to be published on a yearly basis. The proportionality measures of Option 2, including in relation to supervisory reporting, would also be granted to low-risk profile insurers.

Therefore, under Option 3, Solvency II would remain applicable to more firms than in Option 2, and a larger number of Solvency II firms would also be presumably classified as low-risk profile insurers. Those low-risk insurers would benefit from the automatic application of all Solvency II proportionality measures, which would be further expanded compared to Option 2.

Benefits

According to EIOPA’s impact assessment, Option 3 would result in the exclusion from scope of Solvency II of up to 186 companies out of 2525 entities (7 % of insurers that are currently applying Solvency II). Assuming that Member States, which currently apply Solvency II to all insurers do not change their approach, only up to 142 companies (i.e. 6% of all EEA insurers that are currently subject to Solvency II) would actually be excluded in accordance with Option 3.

Consequently, a larger number of firms than in Option 2 would remain in the scope of Solvency II. This also implies that more insurers than in Option 2 could take advantage of the proportionality measures identified by EIOPA, provided that they comply with the criteria to be classified as low-risk profile. Based on EIOPA’s impact assessment, the reduced list of criteria compared to Option 2 would imply that approximately 435 insurers (i.e. 17% of the European market) would be eligible to automatic proportionality under Option 3 68 . However, EIOPA’s figures do not take into account a potential change in the exclusion thresholds. Assuming that the 186 firms that would be excluded from Solvency II would also be low-risk profile, the minimum number of insurers, which would meet the criteria to be considered as “low-risk profile” would be 249 (instead of 435), representing 10% of current total Solvency II insurers.

Therefore, Option 3 would increase proportionality and remove unnecessary and unjustified administrative burden and compliance costs, in a different manner than in Option 2. Indeed, the number of firms that are excluded from the scope of Solvency II under Option 3 is slightly lower than under Option 2. Nevertheless, the scope of insurers that would be eligible to automatic proportionality would be larger, as well as the number of proportionality measures (indeed, additional proportionality measures in relation to supervisory disclosure would be granted under Option 3). Option 3 would therefore further reduce compliance costs of those insurers, which remain in the scope of Solvency II than Option 2. Note also that insurers can always decide remaining in the scope of Solvency II even if they are not in the scope of mandatory application of the Directive. For this reason, if a national framework proves to be more burdensome than Solvency II, insurers would still have the possibility to continue applying Solvency II.

By further enhancing the proportionality principle and the associated reduction of undue administrative and compliance costs for insurers in the scope of Solvency II, Option 3 would be more effective in improving EU insurers’ competitiveness than Option 2. Finally, like under Option 2, proportionality measures in relation to captive insurers could incentivise businesses to establish such firms. This may allow a more efficient risk management by industrial and commercial groups, and improve the resilience of economic activities against systemic events which may not always be appropriately covered by private insurers' product offering (for instance, captives may be used as a risk management tool against pandemic events if private insurers’ supply against such events proves to be insufficient).

For the same reasons as in Option 2, it is not possible to assess the impact of this Option on insurers’ ability to provide long-term and green financing of the economy.

Costs

By slightly reducing the number of insurers that would be newly excluded from Solvency II (compared to Option 2), Option 3 would have a less negative effect on the consistency of insurance supervision and level-playing field than Option 2. Option 3 would indeed ensure that only policyholders of smallest and less risky insurers would be left without the minimum layers of protection of the European framework. Since the size thresholds would be subject to a lower increase than under Option 2, situations where an insurer operating cross-border (and therefore subject to Solvency II) would have to compete on a national market with a larger insurer that is not in the scope of Solvency II would concern less firms. Therefore fair competition within the EU would be better preserved than under Option 2.

Likewise, as more insurers would continue applying Solvency II, Option 3 would be more prudent than Option 2. Therefore, it would raise less financial stability risks, as the share of insurers that would no longer be in the scope of the European monitoring by EIOPA would only represent up to 7.5% only of the European market (i.e. 0.07% of gross written premiums and 0.06% of insurers’ liabilities towards policyholders), according to EIOPA’s impact assessment.

Finally, implementation costs would be similar to Option 2, although sunk costs and one-off costs of transitioning from Solvency II to national regimes would be lower under Option 3 (as less firms would be excluded from the mandatory scope of Solvency II). For those insurers which would have been excluded from Solvency II under Option 2 but remain in its scope under Option 3, compliance costs would be higher. Finally, insurers benefiting from automatic proportionality would be higher than in Option 2 and the additional proportionality measure of lower frequency of publication of “full” SFCR would make compliance costs lower than in Option 2.

Overall assessment

Effectiveness, efficiency and coherence: Option 3 would be more effective in enhancing proportionality and improving EU insurers’ competitiveness, while the impact of excluding some firms from Solvency II on policyholder protection and on financial stability would be lower than under Option 2. Option 3 would also reduce the risk of uneven level-playing field (as the extent of Member States’ discretion to apply or not apply Solvency II at national level to insurers that are below the exclusion thresholds would be lower in Option 3 than under Option 2 69 ). For those reasons, Option 3 is a more efficient approach than Option 2 to enhance proportionality with limited side effects on other objectives. Option 3 would be more coherent with the Better Regulation agenda than Option 2, as it would further expand proportionality measures and eligible entities than what EIOPA proposed, notably in relation to disclosure, which is an area where insurers expect alleviations of regulatory burden.

Winners and losers: Policyholders would be less losers than in Option 2, as a larger number of them would still benefit from the high level of protection provided by Solvency II. Lower compliance costs for insurers in the scope of Solvency II would also imply higher ability for insurers to innovate and supply policyholders with a well-diversified range of insurance products. The reduced disclosure would not necessarily affect policyholders, as the “light” version of the SFCR, which would be published when the full report is not required would still include targeted information towards consumers. However, other specialised stakeholders (financial markets participants, analysts, etc.) would not have the same level of information as in Option 2 for low-risk insurers that are in the scope of solvency II. The impact of insurers is more mixed. For those insurers that would be excluded from Solvency II under Option 2 but would remain in the scope under Option 3, the regulatory burden would be higher and those insurers could be seen as losers. However, under Option 3, more insurers in the scope of Solvency II would be classified as low-risk profile and all low-risk profile insurers would benefit from more proportionality measures, and as such, they gain. Supervisors would also be slightly more losers than in Option 2 as the information disclosed on a yearly basis would be reduced when the “full” SFCR is not required.

Stakeholder views: As part of the qualitative comments received during the Commission’s public consultation, many stakeholders highlighted the need to adopt proportionality measures in relation to reporting and disclosure. The lower frequency of the SFCR was mentioned by several insurance associations. Similarly, many respondents also called for a less strict list of criteria 70 to be classified as low-risk profile. Option 3, which fine-tunes EIOPA’s criteria, would therefore partly address their requests. As regards the scope of application of Solvency II, mutual insurers and mutual insurance associations called for an increase in thresholds that goes beyond what EIOPA envisaged (i.e. raising the threshold of gross written premiums to € 50 billion). For those insurers, Option 3 would therefore not meet their expectations, although most mutual insurers would probably meet the shorter list of classification criteria for low-risk profile insurers included in this option and would therefore benefit from automatic proportionality.

6.3.3.Choice of the preferred option

The below tables provides a high-level summary of how the previously described options compare (note that for the sake of readability of the tables, the labels of the Options have been shortened).

Option 2 would be the most effective in achieving proportionality by simply waiving the mandatory application of Solvency II to the largest number of firms from the European framework. However, this would be to the detriment of policyholders (whose level of protection could be lower if national frameworks are not risk based or rely on a lower level of prudence than Solvency II). It would also affect supervisors (which would lose supervisory discretion compared to current rules, and would face a reduction in the number of data received from insurers due to the lower frequencies of reporting for low-risk profile insurers). Option 2 would also have a negative impact on other specific objectives. Option 3, while being less effective than option 2 (although it enhances proportionality within Solvency II), would be more cost efficient as the negative side effects on other stakeholders or other specific objectives (consistency of supervision, level-playing field and financial stability) would be lower than under Option 2. In addition, one can note that in total, Option 3 would allow covering a larger number of firms in the scope of proportionality (either via an exclusion from the mandatory scope of application of Solvency II or the application of automatic proportionality within Solvency II).

Option 3 would therefore be the most efficient Option, considering the large acknowledgement among all types of stakeholders that there is a need to simplify Solvency II for smaller and less complex insurers. In other words, Option 3 would ensure that most policyholders remain protected by the Solvency II framework while creating a regime for low-risk profile insurers that is more fit in terms of compliance and regulatory costs. Based on EIOPA’s inputs and the feedback from the industry, the Commission identified a series of proportionality and simplification measures which would be part of the implementation of Option 3. The main measures are described in Annex 4.

6.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

The options presented in this section address problem drivers underlying the core problem of insufficient policyholder protection, including in the case of an insurer’s failure. They encompass different sets of measures along a continuum of supervision, recovery, resolution and insolvency. Therefore, although they are complementary in achieving the objective of enhanced policyholder protection, they remain different dimensions for which each set of measures should be discussed and assessed on its own merits. Section 6.4.4 assesses how the respective related costs and benefits interact.

6.4.1.Option 2: Improve the quality of supervision by strengthening or clarifying rules on certain aspects, in particular in relation to cross-border supervision

Under Option 2, the legal framework would be clarified and strengthened so as to ensure more quality and convergence of supervision, in particular in relation to cross-border and group supervision, in line with EIOPA’s general approach. In relation to group supervision, Option 2 would imply: (i) strengthening and harmonising supervisory powers including when their headquarter is in a third country or when the parent company is a non-regulated entity 71 , and (ii) clarifying prudential rules on capital requirements and risk management which are subject to diverging interpretations by Member States 72 . In relation to cross-border supervision, more requirements concerning cooperation between the Home and Host supervisory authorities would be introduced, and EIOPA’s coordination role would be strengthened.

Benefits

Option 2 would have a positive effect on the quality of cross-border supervision and the convergence of supervisory practices of insurance groups as it would remove existing gaps and uncertainties. Therefore, it would improve the level-playing field within the Union and increase legal certainty for insurance businesses. By ensuring a stronger focus on cross-border supervision and cooperation between national authorities, Option 2 would also improve the ability of supervisors to protect policyholders and beneficiaries. Option 2 also ensures stronger coordination by EIOPA which would be empowered to settle a disagreement between authorities on complex cross-border cases. This would ensure higher consistency of supervision and contribute to a more harmonised level of policyholder protection. For those reasons, Option 2 is expected to improve the functioning, and therefore the trust in the internal market.

In addition, Option 2 would reduce the risk of regulatory arbitrage, in particular the opportunities to circumvent European prudential rules. Indeed, group supervision would apply in a consistent manner regardless of the group structure, the type of parent company or the location of the head office. In particular, Option 2 would imply stricter rules governing the supervision of groups headquartered outside Europe, including better monitoring of third-country risk exposures for European entities, and more focus on capital and financial outflows from the European companies to the wider international part of the group. Such an approach would ensure that the European subgroup remains sufficiently capitalised and that policyholders are better protected. Therefore, Option 2 would reduce incentives for a European group to move its head office outside Europe, and would strengthen the level-playing field between EU and non-EU insurance groups. As regards cross-border supervision, enhanced information exchange would help national authorities protect policyholders against forum shopping 73 by those applicants who have been rejected elsewhere.

Option 2 would contribute to improving risk sensitivity and policyholder protection, as it would lead to a clearer and more robust regulatory framework in terms of how to assess the transferability of capital within an insurance group, including for entities from different financial sectors (e.g. banks) or countries (e.g. subsidiaries from third countries) should contribute to group risks.

Option 2 also includes elements of proportionality: for instance, insurance groups for which the consolidation of small and less complex insurance entities would generate undue compliance costs would be allowed to use simplified rules. Similarly, the strengthened information exchange requirements between supervisory authorities would be subject to proportionality considerations, with the aim to limit unnecessary administrative burdens and compliance costs. Therefore, Option 2 would contribute to proportionality, although some of the new rules may make the framework more complex (although clearer) than under current rules.

Option 2 would contribute to preventing systemic risks by ensuring that insurance groups take into account both financial and non-financial exposures to all types of companies within the group, including those belonging to other financial sectors and non-regulated companies. Therefore, any spillover effect stemming from the interaction between insurance and non-insurance entities would be closely monitored. In addition, the enhanced risk sensitivity and the more efficient capital allocation within insurance groups would reduce the likelihood that insurers take excessive risk, and would therefore decrease the risk of build-up of systemic risk.

Finally, the further integration of the Single Market for insurance services stemming from this option can indirectly stimulate the cross-border supply of innovative insurance solutions, including those covering risks related to natural catastrophe, climate change. Therefore, Option 2 can have an indirect positive effect on insurers’ contribution to a more sustainable and resilient European economy. By improving rules on group supervision Option 2 would also indirectly incentivise insurance groups to optimise their capital allocation and diversify their risks across the different entities of the group, which can also have positive impacts on the ability to provide funding in long term and sustainable assets across Europe.

Costs

Option 2 would have a slightly negative effect on insurance groups’ competitiveness at international level, as it would generate overall a limited increase in quantitative requirements, as explained in EIOPA’s impact assessment. In addition, although it is expected that this impact may be concentrated on a few active international groups with complex structures, material activities outside Europe, and possibly other financial activities (e.g. banking). For those groups, Option 2 would lead to a slight deterioration in their international competitiveness as the lower level of “free excess capital” or the higher capital requirements stemming from third-country subsidiaries could be seen as reducing their ability to expand internationally. On the other hand, as explained above, the strengthening of the supervision of third-country groups stemming from Option 3 would imply that non-EU groups do not have a competitive advantage over EU ones when establishing a European subsidiary.

In order to assess the significance of implementation costs, EIOPA invited 83 insurance groups from 20 EEA Member States to participate to a survey. 41% of respondents indicated that EIOPA’s draft proposals would have significant one-off cost, and 36% that on-going costs would remain significant. Similarly, a survey submitted to NSAs suggests that implementation costs for supervisory authorities is expected to remain limited, as only 7% and 21% of respondents indicated expecting significant increase in one-off or ongoing costs depending on the amendment considered. As EIOPA amended its proposals and simplified technical changes, which were assessed as generating the most significant implementation costs, the actual implementation costs stemming from Option 2 is expected to be lower. As regards cross-border supervision, implementation costs are expected to be limited for the insurance industry. Option 2 would require more information exchange between NSAs, which may generate additional work in Member States where insurers have significant cross-border activities. The stronger focus on cross-border activities implies dedicating sufficient resources to it. However, in practice this cost is expected to be limited as Option 2 would imply upgrading into European law principles that are already part of the Decision on the collaboration between supervisory authorities, and are therefore expected to be already agreed and applied by supervisory authorities.

Overall assessment

Effectiveness, efficiency and coherence: Option 2 would be more effective than the baseline on improving the quality of supervision. On cross-border supervision, Option 2 would be effective in removing any gap to cooperation and information exchange between supervisory authorities, and ensure a level-playing field with the Union by ensuring that the principles set out in EIOPA’s non-binding tools become EU law. Option 2 increases legal certainty for supervisors, insurance companies and groups, and is cost-effective by simply formalising into EU legislation what is supposed to be existing best practices. European coordination by EIOPA also ensures an efficient and consistent implementation of the rules across the Union. On group supervision, Option 2 would in contrast to the baseline be effective as the proposed changes would clarify and strengthen the legal framework and increase the quality and convergence of supervision. The measures taken by choosing Option 2 come with a cost, in particular to insurance groups but also to public authorities. In general a cost benefit analysis as such is not possible in the regulatory context as the expected benefits are not quantifiable. However, it is important that the desired outcome cannot be achieved in a less cost intensive way, as ultimately policyholders have to bear any increase in cost. Also any unjustified cost would harm the international competiveness of the Union’s insurance sector. The measures under Option 2 consider the above elements and there is no more efficient way in achieving the desired outcome. Option 2 is also coherent with specific objectives of this review as well as with the primary objectives of Solvency II (policyholder protection and financial stability).

Winners and losers: The clarification of the framework and increased cooperation of public authorities would lead to a better and more consistent level of consumer protection across Europe. Insurance groups would face in general slightly stricter rules by clarifying the framework and applying it equally across the Union. In particular, those groups, which have interpreted deficiencies in the current framework in their favour, would face a considerable increase in the level of regulation. On the contrary, insurance groups are also winners as there are also elements in Option 2 they would be benefitting from. It is also the general interest to have a level-playing field for insurance groups, irrespective of whether the groups are headquartered inside or outside the EU. Similarly, more consistent and efficient supervision of cross-border business would improve supervisory convergence and level-playing field and would therefore deepen the integration of the Single Market for insurance services, with positive impact on insurance business. Finally, impact on supervisors is somehow mixed, as they would benefit from enhanced cooperation and coordination between them, and more legal certainty in the interpretation of prudential rules. On the other hand, their responsibilities and the resources needed for the supervision of cross-border business would have a cost, as well as the stricter requirements for information exchange and cooperation, under EIOPA’s coordination.

Stakeholder views: In the context of EIOPA’s consultation activities, insurance groups, notably internationally active ones, expressed strong concerns about EIOPA’s proposals, in particular those which would result in an increase in capital requirements. This partly results from the possibility that due to the lack of clarity of the current framework insurance groups and NSAs have interpreted the framework in their own way 74 , and any clarification of the rules may lead to an increase in capital requirements for some groups 75 . However, single voices acknowledge the need for harmonization and clearer rules, in particular regarding capital requirement calculations. Furthermore, internationally active groups, which are the most affected by the implementation of Option 2, perceived a risk of deterioration in their international competitiveness. This concern has also been raised by a few public authorities as part of the Commission’s public consultation.

As regards cross-border activities, as part of the Commission’s public consultation, the majority of stakeholders (81%) who expressed a view on this topic are satisfied with the current approach according to which cross-border activities are supervised by national authorities under the coordination of EIOPA where appropriate. The insurance industry generally supports enhanced information exchange between authorities and a stronger mediation role by EIOPA. In addition, the majority of stakeholders who had a view on cross-border supervision (58%) supported reinforcing the role of the Host supervisor when the Home authority does not take appropriate measures to address identified deficiencies. This concerns in particular consumers/citizens/NGOs and insurers having a view on this issue (respectively 83% and 55% of support), as feedback were more split among public authorities, illustrating the complex debates around the most effective balance of powers and responsibilities between the different supervisory authorities. Finally, some of EIOPA’s proposals are criticized by insurance stakeholders, notably the empowerment granted to Host supervisors to directly request information from insurers rather than asking access to them via the Home authority, which is not assessed as an improvement of the functioning of the Single Market.

6.4.2.Option 3: Introduce minimum harmonising rules to ensure that insurance failures can be better averted or managed in an orderly manner

Under Option 3, and in line with EIOPA’s advice, rules aiming at the prevention of failures would be strengthened, and, a framework for the orderly resolution of insurers would be introduced with the objective to protect policyholders, beneficiaries and claimants, as well as to ensure the continuity of insurance functions whose disruption could harm financial stability and/or the real economy, and to protect public funds. This would notably encompass:

-the requirement for insurers to draft pre-emptive recovery plans describing the possible actions that would be taken in order to remedy a potential non-compliance with capital requirements;

-the establishment of national resolution authorities that would draft resolution plans and would assess and, where necessary, improve the resolvability of insurers. Resolution would be triggered when the insurer is no longer viable or likely to be no longer viable and when a resolution is necessary in the public interest, i.e. to achieve the resolution objectives above.

The resolution authority would be equipped with a range of resolution tools and powers that provide an administrative alternative to insolvency. For cross-border groups, the effective planning and coordination between national resolution authorities in case of an insurer’s distress would be organised in resolution colleges of all relevant authorities involved in supervision and resolution under the control of the lead resolution authority.

The costs and benefits of those elements were thoroughly assessed and consulted upon at two occasions by EIOPA, 76 . The main insights are reflected in the following analysis.

Benefits

Option 3 would further decrease the likelihood of insurance failures and, in particular, provide a credible framework to address the distress of insurers whose failure could negatively affect policyholders. As such, it improves the level of policyholder protection.

A harmonised set of powers to prevent and address failures with consistent design, implementation and enforcement features would foster cross-border cooperation and coordination during crises and help to avoid any unnecessary economic costs stemming from uncoordinated decision-making processes between different public authorities and courts. Effective cross-border arrangements would also help ensure that the interests of all affected Member States, including those where the parent company is located as well as those where the subsidiaries and branches of a failing group are operating, are given due consideration and are balanced appropriately during the planning phase, and when recovery and resolution measures are taken. Hence, it would address potential risks of conflicts of interest for local supervisory and resolution authorities to give priority to the protection of “local” policyholders over other stakeholders. A harmonised approach would also foster the level-playing field and avoid regulatory arbitrage. Option 3 is largely in line with international standards for systemic risk in the insurance sector. As such, it would not affect EU insurers’ competitiveness.

Option 3 would be applied in a proportionate way. Planning requirements would depend on a set of criteria, i.e. the size, cross-border activity, business model, risk profile, interconnectedness and substitutability of services of insurers. In addition, simplified obligations would be applied where the supervisory or resolution authority deems it possible. The existence of critical functions and other functions that are material for the financial system or the real economy should additionally be taken into account for the decision on the need for proportionate resolution planning. Therefore, the scope of resolution planning would be smaller than that of pre-emptive recovery planning.

Finally, Option 3 would also have a positive impact on preventing systemic risks. Indeed, the resolution framework would allow maintaining financial stability, and ensuring the continuity of functions by insurers whose disruption could harm financial stability and/or the real economy and to protect public funds (by limiting the risk of needing to “bail-out” failing insurers). 77

Costs

The implementation costs related to Option 3 stem mostly from the planning and resolvability assessment requirements. Public authorities would have to bear the costs of establishing a resolution authority, supervising pre-emptive recovery plans, resolution planning and cross-border coordination work. EIOPA’s impact assessment provides an overview of the range of costs estimated by the NSAs for drafting and maintaining resolution plans and resolvability assessments as well as for the supervision of pre-emptive recovery plans. 78  

Similarly, the one-off costs estimated by NSAs for the supervision of pre-emptive recovery plans would lie between 0.04 and 5 FTE, and the on-going costs between 0.06 and 3 FTE.

Insurers would face costs from drafting pre-emptive recovery plans but also from resolution planning where they have to provide information to the resolution authority or make changes to address impediments to resolvability. No assessment of additional costs is available, but recovery plans would be integrated in the ongoing risk management of insurers and the cost of drafting ORSA reports and contingency planning could serve as a source of input for the drafting of the pre-emptive recovery plan. In view of the different approaches to the financing of resolution 80 , it would not be appropriate to require in the EU framework – as is the case in banking – the financing of a resolution fund or the building-up of liabilities that could be bailed-in for the purpose of loss absorption and recapitalisation of failing insurers. These measures would result in inflating the balance sheet of insurers to create a loss absorbing capacity in proportion of their technical provisions that would entail higher costs for the industry and impose additional servicing risks on the companies that would not be justified by materially increased benefits 81 .

Overall assessment

Effectiveness, efficiency and coherence: Option 3 would effectively address the identified problem drivers of lack of preparedness, delayed intervention, inappropriate toolbox and uncoordinated management of cross-border (near-) failures combined with a home bias to address such issues. It would also provide an alternative to insolvency. While it is important to establish clear rules on powers to foster the recovery and enable the resolution of failing of insurers where this becomes necessary, in particular in cross-border situations, Option 3 would remain a minimum harmonisation approach, which takes into account proportionality elements. In particular, national insolvency procedures would remain a possible exit from the market for a failed insurer. Option 3 would also ensure that supervisory intervention remains judgement based and that the trigger of recovery measures remains the breach of capital requirements. Therefore, there would be no new additional intervention levels in Solvency II. However, it is necessary to introduce specific conditions for entry into resolution in order to address situations where an insurer would be systemic if it fails. This is in line with international guidance and standards. The policyholder protection and financial stability objectives would be coherent with the objectives of Solvency II and Option 3 would extend these objectives to the management of failures.

The establishment of a recovery and resolution framework for insurers is also a necessary step to improve the options for recovery and resolution of financial conglomerates. So far, only the banking part of a conglomerate is subject to the Banking Recovery and Resolution Directive. An EU framework is also necessary to address any legal uncertainties about the interaction with other parts of EU legislation 82 that national solutions could face.

Winners and losers: Policyholders, the society at large and public authorities would benefit from a decreased likelihood of failure, better resolutions of crises and from financial stability. Member State authorities would have to bear the costs of establishing a resolution authority, resolution planning and cross-border coordination work. Insurers would face higher costs from recovery planning but also from resolution planning where they have to provide information to the resolution authority. On the other hand, pre-emptive planning enhances the awareness of and preparedness for adverse situations. This allows companies to take informed and timely remedial actions when needed. Many insurers would also benefit from a more level-playing field in the measures taken by authorities to restore their financial conditions or resolve them.

Stakeholder views: Feedback to the Commission’s public consultation confirmed the results of EIOPA’s consultation that there are generally divided views on this topic. On the one hand, the insurance industry consider that insurers and authorities are sufficiently prepared to deal with distressed insurers (51% yes, 19% no, 30 % no answer). On the other hand, public authorities, NGOs, consumer associations and citizens consider them insufficiently prepared (10% yes, 60% no, 30% no answer) and welcome further initiatives in this field. In particular, according to the insurance industry, there should be no intervention points for NSAs as long as capital requirements have not been breached, and run-offs and portfolio transfers are sufficient to deal with the large majority of failures. In their view, more intrusive tools should therefore be very cautiously considered. While the toolkit of resolution powers needs to be complete to address the failure of large and complex insurers, it is expected that traditional tools would be indeed the first choice of resolution authorities. Feedback to EIOPA’s consultation further highlighted that while most stakeholders agreed that the application of the proportionality principle is essential, some oppose the proposal that the requirement to have pre-emptive recovery and resolution plans should capture a specific share of each national market. Finally, some respondents to EIOPA’s consultation also expressed concerns on the applicability of the intended framework to reinsurers for two main arguments: (a) the fact that reinsurance is a business-to-business activity with limited policyholders’ protection implications and (b) the nature and type of risks as well as its limited contribution to systemic risk.

6.4.3.Option 4: Introduce minimum harmonising rules to protect policyholders in the event of an insurer’s failure

Under Option 4, which would be in line with EIOPA’s general approach, a coherent EU framework for IGS would be implemented in all Member States by way of a dedicated EU Directive. It would ensure that all policyholders 83 acquiring insurance policies in the EU would benefit from a harmonised minimum level of protection in the event that an insurance company defaults. Based on minimum harmonisation, the EU framework would introduce an obligation to establish IGS and determine a coherent set of minimum requirements, but would provide flexibility to Member States to adapt IGS protection to the varying characteristics of local insurance markets.

Annex 5 examines in detail the different options for technical features of the design of a minimum harmonised EU framework for IGS, as well as the related costs and benefits. On this basis, assuming EU action, the preferred features would be the harmonisation of the geographic scope according to the home-country principle 84 , as well as the coverage of a minimum scope of eligible policies, encompassing life and selected non-life insurance policies, to a harmonised minimum level by either paying compensation or ensuring continuity of insurance policies. Mechanisms for cross-border cooperation and coordination would also be established. In order to ensure an adequate protection of policyholders, an IGS would need to be adequately funded (see sub-section on costs below), taking into consideration the specificities of insurance activities and of local markets.

Benefits

Action taken at EU level would benefit primarily policyholders by increasing their protection in the event that insurers are unable to fulfil their commitments. This would also foster the trust in a properly functioning Single Market for insurance and increase consumer choice by ensuring that consumers feel comfortable in purchasing insurance provided by insurers from other Member States, including innovative solutions aimed at improving the resilience of our economies against systemic risks (natural catastrophes, cyber-risks, etc.). The introduction of IGSs in all Member States would additionally reduce the risk of recourse to public funds to protect policyholders from losses, and could shield public funds from a potential liability of around EUR 21 billion 85 on an aggregated based, based on estimations provided in Annex 5. The proposed policy options are expected to generate two main advantages for the economy. First, they would ensure a level-playing field that would address the existing competitive distortions between domestic and non-domestic insurers. By contributing to the safety and well-functioning of the internal market for insurance services, the envisaged EU action would facilitate the provision of cross-border activities for individual insurers and groups. Second, EU action would reduce the risk of allocating losses to policyholders and taxpayers in a sub-optimal fashion, thereby also contributing to improved overall social welfare. In addition, EU action based on the home-country principle would align and enhance supervisory incentives, including in the context of cross-border activities, as the financial consequences of a failure would have to be borne consistently by the insurers of the Home Member State.

Costs

Introducing IGSs throughout the EU would also have a direct cost for insurers and an indirect cost for policyholders, as insurers would pass on part of their contributions to consumers through increased premiums. IGS can be financed either ex-ante, or ex-post (following a failure case), or through a combination of both approaches. EIOPA suggested a combination of ex ante and ex post funding. 86 In an ex-post funded scheme, resources would remain with the contributing institutions until a failure occurs, and levies would be paid only once losses arise and are known. However, ex-post funding may entail payout delays and would be more exposed to moral hazard, as failed insurers would have never contributed to the IGS. Furthermore, depending on the market circumstances and the degree of market concentration, raising contributions following the failure of an insurer could have a pro-cyclical effect. In a pre-funded scheme, funding is readily available, pro-cyclicality is avoided, and the incentive structure is preserved, contributing to market discipline. Annex 5 discusses the pros and cons of the financing models in more details.

IGS funds can be considered as the additional premiums that policyholders pay to insure themselves against the insolvency of their insurer. The payments made by each policyholder can be considered roughly equivalent to the expected value of the losses they would avoid incurring, in the event that their insurers defaulted. Depending on the specificities of national insolvency frameworks, the possibility to use alternative funding mechanisms and the use of certain resolution tools, actual funding needs in Member States may be lower than those estimated by the model in Annex 5. In addition, the financial burden could be smoothened over a sufficiently long transition period in order to maintain the yearly impact at an acceptable level. While risk-based ex-ante contributions create the preferred incentive structure for all types of insurance commitments, the choice of a funding structure may also need to reflect that some insurance products have more limited payout and maturity profiles. These considerations may be suitable to balance adequately the interests of all stakeholders and should be assessed globally with other elements of the Solvency II review.

As shown in Annex 5, the building up of a protection scheme in all Member States could require around EUR 21 billion. This currently corresponds to 2.33% of annual gross written premiums. Applying this target level over, for instance, a 10-year horizon would translate into an annual contribution of 0.233% of gross written premiums or EUR 2.33 per yearly policy of EUR 1,000. However, this estimate does not take account of the funds that are already available in the current national IGS that are pre-funded. 87  

EU action on IGSs would also affect insurers in different ways, depending on whether they operate in Member States that already have an IGS or not and depending on the specific market structures in place. For insurers, unlike policyholders, these contributions – or at least the portion that would not be passed on to policyholders – constitute a financial cost in themselves (and not an early payment), as losses hitting insurers in the event of default only depend on capital, not on premiums paid. The financial costs for the industry can be computed by using the Solvency II cost of capital rate of 5% 88 . For an IGS with a level of funding of 2.33% of annual premiums, this would translate into financial (capital) costs of about 0.12% of annual premiums.

Overall assessment

Effectiveness, efficiency and coherence: The minimum harmonisation of a network of IGS would address the problem drivers that lead to insufficient policyholder protection in case of failure by closing the identified gaps and by removing potential overlaps. In the event that insurers fail, IGSs would absorb insurers’ losses up to at least the EU minimum coverage level. This mutualised “tail-risk” protection would achieve a high level of security for policyholders and beneficiaries in a cost-effective manner (i.e. considering the smoothing and mutualisation effect) by covering the potential excess losses that would not be accounted for by existing capital requirements (or any available excess capital). The pre-funded nature of the funding and its spreading among a larger base (of insurers and of end-consumers) would provide the desired level of protection at a lower cost and in a counter-cyclical manner. However, insurance failures remain rare events. Therefore, the potential costs and challenges (see the sub-section on “winners and losers” below) of EU minimum harmonisation have to be assessed bearing in mind the level of protection that is sought throughout the Single Market and the level of risk tolerance that policyholders and/or taxpayers may accept (as they have to ultimately bear the losses of insurance failures). In contrast to normal court-based insolvency proceedings, IGSs would help ensure a swift pay-out to policyholders, minimise potential social hardship and possibly bring to zero the loss incurred by policyholders at the time of failure, and, introduce an element of predictability and certainty on the effects of the failure of an insurance company for its policyholders. By optimising these elements together with a better allocation of insurance failure losses, an EU minimum harmonisation framework for IGS would contribute to maximising EU social welfare, developing a more competitive EU market and achieving consumers’ trust in the internal market for insurance. The design of IGS features, in particular an ex-ante risk-based contribution mechanism, could address and manage potential moral hazard effects that could be linked to the introduction of a framework of protection schemes. On the supervisory side, minimum harmonisation in accordance with the home country principle would be coherent with the supervisory architecture of Solvency II as it would reinforce incentives for the adequate supervision of cross-border branches and direct sales of national insurers. It would also complement and follow the same approach as the proposed revision of the Motor Insurance Directive that ensures third party protection in the case of insurance failure for the specific product of motor third party liability.

Winners and losers: Overall, policyholders would benefit from EU action that would offer them an increased protection in the event that insurers fail irrespective of their place of residence and of where they bought their insurance cover. The associated costs could be seen as a premium for being insured against such failure. In exchange, policyholders and beneficiaries would have the certainty that their eligible claims would be covered, even in adverse circumstances. Similarly, the EU action on IGS would benefit taxpayers, as the likelihood that public resources would need to be used in the future in case of default of an insurance undertaking would be reduced. On the one hand, as explained above, where no pre-funded IGS has been established so far, or in the cases where the scope would need to be extended, insurance companies and policyholders would face additional financial costs. On the other hand, EU action would eliminate the existing duplication of levies that might currently be imposed on firms that perform cross-border activities. In addition, an IGS framework would contribute to reinforcing market discipline, level-playing field and competitiveness and ensure a better functioning of the internal market for insurance that would be beneficial for insurance companies as a whole. Finally, existing IGS schemes would be affected to the extent that the framework established at EU level deviates from the national IGS framework in place, in particular where the minimum level of protection established at EU level would exceed their coverage.

Stakeholder views: During the Commission’s public consultation, participants were asked whether IGSs should become mandatory across the EU. Overall, views were split among respondents. NGOs/consumers/citizens who expressed a view were largely in favour. The main rationale behind supporting the requirement to set up IGS was the enhancement of policyholders’ protection and the strengthening of the Single Market. By contrast, public authorities and insurance industry representatives that responded to the consultation were mainly opposed. A strong focus on proportionate minimum harmonisation takes these concerns into account. However, a quarter of the industry respondents, notably five national insurance associations, supported IGS minimum harmonisation. In the Commission expert group, a majority of Member States was of the opinion that minimum harmonisation would be beneficial (see Annex 2). During EIOPA’s consultation activities, several stakeholders agreed that there should be a minimum degree of harmonisation but that its legal structure should be left to national discretion. Other stakeholders, mostly from the industry, were against a harmonisation in the field of IGSs. Some respondents also pointed at a lack of harmonization of the supervisory practices (see Sub-section 6.1.3 of the Evaluation Annex) and of recovery and resolution frameworks.

6.4.4.Choice of preferred options

The below tables provides a high-level summary of how the previously described options compare and interact (note that for the sake of readability of the tables, the labels of the Options have been shortened). The incremental impacts of each of these options remain broadly similar whether they are compared to the baseline option or between them, as alternatives to foster policyholder protection.

In relation to Option 2, the assessment has to reflect possibly contradictory effects of changes on group supervision and cross-border supervision. For instance, regarding effectiveness on quality of supervision, there is a strong added value of changes in relation to group supervision due to the removal of legal gaps and uncertainties. In relation to cross-border supervision, while the effect of Option 2 is overall positive, the added value depends on the extent to which the principles embedded in existing soft convergence tools (notably the Decision on Collaboration) are already applied by national authorities (for those countries which already full apply those principles, the improved effectiveness would be limited).

Remedying legal uncertainties and strengthening the way supervisors apply Solvency II and cooperate, in particular in a cross-border context is a prerequisite to improving quality of supervision and policyholder protection. Similarly, reinforcing the coordination and mediation role of EIOPA would be coherent with the maximum harmonisation approach of Solvency II in relation to supervision. Therefore, Option 2 would be effective in improving the quality of ongoing supervision of insurance companies and groups and improve the level-playing field and the integration of the Single Market for insurance services. However, considered alone, it would not contribute fully to the objectives of an EU action in terms of addressing adequately the management of an insurer’s failure and ensuring policyholders’ protection in such a case.

In order to foster further supervisory convergence and support policyholder protection, Option 3 would further clarify and strengthen the Solvency II provisions that aim at addressing the deterioration of the financial situation of insurers. However, as the possibility of an insurance failure can never be entirely excluded, Option 3 would also implement a resolution framework that would ensure the continuity of an insurer’s important functions for the economy, minimise reliance on public financial support and mitigate the adverse effects on financial stability in comparison to normal insolvency proceedings. Therefore, these additional benefits of Option 3 in terms of reducing negative social and welfare effects of an insurer’s failure would justify the additional costs of recovery and resolution planning as long as they are applied in a proportionate manner.

At the same time, normal insolvency proceedings would remain a possibility under Option 3. In this case, as illustrated by recent insurance failures, it cannot be excluded that losses have to be borne by policyholders. In addition, even in the context of a resolution framework, the successful implementation of some tools, such as a transfer of portfolio, may require to haircut the value of some policies. Options 2 and 3 alone would thus not ensure that policyholders are shielded completely from social or financial hardship resulting from their insurer’s failure. Depending on the judgement on the need to mitigate these risks for individual policyholders in all Member States, Option 4 could implement an effective IGS protection that would safeguard the confidence of consumers in the Single Market for insurance and ensure a level-playing field across the EU. By its design, Option 4 would contribute to fostering market discipline and to incentivise insurers to adequately monitor and manage their risks. It would also contribute to the effectiveness of Option 2 by reinforcing the incentives for supervisors to exert appropriate oversight on cross-border business. However, Option 4 would entail additional implementation costs the amount of which would depend on the design and on the starting point of the different Member States, as explained in above and in Annex 5. In conclusion, all three options are complementary and contribute together to the achievement of the objectives set for EU action.

6.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector 

6.5.1.Option 2: Make targeted amendments to prevent financial stability risks

Under Option 2, targeted amendments to the framework would be introduced to prevent the building-up of systemic risks stemming from or amplified by the insurance and reinsurance sector, which could be detrimental to financial stability. Those tools would in particular aim at:

-Better incorporating macro-prudential considerations in insurers’ investment and risk management activities: insurance companies would be required to take into account how the macroeconomic developments can affect their underwriting and investment activities, and reciprocally how their activities may affect market drivers;

-Preventing liquidity risks: insurance companies would be required to strengthen liquidity management planning and reporting, while supervisors would be able to intervene whenever any resulting liquidity vulnerabilities are not appropriately addressed by insurers. In addition, as a last resort measure, supervisory authorities would have the power to temporarily freeze redemption options on life insurance policies to avoid “insurance run”;

-Avoiding excessive risk-taking: prudential rules would be amended so that banking-type loan origination activities by insurers are not subject to a more preferential treatment than in the banking sector thus preventing regulatory arbitrage and curtailing “shadow-banking”;

-Preserving capital position of vulnerable insurers during exceptional situations: in crisis situations, supervisory authorities would be granted the power to restrict or suspend dividend distributions and variable remunerations on a case-by-case basis, in order to preserve an appropriate capital position for the insurance sector.

Where necessary, EIOPA would be mandated to develop technical standards or guidance regarding operational details of these tools.

Benefits

Option 2 would determine a very tangible improvement of the ability of supervisors to monitor and prevent systemic risks stemming from or affecting the insurance sector. In addition, this option would further reduce pro-cyclical behaviours by insurers 90 and would ultimately produce positive effects for the stability of financial markets in the longer term. Insurers would be required to incorporate macro-prudential considerations in their underwriting and investment activities, which would limit excessive risk-taking behaviours. Supervisors would be entitled to intervene in case of liquidity vulnerabilities that are not addressed or to ensure prudent capital management during crisis situations, in the interest of policyholders and to preserve financial stability. Option 2 would also be in line with a risk-based framework, because supervisory intervention on dividends policies would be entitled only when justified by the application of risk-based considerations and criteria. As there is no quantitative requirement for liquidity risk as in the banking sector, those additional tools would ensure that liquidity risk is appropriately monitored and controlled without imposing standardised liquidity metric which would not be fit for the specificities of different insurers’ business models.

In addition, while not affecting volatility and not directly improving risk sensitivity, Option 2 would still require that insurers better take into account sector-wide developments and liquidity risks in a prospective manner, and therefore would provide good incentives for improved risk management beyond capital requirements.

Costs

Option 2 could possibly depress, to a certain extent, insurers’ ability to invest in activities which may provide long-term and sustainable financing to the economy. However, this would only occur when prudentially justified (for instance the inclusion of a macro-prudential dimension in investment activities could discard some specific investments which may generate financial stability risks although they could still allow for better expected returns for policyholders), and with the aim of ensuring the long-term stability of financial markets and the broader economy. In addition, additional focus on liquidity risks may prompt insurers to divest from certain “illiquid” assets if these contribute to systemic risks, although such investments could be considered beneficial for the purpose of achieving the CMU objectives (e.g. investments in unlisted equity of SMEs).

Option 2 would increase the complexity of the framework because it would introduce new risk management requirements for insurers. Still, Option 2 would also aim at ensuring that the new requirements are implemented in a proportionate manner. For instance, EIOPA proposes that supervisory authorities should have the power to waive requirements in relation to liquidity risk management planning depending on the nature, scale, and complexity of the insurer’s activities.

Although Option 2 would grant supervisors with a common set of macro-prudential tools to prevent systemic risks, it cannot be excluded that supervisors facing similar systemic risks emerging at national level would not act in the same way. Even with guidance and coordination at EU level, supervisors would still be in a position to deviate from supervisory recommendations put forward by EIOPA or the European Systemic Risk Board (ESRB). Such an issue already materialised in the context of the statements by EIOPA and the ESRB in 2020 to prohibit dividend distributions by European insurers, where some NSAs decided to deviate from EIOPA’s approach (i.e. insurers in some countries could distribute dividends whereas their direct competitors in others could not).

A lack of harmonisation in supervisory responses to financial stability concerns may hinder public authorities’ ability to address sector-wide systemic risks at European level, considering that macro-prudential policy would largely remain a national competence. However, Option 2 would still be an improvement compared to the baseline as public authorities would still be granted new powers to prevent financial stability risks at least at national level. Option 2 would also negatively affect the level-playing field if some insurers were imposed additional requirements (e.g. dividend restrictions) whereas their competitors were not while facing similar risks. Similarly, in relation to waivers of some requirements (e.g. liquidity requirements), EIOPA proposes to issue guidelines, but those non-binding tools would not necessarily ensure consistency across Member States.

The new tools would be in line with the international framework for systemic risk 91 , and would not result in an increase in capital requirements. However, the power for supervisors to restrict or suspend dividend distributions could increase financing costs for European insurers compared to non-European ones. Therefore, Option 2 would have a slightly potential negative impact on insurers’ international competitiveness. On the other hand, such restrictions could improve or preserve the solvency ratio of insurers during exceptional situations (such as adverse economic or market events), and thus contribute to policyholder protection and the preservation of financial stability.

Finally, Option 2 would imply moderate implementation costs for the insurance industry. Indeed, based on a survey included in EIOPA’s impact assessment, 61% of insurers do not currently include a macro-prudential perspective in their investment and risk management activities, and among them, 59% (i.e. 36% of all insurers surveyed) identify that such a requirement would generate significant additional costs (although such costs are not quantified). Similarly, almost half of insurers (48%) do not yet produce a liquidity risk management plan. However, EIOPA estimates that drafting and maintaining such a plan involves very limited additional human and financial resources as shown in the below table:

The additional cost of reviewing such plans would also be limited for supervisory authorities. EIOPA considers that the average one-off cost for public authorities would lie between 0.05 and 3 FTE, and the average ongoing cost between 0.03 and 2 FTE.

Overall assessment

Effectiveness, efficiency and coherence: Option 2 would be effective in preventing systemic risks without overburdening the current system. It would therefore be coherent with one of the main objectives of Solvency II, namely financial stability. In addition, Option 2 would be consistent with the international standards; regulatory capital requirements would remain based on the risks faced by individual insurers and excessive risk-taking would be prevented without introducing limitations to insurers’ ability to invest for the long-term, nor through additional “cost of capital”. Still, supervisors would have new tools to address excessive risk taking and liquidity risks, and to ensure that macro-prudential concerns are appropriately embedded in insurers’ activities. Implementation costs for such new tools would be moderate. Efficiency would be achieved as more “far-reaching and stronger” tools (liquidity and capital buffers, concentration limits), while contributing to financial stability, may generate additional costs (including opportunity costs in terms of contribution to the long-term and sustainable financing of the economy and international competitiveness) and uncertain benefits. In fact, the added value and the appropriateness of those “far-reaching” tools have not been demonstrated and remain at this stage hypothetical. Finally, regulatory arbitrage between banks and insurers regarding banking-type activities would be prevented and the role of supervisors would be enhanced in the context of liquidity risks, although no discretionary powers to impose “liquidity buffers” would be introduced. EIOPA and ESRB would continue to be central in exercising systemic risks’ oversight and facilitating dialogue and coordination among NSAs, although national authorities would still have the final word.

Winners and losers: Improved financial stability would have no direct effect on policyholder protection. However, financial instability risks and possible spill-over effects on the real economy could affect policyholders both as taxpayers (since business failures and economic recession may require public intervention) and as workers (since EIOPA demonstrates that there is a correlation between financial instability and unemployment). On the contrary, some of the tools embedded in Option 2 (in particular, the power to freeze the exercise of surrender options on life insurance contracts) may be considered detrimental to policyholders in the short term. However, this would only be a last resort measure to avoid the failure of an insurer, which may result in financial losses for all remaining policyholders in the longer run.

The impact of Option 2 is mixed. Shareholders of insurers might be considered losers in the short term because of the possibility of dividend restrictions, however as such restrictions would strengthen the solvency position of insurers and thus their probability of survival, shareholders might win in the long run. Similarly, insurers conducting banking-type loan origination activities may face a slight increase in capital requirements due to more convergence with banking rules but this might benefit the economy in the long term as the risk of regulatory arbitrage is reduced. Insurers might also be considered winners as the possibility to freeze redemption rights would make them less exposed to liquidity risk under stressed circumstances. Other changes embedded in Option 2 would not make it more costly for them to conduct their underwriting and insurance activities. There would still be some implementations costs in relation to the development of enhanced risk management and reporting systems, which would include the macro-prudential dimension. However, as explained above, a number of insurers already embed such requirements in their processes (and thus those would face no implementation costs), and the implementation costs for those which do not apply them yet would remain moderate. Option 2 would also have a limited negative impact on insurers’ capacity to compete at international level with non-European insurers. Supervisors would be winners compared to the status quo, although they may not be largely satisfied by Option 2 because they would not get a fully-fledged set of new powers as proposed by EIOPA and the ESRB and may consider they lack certain tools to address potential systemic risks. At the same time, Option 2 would not limit the wide margin of discretion that they have in the exercise of macro-prudential supervision.

Stakeholder views: The feedback to EIOPA’s and the Commission’s consultations are not fully consistent. In the context of EIOPA’s consultations, the vast majority of stakeholders expressed the view that should amendments be brought to Solvency II in order to incorporate a macro-prudential dimension, such changes should remain limited, broadly in line with Option 2. The situation is however more nuanced for respondents to the Commission’s public consultation, where only 27% of respondents (42% if we exclude those who did not provide an answer to the question) expressed support for targeted amendments only (the alternatives being either no change or a broad range of new powers). However, among public authorities, 63% (71% if we exclude those with no answer) express support for targeted amendments. A specific question of the Commission’s consultation was about circumstances in which public authorities should have the power to freeze surrender rights. The majority of respondents expressed support for such a power, either at the level of individual insurers when they are in weak financial position or in financial distress (41%) or at sectoral level (24%). This applies to all stakeholder categories.

6.5.2.Option 3: Introduce an extensive macro-prudential framework

Under Option 3, a broad range of macro-prudential tools would be included in Solvency II, which are partly inspired from the banking sector although adapted to the insurance context. In addition to those tools already mentioned in Option 2, Option 3 would grant additional powers to supervisors with the aim of further avoiding excessive risk-taking activities and liquidity risk.

In relation to risk-taking, Option 3 would encompass, in addition to the tools already covered by Option 2, the following discretionary powers for NSAs, subject to possible EIOPA’s technical standards and guidance where deemed appropriate:

-imposing capital surcharges for systemic risk to single insurers that are deemed “too big to fail” or to insurers whose common (herding) risky behaviour may pose issues to financial stability, and/or countercyclical buffers in order to increase own fund requirements when market credit spread levels are lower than their historical average and may indicate the presence of a system-wide underestimation of risks (i.e. to ensure that insurers establish a buffer against future increases in spreads);

-imposing (soft) concentration limits on investments so that supervisors can decide to intervene when insurers’ investments are deemed excessively concentrated in certain asset classes or sectors and public authorities consider that systemic risks may be generated or amplified by these asset classes or sectors;

-requiring the establishment and maintenance of a systemic risk management plan (SRMP) so that insurers that are deemed to be systemic or to undertake systematically risky activities have to plan and report to supervisors all applicable measures that they intend to undertake in order to address their systematically risky activities;

-prohibiting at sector-wide level dividend distributions and variable remuneration under crisis situations, regardless of the individual solvency position of insurers.

In relation to liquidity, under Option 3, supervisors would impose, in addition to the tools of Option 2, discretionary liquidity buffers to insurers that they deem to have a “vulnerable” liquidity profile (for instance, high exposure to derivatives, which may generate risks of massive margin calls if financial markets deteriorate). Those buffers would be calculated based on standardized liquidity metrics inspired from the banking sector, but adapted to the insurance context.

Benefits

Option 3 would have a very positive effect on the ability of supervisors to preserve financial stability and address systemic risks stemming from or affecting the insurance sector. This option would also contribute to stabilise financial markets in the long term by avoiding excessive concentrations or excessively risky behaviours of insurers. Supervisors would indeed be granted with a large set of tools aiming at (i) limiting insurers’ risk taking activities which may generate “price bubbles”, (ii) ensuring that insurers are not exposed to material liquidity risks, including in relation to margin calls on derivative transactions and possible massive exercise of surrender options by policyholders and (iii) preserving the financial solvency of the sector by limiting insurers’ ability to make payments to shareholders under crisis situations. Capital surcharges may mitigate both entity based 92 , activity-based 93 and behaviour-based sources of systemic risk. Concentration thresholds would be “soft” thresholds, in the meaning that the intensity of the supervisory response to a breach of threshold would be fully discretionary (and may consist in simply engaging dialogue between the supervisor and the firm). Liquidity buffers would be based on standardized liquidity metrics and would ensure that liquidity risk is assessed in a consistent way across Europe, although the decision to impose such buffers would remain discretionary.

In addition, Option 3 would, to a certain extent, improve risk sensitivity by taking into account the state of financial markets (in particular credit spreads) in capital requirements. In addition, it would ensure that the risk related to loan origination activities is not underestimated compared to the banking sector (by making risk factors of the Solvency II counterparty default risk more consistent with those of the banking credit risk framework). This would be an improvement to policyholder protection.

Finally, Option 3 would be in line with international agreed standards, which require supervisors to act appropriately to reduce systemic risk when identified, assess the potential systemic importance of insurers and target supervisory requirements to those insurers.

Costs

Option 3 would affect insurers’ ability to contribute to the long-term sustainable financing of the economy. Option 3 would indeed imply that certain insurers, if systemic risks are identified, may be incentivised or required to hold more liquid (due to the liquidity buffers) and less risky assets (i.e. cash and money-market funds, due to capital surcharges or concentration limits) to the detriment of asset classes such as equity, bonds and securitisations. While macro-prudential tools would be subject to supervisory discretion, the uncertainty surrounding their use by public authorities may indeed incentivise insurers to anticipate such restrictions and implicitly embed them in their investment behaviour and capital management, in particular if public authorities indicate that they identify systemic risks in these asset classes. Option 3 would also reduce insurers’ profitability, as the capital surcharges and concentration limits, where applied, may increase capital costs or reduce investment opportunities. In turn, their activation would have a negative impact on EU insurers’ international competitiveness, as these specific tools are not part of the macro-prudential framework in other jurisdictions. The risk of being restricted in investment decisions or in dividend distributions would put European insurers at a disadvantage vis-a-vis their international competitors, albeit at the benefit of being better prepared to cope with systemic risks. The uncertainty for investors regarding the actual level of capital requirements (including buffers) on insurers and decisions on dividend restrictions may increase the relative financing cost for EU insurers compared to third-country companies. In addition, lower risk taking would also limit insurers’ ability to supply (life) insurance policies that meet consumers’ demand.

Although EIOPA’s Opinion highlights that macro-prudential tools should be implemented in a proportionate manner, no concrete safeguard is proposed to ensure that this principle is satisfied. As shown in Section 6.2 of the Evaluation Annex, a general and abstract principle of proportionality does not result in an effective implementation within Solvency II. Therefore, Option 3 would not guarantee that its effective implementation would ensure coherence with the overarching principle of proportionality embedded in Solvency II. Ensuring proportionality would require further conditions or technical standards that have not been developed by EIOPA as part of its Opinion on the Solvency II review. In any case, Option 3 would imply that the framework would become more complex and less predictable for firms, notably in terms of capital management policies.

In addition, most of the tools that would be introduced as part of this option would be largely discretionary in nature (e.g. capital surcharges would be defined subject to supervisory judgement, the level of concentration thresholds and supervisory response to a breach of thresholds would be discretionary, as well as the definition of liquidity buffers or restrictions on dividend payments). Although EIOPA’s Opinion acknowledges that further guidance or technical standards would be needed at a later stage (through non-binding guideline by EIOPA for instance), Option 3 could lead to further inconsistencies between national supervisory processes, as also explained in Option 2. If the very same situation does not trigger a similar supervisory response (e.g. no application of capital surcharge for systemic risk in one jurisdiction but imposition of such buffers in others), there would be a risk of unequal level-playing field within the European Union, as some jurisdictions may be less willing to address systemic risks than others.

Finally, Option 3 would imply moderate implementation costs for the insurance industry. In addition to those identified in Option 2, the main additional implementation cost would be in relation to systemic risk management plans. EIOPA estimates that the drafting and maintenance of both liquidity management and systemic risk management plans involves limited additional human and financial resources as shown in the below table.

The additional cost of reviewing such plans would also be limited for supervisory authorities. EIOPA considers that the average one-off cost for public authorities would lie between 0.1 and 6 FTE, and the average ongoing cost between 0.08 and 4 FTE.

Overall assessment

Effectiveness, efficiency and coherence: By granting all the necessary tools that may be needed to address macro-prudential concerns, Option 3 would be the most effective option to preserve financial stability. However, if Option 3 was chosen, the EU would go further than other jurisdictions in addressing potential sources of systemic risks (for instance widespread collective reactions of firms to exogenous market shocks). Some of the sources of systemic risks in the insurance sector remain quite theoretical until now as they have not materialised yet. Furthermore, the articulation between risk-based capital requirements and capital surcharges defined at individual level to prevent excessive risk taking is not straightforward. In particular, as discussed as part of the first problem on long-term and sustainable financing of the economy, it is acknowledged that capital requirements – although not being the main driver of investment decisions – may generate undue disincentives to invest in certain asset classes, in particular equity. Introducing the power for supervisors to impose systemic capital surcharge or concentration thresholds on equity investments would contradict such diagnosis. It could also undermine any solution aiming to address the insufficient incentives for long-term equity financing in situations where further investments in equity would not affect policyholder protection 94 . Furthermore, the risk-based nature of capital requirements makes it less justified to add capital buffers or to impose ex-ante concentration thresholds at individual level. Capital requirements in Solvency II are conceived in a way that insurers are actually discouraged to take excessive risk on assets which generate high capital charges (or otherwise they would have to be so highly capitalised to be in a position to weather market downturns and stick to their investments when the economic cycle is at a low level).

The main exception would be government bonds because they are not subject to any capital charge under standard formula rules (therefore, quantitative rules do not deter concentration in such investments). However, the “prudent person principle” embedded in Solvency II ensures that the risk of concentration in any asset class or in certain counterparties is duly monitored and mitigated by insurers. An expansion of such principle to integrate “macro-prudential” considerations (as envisaged in both Option 2 and Option 3) would similarly enhance supervisors’ possibility to discourage excessive concentrations or excessive expositions to temporary “price bubbles”. Similarly, countercyclical buffers, which could be imposed when spreads are low (as proposed by the ESRB), would be to a certain extent redundant because the risk of rising spreads is already captured in existing capital charges for spread risks. This was the reason why this tool was not retained in EIOPA’s final Opinion.

In addition, as described above, the additional tools which are conceived as part of Option 3 would make it more difficult for insurers to compete at international level and more costly for them to invest in “real” assets (which may be more risky and less liquid). Option 3 would be coherent with the objectives of Solvency II (financial stability) although it may enter in conflict with other political objectives (e.g. facilitating insurers’ contribution to the Capital Markets Union). In addition, the power for supervisors to impose a sector-wide blanket ban on dividend distributions without the application of risk-based criteria related to the risk appetite limits/tolerance, which are firm-specific, would undermine the credibility of capital requirements. In fact, under this approach, even an insurer which is very well capitalised (e.g. with a solvency ratio above 300%) could be subject to such restrictions if a sector-wide blanket ban was imposed.

Winners and losers: Like in Option 2, policyholders would be in a relatively neutral position, as improved financial stability would have no short-term direct effect on policyholder protection (while only indirect effect on taxpayers and workers in the longer term). However, if financial stability was threatened, insurance firms, as well as policyholders, would be affected. On the contrary, some of the tools embedded in Option 3 (e.g. power for NSAs to freeze the exercise of redemption options on life insurance contracts) may, like in Option 2, be harmful to some policyholders in the short term. Insurers would be losers under Option 3 as it would be more costly for them to conduct their activities, and to generate return on investments, in particular because potential capital surcharges for systemic risks and concentration limits on investments may constrain their ability to “search for yield” and their capital management. On the other hand, Option 3 might be beneficial for their longer-term survival, as well as for preventing such kinds of behaviour for financial stability purposes. Option 3 would also make it more difficult to compete at international level with non-European insurers that are not subject to similar rules. Shareholders would thus lose as they could receive less dividends. On the other hand, shareholders would lose if insurance companies were to fail more easily during exceptional situations (e.g. during a financial crisis). Finally, supervisors would be largely winners of this option, due to the enhanced and fully-fledged set of new powers at their disposal and the wide margin of discretion that they would have when using them in practice.

Stakeholder views: The vast majority of respondents to EIOPA’s consultations opposed the introduction a fully-fledged macro-prudential framework in Solvency II. This is more or less in line with the Commission’s public consultation where only 22% of respondents who expressed a view supported a broad set of new tools in Solvency II. Support ranges from 13% (public authorities) to 30% (NGOs/consumers/citizens) depending on the stakeholder category. Therefore, Option 3 would receive limited support by stakeholders. As regards the power to freeze surrender rights, please refer to the summary provided as part of the analysis of Option 2.

6.5.3.Choice of the preferred option

The below tables provides a high-level summary of how the previously described options compare (note that for the sake of readability of the tables, the labels of the Options have been shortened).

Option 3 would be the most effective in preserving financial stability. However, it could generate significant additional costs for capital management for the insurance industry. There is no evidence that those costs outweigh the added value of the new powers that would be granted to supervisors. In addition, the material risk of inconsistent approach in their application may also be detrimental to the level-playing field. In comparison, Option 2 seems to find the right balance between the need to enrich the supervisory toolkit to address systemic risks, in line with international standards, while ensuring a proportionate increase in complexity and limited additional costs for the capital management of the insurance industry.

7.Preferred combination of options

As discussed in Section 6, the selection of certain options to achieve an objective has been done with the aim of maximizing the effectiveness in addressing the specific objective related to a problem while limiting the costs and potential negative side effects on other specific objectives.

The following tables summarize the impact of the different preferred options.

7.1.General impacts 96

Most options retained have a positive effect in supporting insurers’ long term and sustainable financing of the European economy. By facilitating the use of the long-term equity asset class which benefits from a preferential treatment, by requiring that insurers incorporate climate and sustainability considerations in their investment and underwriting activities, and by reducing the volatility of the framework, insurers benefit from a conducive prudential environment, which fosters long-termism and sustainability in investment decisions. Other options retained, which reduce regulatory compliance costs and facilitate the dissemination of insurance supply that can improve resilience against climate change and/or natural catastrophes, also have a positive impact. The proposal to make targeted changes to Solvency II in relation to financial stability may hinder the objective of long-term financing and greening of the economy. It achieves however the appropriate trade-off between what is needed in order to ensure that public authorities have the appropriate toolkit to address systemic risks, and the limitation of side effects on the political objectives of the Capital Markets Union and the European Green Deal. In addition, the framing of the revised criteria for long-term investments in equity would aim at rewards where insurers are able to avoid forced selling under stressed situations, which limits the risk that the insurance sector could amplify systemic financial market turmoil.

Furthermore, the combination of preferred options reduces volatility, but also improves risk sensitivity by appropriately reflecting the risk of negative interest rates in capital requirements and in the valuation of insurers’ liabilities towards policyholders. The clarification of prudential rules in relation to group supervision, and the targeted amendment on macro-prudential supervision in relation to banking-type activities by insurers (to remove risks of regulatory arbitrage) also contribute to improving risk sensitivity. However, the revision of the eligibility criteria for long-term equity investments, which aims at facilitating its use by insurers, would reduce the risk-sensitivity of the framework as EIOPA’s analysis concludes that the preferential treatment on such investments is not justified by evidence. Still, EIOPA did not recommend removing this asset class, and on the contrary supported the objective of clarifying supervisory criteria for its use. There is a clear trade-off between risk sensitivity and facilitation of long-term equity, but the deterioration of risk sensitivity generated by the facilitation of the use of the long-term equity asset class seem limited (as the classification criteria remain robust) and are justified by the political priority given to the completion of the Capital Markets Union. Still, overall, the level of prudence of the framework is slightly increased compared to current rules.

One key consideration is the overall balance of the review in terms of capital requirements. Based on EIOPA’s impact assessment, the Commission services tried to quantify the impact of all changes brought on the average solvency position of insurers at two different reference dates. The below table provides a summary of those calculations – assuming that no transitional period would be introduced. It shows that the impact of the review depends on how low interest rates are. The review would in all cases improve the capital surplus at EEA level, although there would be a slight decrease in solvency ratios. The impact would in any case be spread over several years and would result in the short term in an increase in capital resources in excess of capital requirements of up to € 90 billion euros which would facilitate insurers’ contribution to the post-Covid recovery. At the end of this phasing-in period, the overall impact would depend on market conditions, but would in any case imply an increase in insurers’ capital resources in excess of capital requirements as shown in the below table. The below figures which show the long-term impact of the review are provided for the sample of insurers which participated to EIOPA’s data collection exercises, as well as for the whole EU market. As the figures for the whole market are “extrapolated” from the sample, they may be less reliable. Note that those figures provide a floor to the impact of the review, as they do not take into account the extinction of older contracts with high guaranteed rates which generate more capital requirements 97 .

In addition, as the negative changes would be gradually implemented over at least five years, any cost of the review would be smoothened, and insurers would be given sufficient time to issue new capital or debt instruments if needed. Finally, as the average solvency ratio by mid-2020 remained above 220%, the few percentage points change in solvency ratios, spread over five years, would not have had a disruptive effect on the market. Therefore, the options chosen achieve a balanced – and even positive – outcome in terms of capital requirements. This also confirms the choice of not introducing those new macro-prudential tools, which would have an effect on capital requirements, as it would undermine the objective of “balance” while not being necessarily technically justified. The technical changes retained in order to address volatility have a slightly negative impact on the simplicity of the framework, but those changes remain moderate.

The combination of options is improving proportionality by excluding more insurers from Solvency II and by applying automatic proportionality to a number of insurers, which have a low-risk profile. As the outcome of the review, up to 20% of insurers would be excluded from Solvency II, to be compared with 14% under current rules. This represents a significant increase while ensuring that the vast majority of insurers remain subject to Solvency II. The technical changes retained in order to address volatility have a negative but limited impact on the simplicity of the framework. Therefore, overall, the review would achieve its objective of making the framework simpler for less complex insurers.

The quality and consistency of supervision and policyholder protection would be improved by clarifying rules on group supervision, by remedying gaps in and insufficient coordination on cross-border supervision, and by considering the introduction of minimum harmonising rules on recovery, resolution and IGSs. Based on Commission services’ calculations (see Annex 5), the financial (capital) costs of introducing IGSs for the industry is estimated to be about 0.12% of annual premiums. In absolute terms, these estimated costs 98 are justified by the benefits of introducing IGSs for policyholders, taxpayers and the economy more broadly. Clearer rules in those fields also contribute to improving the level-playing field within the EU, by ensuring that rules are applied consistently across the EU. The clarification of criteria for long-term equity investments would also contribute to this objective. However, the enhancement of proportionality, by excluding more firms from Solvency II, does not support “consistent supervision”, as it reinforces the co-existence of a European regime with national frameworks. This is also the reason why it was preferred to prioritise proportionality for firms within Solvency II rather than to exclude a larger number of companies from the framework. In addition, the reduction of compliance costs for those firms outweighs the side effects on consistency of supervision. Should a small insurer want to operate cross-border, it would have to apply Solvency II. Therefore, the level-playing field within the Single Market would be preserved and even improved.

Finally, the combination of preferred options contribute to preserving financial stability, by granting supervisors targeted additional powers to address macro-prudential risks, including liquidity risk, but also by harmonising recovery and resolution frameworks that ensures the orderly management of insurers’ failures, which could be facilitated by IGS funding. As explained above there are trade-offs to be found between achieving this objective and supporting insurers’ long-term investments in equity (which implies facilitating risk taking). However, robust criteria for long-term equities (notably the clarification of expectations on how insurers can demonstrate their ability to hold on to their investments under stressed conditions) would avoid excessive risk taking. Similarly, there may also be trade-offs between proportionality and financial stability. Indeed, by excluding more firms from the mandatory scope of Solvency II, the combination of options reduces EIOPA’s ability to have a European-wide consolidated view of macro-trends and the build-up of systemic risks. However, the firms concerned by exclusions represent less than a few percentage points in terms of both, gross written premiums and liabilities towards policyholders. Therefore, again, the benefit of enhancing proportionality outweighs the (limited) side effect on financial stability.

Finally, the cumulative impact of the options achieves a satisfactory balance for all types of stakeholders. Insurers benefit from better recognition of their long-term business model, by facilitating long-term investments and reducing the impact of short-term volatility, and by enhancing proportionality (hence reducing compliance costs). Policyholders are overall better off by the improved risk sensitivity, and the better integration of climate risks by insurers, but also by a higher quality of supervision and new layers of protection provided by the frameworks on recovery, resolution and on insurance guarantee schemes. Supervisors are relatively neutral with the review. In some areas, they benefit from clearer rules (e.g. on equity), on others, the framework becomes more complex to supervise (e.g. on volatility). Supervisors also lose some discretion in relation to proportionality, but gain new powers to preserve financial stability.

In conclusion, insurers would be subject to a prudential framework that is more conducive to long-term equity investments and better incorporates the long-term climate and sustainability risks. As such, insurers would have stronger incentives to play their pivotal role in the long-term capital funding and the greening of the European economy, and to support the economic recovery in the aftermath of the Covid-19 crisis, in line with the political objectives of the CMU and the European Green Deal. While making the framework more sensitive and contributing to the main objective of Solvency II (policyholder protection), the review would not have a market-disruptive impact on insurers’ solvency ratios and would therefore not materially affect insurers’ international competitiveness. While remaining very sophisticated, the framework would be designed in such a way that undue complexity is avoided for low-risk insurers, which would benefit from more proportionate and simpler rules. The initiative would also strengthen the trust in the Single Market for insurance services, by ensuring that Solvency II is applied in a more harmonised and more coordinated manner, in particular in relation to cross-border business. In addition, a more integrated Single Market would also be fostered by introducing new layers of policyholder protection against the consequences of insurers’ (near-)failures through minimum harmonisation on resolution and IGSs. Finally, existing gaps in the toolbox for macro-prudential supervision would be addressed in a proportionate manner, by introducing new provisions, which would have a clear added value to prevent financial instability in line with international standards on systemic risks. While those tools could have a short-term implementation cost for insurers, they would benefit in the longer term from more robust risk management and a lower likelihood of financial instability.

7.2.Impact on SMEs

The review would have a positive impact on SMEs. First, the preferred options on proportionality would reduce compliance and regulatory costs by both excluding a larger number of small insurers from the scope of mandatory application of Solvency II, and enhancing the application of proportionate rules for other smaller and less complex insurers in the scope of Solvency II (see subsection 7.3 below). Second, all SMEs (beyond the insurance sector) would benefit from easier access to long term capital funding. Indeed, one of the preferred options implies simplifying the eligibility criteria for long-term equity investments, which is expected to facilitate the use of this asset class by insurers. Eligible equities would benefit from a risk factor of 22% instead of an average risk factor of 39% for listed equity and 49% for unlisted equity. Long-term investments in SMEs, which are largely unlisted, would therefore benefit from a higher capital relief than long-term investments in listed equities. Therefore, insurers would have an incentive to further provide long-term capital funding to SMEs 99 .

7.3.REFIT (simplification and improved efficiency)

The review would only contribute to REFIT cost savings by addressing the problem insufficient proportionality of the current prudential rules.

8.How will actual impacts be monitored and evaluated?

An evaluation of this initiative will be carried out five years after its entry into application.

Annex 1: Procedural information

1.Lead DG, Decide Planning/CWP references

This Impact Assessment Report was prepared by Directorate D "Bank, Insurance and Financial Crime" of the Directorate General "Directorate-General for Financial Stability, Financial Services and Capital Markets Union" (DG FISMA).

The Decide Planning reference of the “Review of measures on taking up and pursuit of the insurance and reinsurance business (Solvency II)" is PLAN/2019/5384.

This initiative is part of the Commission’s 2021 Work Programme 102 . Furthermore, parts of the initiative represent actions proposed by the European Commission to implement the European Green Deal 103 and the new Capital Markets Union action plan 104 .

2.Organisation and timing

Several services of the Commission with an interest in the initiative have been involved in the development of this analysis.

Three Inter-Service Steering Group (ISSG) meetings, consisting of representatives from various Directorates-General of the Commission, were held in 2020 and 2021.

The first meeting took place on 6 March 2020, attended by DG CLIMA, COMP, LS and the Secretariat General (SG).

The second meeting was held on 21 January 2021. Representatives from DG CLIMA, COMP, ECFIN, GROW, LS and SG were present.

The third meeting was held on 1 March 2021 and was attended by DG CLIMA, COMP, ECFIN, ENER, GROW, MOVE and SG. This was the last meeting of the ISSG before the submission to the Regulatory Scrutiny Board on 19 March 2021. The meetings were chaired by SG.

DG FISMA has considered the comments made by DGs in the final version of the impact assessment. In particular, it has clarified the links of this initiative with other initiatives of the Commission as well as improved the coherence of this impact assessment with the impact assessments for those other initiatives. FISMA also added information as regards the specific impact on SMEs. The analysis of impacts and the preferred option takes account of the views and input of different DGs.

3.Consultation of the RSB

The Impact Assessment report was examined by the Regulatory Scrutiny Board on 21 April 2021. The Board gave a positive opinion on 23 April 2021 following which the Commission made a few changes in order to address the Board’s request to further develop the problem analysis and narrative in a consistent way. in the final version of the Impact Assessment.

4.Evidence, sources and quality

The impact assessment draws on an extensive amount of desk research, meetings with stakeholders, a public conference, an open public consultations, an external study and opinions by EIOPA. The material used has been gathered since the Commission Services started monitoring the implementation of the Solvency II in 2016. This material includes but is not limited to the following:

·A public conference: “2020 Solvency II review: Challenges and opportunities”, 29 January 2020, Brussels;

·Technical reports from EIOPA (see box below);

·Seven (29/03/19, 30/09/19, 19/02/20, 26/05/20, 10/11/20, 16/12/20, 01/02/21) (physical and virtual) meetings with Member State representatives in the Expert Group on Banking, Payments, Insurance and Resolution to gather the views on the revision of the Solvency II Directive;

·An Open online public consultation described in Annex 2, section 7;

·External study by Deloitte Belgium and CEPS for the Commission: Study on the drivers of investments in equity by insurers and pension funds, December 2019;

·The JRC Technical Report on Insurance Guarantee Schemes.

The material used to inform this impact assessment comes from reputable and well-recognised sources that act as benchmarks and reference points for the topic. Findings were cross-checked with results in different publications in order to avoid biases caused by outliers in the data or vested interests by authors.

Annex 2: Stakeholder consultation

1.Introduction

As part of the Solvency II review, the European Commission will make legislative proposals expected in the third quarter of 2021. The review is an opportunity to reflect the current economic outlook, incorporate the political priorities of the European Union (the European Green Deal and the Capital Markets Union) and finally to build on the lessons learnt from the Covid-19 outbreak. Annex 2 aims to provide a summary of the ongoing consultation activities that will be considered when the Commission will be making its legislative proposal.

2.Consultation strategy

The consultation activities has fed into the European Commission’s review process of the Solvency II framework. In order to collect the views of all stakeholders, the European Commission has built its consultation strategy on the following components:

·A conference on the 2020 Solvency II Review: challenges and opportunities bringing together the insurance industry, insurance associations, public authorities, civil society;

·An Inception Impact Assessment for the review;

·A public consultation open to all stakeholder groups;

·Targeted consultations of Member States.

3.Conference on Solvency II

The European Commission organized a conference, which took place on 29 January 2020, with three keynote speeches and four panel debates focusing on the key challenges for the insurance sector and the opportunities arising from the Solvency II review. Amongst keynote speakers and panellists: representatives from the insurance industry, insurance associations, national and EU authorities, civil society, and Members of the European Parliament.

The panels concluded that:

·The current economic and financial conditions are not adequately reflected in the prudential rules. There is a need to maintain a robust framework, while duly considering the CMU priorities. There are different views on which areas to review, but it is important to safeguard policyholder protection and to ensure that the prudential framework does not influence insurance product design.

·There is a need to clarify the scope and the rules for the application of the proportionality principle, improve legal certainty as well as achieve supervisory convergence.

·It is essential to ensure supervisory convergence and coordination, proved by several insurer failures operating cross-border. Panellists made several recommendations aiming to achieve proper functioning of the internal market and policyholder protection, while avoiding unnecessary costs for EU insurers.

·The insurance sector is exposed to emerging risks associated with climate change and new technologies. The new Climate Adaptation strategy aims to increase insurance penetration for climate risks. In addition, new technological innovation creates challenges as well as opportunities for growth and enhanced competitiveness in the global market.

In the concluding remarks, the Commission services invited stakeholders to provide their views through the Public Consultation, which would complement EIOPA’s technical advice and would be duly considered in the Commission’s legislative proposal.

4.Inception impact assessment

The Inception Impact Assessment aims to provide a detailed analysis on the actions to be taken at the EU level and the potential impact of different policy options on the economy, the society and the environment. In this context, the Commission ran an extended feedback period from 1 July to 26 August 2020, which was initially planned for four weeks. The Commission received twelve feedback responses across different stakeholder groups: insurance industry (six), public authorities (three), civil society (two), and academia (1).

4.1.Priorities of the Solvency II Review

Respondents acknowledged the need for a review but agreed on the fact that Solvency II has worked well to date, especially in the light of Brexit and the Covid-19 crisis. However, a few respondents focused on the need to find the balance between (i) financial stability and prudence and (ii) efficiency and growth. All respondents supported the objectives of the Solvency II review: ensuring policyholder protection, preserving financial stability and promoting fair and stable markets. A respondent highlighted the need to keep policyholder and beneficiaries protection as a top priority. In addition, some respondents also pointed out the consideration of international competitiveness in the Solvency II review and the need to keep a “risk-based” framework. Finally, the respondent from the academia underlined the necessity to reflect international financial accounting and IAIS developments in the review, as well as considering technology-related and ethical risks.

4.2.Long termism and sustainability

All respondents underlined the need to preserve the insurance industry’s ability to contribute to the long-term financing and investment and the continuation of long-term product offering. Some respondents from the public authorities, insurance industry and academia supported that the ability to provide long-term guarantees should be a priority in order to serve consumers and set for the growth of the internal market. Moreover, the insurance industry called for a reduction to overall capital requirements to facilitate the insurance industry’s contribution to the political objectives of the EU. In contrast, a public authority suggested that it is controversial to introduce political objectives in a prudential framework. All respondents agreed that the prudential framework should incentivize sustainable investment, while the insurance industry clarified that the incentives should be limited to the extent that Economic, Social and Governance (ESG) factors affect the insurer’s risk profile.

4.3.Volatility and proportionality

The insurance industry underlined the necessity to better mitigate undue volatility to provide the right incentives (for long-term guarantee products and financing) and limit fire sales of assets, especially in the context of the low interest rate environment.

Respondents called for a better application of the proportionality principle. The insurance industry supported the extension of the proportionality principle thresholds to avoid unnecessary cost and barriers. Mainly public authorities and the civil society, as well as some representatives from the insurance industry called for a consistent application of the proportionality principle to ensure the level-playing field. A respondent from the academia was against extending thresholds, since it is contradicting the harmonization objective at EU level.

4.4.Recovery, resolution, IGS, group supervision and cross-border supervision

Some respondents (mainly public authorities, civil society and academia) highlighted the need for improving harmonization of IGS to contribute to financial stability and ensure level-playing field. The insurance industry mainly supported that IGS and recovery and resolution should remain unchanged. A public authority pointed out that insurance recovery, resolution and IGS potentially lead to unnecessary high compliance costs.

In regards to cross-border supervision, all stakeholder categories pointed out towards a better coordination and information exchange between Home and Host supervisors. Some representatives from the insurance industry called for amendments to prudential rules in order to prevent regulatory and supervisory arbitrage.

Finally, one stakeholder recommended that the Solvency II Review should put more emphasize on group supervisions issues, and to reflect international developments in relation to systemic risks in the insurance sector (“Holistic framework” by the International Association of Insurance Supervisors).

5.Public consultation

The Commission launched a public consultation to obtain stakeholder views on the review of the Solvency II Directive. The feedback period ran from 1 July 2020 to 21 October 2020. The consultation received 73 responses from a variety of stakeholders representing the insurance industry (56%), civil society (14%) and public authorities (11%). Most respondents were stakeholders from the European Economic Area. The Commission services published a “summary report” on the feedback to this consultation on 1 February 2021 107 . A summary for the four topics of the public consultation results on the Solvency II Review is provided below. Please note that those who did not provide a view were not considered in the analysis of answers.

5.1.Long-termism and sustainability of insurers’ activities and priorities of the European framework 

5.1.1.Priorities of Solvency II and of the review

Respondents overall supported the three main objectives of the Solvency II: policyholder protection (top priority), financial stability, and fair and stable markets. Regarding the priorities of the Solvency II review, stakeholders were split. The most important priorities for the civil society and the public authorities were solvency, policyholder protection, and prevention of systemic risk. The insurance industry considered as very important the facilitation of long-term guarantee products and long-term and sustainable investments.

5.1.2.Long termism and sustainability

The majority of respondents who provided a view (87%) supported that the current treatment for equity and debt investments is not appropriate and stressed the necessity for re-assessing the risk margin, the criteria for long term equity and calibration of equity. Furthermore, most public authorities supported that framework gives the right incentives to provide long-term debt financing, while the insurance industry largely disagreed. Regarding the incentives for increasing sustainable investment and financing of SMEs under current rules, the insurance industry (78%) called for a better treatment, while the public authorities opposed it. In terms of preferential treatment for “green” investments, all stakeholder groups were mainly against it (60%). Finally, both public authorities and the insurance industry (78%) largely opposed the introduction of a brown-penalizing factor, while the civil society mainly supported it (80%).

5.1.3.Volatility, procyclicality and lessons learnt from the Covid-19 crisis

The insurance industry called for a review of the volatility adjustment and risk margin, and largely considered that the framework does not appropriately mitigate volatility (88%) and generates procyclical behaviours (65%). Public authorities were divided on the matter, while 70% of the civil society did not have a view.

In the context of the Covid-19 crisis, only a few participants identified new issues in relation to prudential rules, mainly public authorities. The answers received underlined the need to address short-term excessive volatility and also expressed that Solvency II does not provide enough possibilities for creating short-term crisis operational reliefs. Finally, some respondents suggested that the crisis revealed underestimation of interest rate risk and of correlation between underwriting and market risks.

5.1.4.Risk shifting to policyholders and impact of Solvency II

All stakeholder groups that expressed a view mentioned that Solvency II provides incentives for risk shifting to policyholders. In fact, stakeholders representing the civil society that had a view (75%) supported disincentivising life insurance guaranteed products in order to preserve financial stability. In contrast, the insurance industry and the public authorities opposed it and stressed the importance for product design freedom and sound risk management.

5.2.Proportionality of the European framework and transparency towards the public

5.2.1.Proportionality

Participants indicated that Solvency II imposes operational burden, complexity and cost to small insurers, with the majority of insurers who provided a view (70%) supporting the extension of the thresholds of exclusion from Solvency II. Public authorities and the civil society had mixed views on the matter, claiming that extending the scope of proportionality could potentially undermine policyholder protection and would negatively affect the level-playing field. Public authorities (67%) and the civil society (80%) mainly supported a potential preferential treatment of mutual insurers, while the insurance industry had mixed views. Finally, public authorities (71%) were the only stakeholder group opposing less discretion in applying proportionality by supervisory authorities.

The insurance industry (77%) was against imposing requirements for internal models users to calculate their solvency capital requirements under the standard formula, explaining that such a requirement would be burdensome and could create doubts on the credibility of internal models. The civil society was in favour claiming that it would enhance comparability and the level-playing field. Public authorities were either supporting the requirement but only for supervisory reporting or not supporting it at all.

5.2.2.Supervisory reporting and public disclosure

The insurance industry supported the inclusion of more automatic criteria for granting exemptions and limitations in supervisory reporting. In fact, some suggested to follow a risk-based approach with some supervisory discretion, rather than a size-based approach. The civil society was split of the matter, with the majority supporting automatic criteria with no discretion. The public authorities were split as to whether or not the status quo should be preserved. Some stakeholders pointed out the need to achieve consistent policyholder protection across EU, by introducing clear-cut criteria. Regarding the solvency and financial condition report (SFCR), participants pointed out the need to consider the audience, since it can be very complex, detailed and technical, especially for policyholders. Some respondents also suggested to reduce the length of the report as well as increase visibility of SFCR in insurers’ website.

5.3.Improving trust and deepening the Single Market in insurance services

5.3.1.Cross-border supervision

The civil society (83%) supported enhanced safeguard powers of intervention by host authorities when needed, while the insurance industry and public authorities were divided on the matter. Some suggestions for additional powers include restrictive measures on product offering subject to some conditions, enhanced coordination between Host authorities, Home authorities and EIOPA and establishment of a specific “early warning alert system” for entities established in one member state but mainly operating in others. Finally, most participants (81%) supported cross-border supervision by national authorities with EU coordination where appropriate.

5.3.2.Recovery, resolution, and Insurance Guarantee Schemes

The insurance industry had confidence in insurers’ and public authorities’ preparedness in case of an adverse event (72%), while public authorities and the civil society (73%) had doubts on the matter. Some participants pointed out the need to have a harmonised recovery and resolution framework and proportionate application of the rules. In total, views on the need for EU action on IGS were rather split among respondents with 39% supporting it and 43% seeing no reason for it. Public authorities and the insurance industry were mainly against (62%) a mandatory setup of IGS, having concerns for the differences across countries that would affect the design and funding of IGS. However, a quarter of the industry respondents, notably several national insurance associations, supported action on IGSs. The civil society was largely in favour (75%), supporting that IGS would enhance policyholder protection and would strengthen the Single Market. Respondents agreed that the main role of IGS should be consistent policyholder protection across the EU and considered that compensation and continuation depends on the type of claim and policy. Finally, civil society was mainly supportive of a harmonized minimum level of protection by IGS (87.5%), while the two other stakeholder groups mainly opposed it (69%).

5.3.3.Macro-prudential tools in Solvency II

Public authorities and the civil society were mainly in favour for providing authorities with the power to temporarily prohibit redemptions, but only when an insurer is in financial distress. The insurance industry was also supportive but there were mixed views as to under which situations the powers should be exercised. The majority of respondents supported providing public authorities with power to reduce entitlements of insurer’s clients, but only as a last resort measure. Participants also acknowledged the necessity to strengthen macro-prudential supervision in Solvency II but only in certain areas, while the insurance industry supported to limit the measures only to the areas covered by the Commission’s call for advice , as going further that those areas would jeopardize the international competitiveness of the European insurance industry in their view. Moreover, the civil society was the only stakeholder group supporting regulatory flexibility in adverse events. Some recommendations included removing eligibility limits on lower-quality capital, providing reporting flexibility and recalibrating requirements during crises.

5.4.New emerging risks and opportunities

5.4.1.European Green Deal and sustainability risk

The civil society deemed as very important the requirement for climate scenario analyses as part of the risk management and governance requirements (“Pillar 2”) rules. Public authorities were also supportive but gave various levels of importance, while only a few insurance stakeholders supported that climate scenario analyses are of high or medium importance. Some recommendations included lowering the risk margin and capital requirements for long term investments and strengthening insurers’ advisory role towards clients in regards to climate resilience and adaptation.

5.4.2.Digitalisation and other issues

The insurance industry was mainly against having additional requirements for monitoring ICT risks (80%), as part of the prudential framework. The civil society was mainly in favour (86%), by pointing out the need to reflect those risks given the current outlook of digitization and the increasing threat of cyber-attacks. Furthermore, the insurance industry was against having cyber insurance as a distinct class, while the public authorities were in favour (75%).

5.4.3.Group-related issues

The insurance industry mainly supported (86%) providing lighter requirements for intra-groups and distinguishing between intra-group and extra-group outsourcing, but subject to additional criteria. Some recommendations on the additional criteria include taking into account proportionality, risk exposure and the need for clear harmonized criteria. Public authorities largely opposed this proposal (86%), while the civil society had mixed views, with the majority opposing the proposal. The majority of participants (80%) thought it is unacceptable that group supervision waives solo supervision in certain circumstances.

5.5.Additional or late feedback to the consultation

Stakeholders were offered the opportunity to make an attachment to their contribution, in order to cover any topic or provide any complementary information that they would deem useful. 31 stakeholders provided such inputs. Most of them aimed at expanding or clarifying the stakeholder’s point of view on certain areas of the consultation. Some contributions, mainly from stakeholders classified as “other businesses” (non-insurance related), also touched upon additional topics not covered by the consultation document. However, each of those specific issues was only raised by a couple of participants to the public consultation. Those topics include, although not limited to, the following:

·group supervision issues, including the prudential treatment of insurance subsidiaries headquartered in third countries, and the generalization of the use and disclosure of Legal Identity Identifiers;

·market access of third country companies which exclusively conduct reinsurance activities;

·the prudential treatment of derivatives, securitisation, exposures to central counterparties, and credit and suretyship insurance business;

·the definition of the insurance business in view of financial innovations.

Two additional feedbacks, from a non-governmental organisation (NGO) and the European Systemic Risk Board (ESRB) were received in the context of the public consultation. An analysis for the two individual responses is presented below, while it is important to highlight that the answers were not included in the statistics of the Public Consultation.

The feedback received from the ESRB focused on macro prudential considerations, recovery and resolution, as well as appropriate reflection of risk in the prudential framework. For better reflecting macro prudential considerations, the ESRB provided recommendations for introducing three types of tools to the framework: solvency tools, liquidity tools and tools for addressing risks from financing the economy. In addition, the ESRB called for a harmonized recovery and resolution framework across the EU and improved harmonization of the IGS. In order to ensure that risks are reflected properly in the Solvency II, the ESRB recommended to adjust the risk-free rate term structure to better reflect the current low interest rate environment. In the context of the Covid-19 crisis, ESRB called for coordinated responses during crises, highlighted the need for a capital buffer, called for a reflection of volatility in insurers’ solvency ratios and finally stressed the need for a better monitoring of liquidity and supervisory intervention.

The feedback received from the NGO is mainly in line with the views provided to the public consultation by the civil society. The respondent opposed preferential treatment for “green investments” and highlighted the need to reflect the current low interest rate environment, while opposing the offering of guaranteed products. In addition, the participant supported considering the audience when preparing the SFCR and providing a shorter and simpler version for policyholders. Regarding the IGS, the respondent was in favour of minimum harmonization and at the same time considering the national differences between member states and also pointed out the need for better recovery and resolution. Finally, the respondent acknowledged the need to reflect IT risks in insurers’ management practices.

6.Targeted consultations of Member States

The Commission services discussed the different aspects of the review of Solvency II during several Expert group meetings with Member States on Insurance matters:

·On 29 March 2019, Member States were consulted on the overall scope and process of the review

·On 30 September 2019, there was an exchange of views between EIOPA and Member States about EIOPA’s draft consultation document. Member States were also asked to provide feedback on the Commission’s finding in its report on group supervision which was published in June 2019

·On 19 February 2020, Member States were invited to comment on the European Commission’s consultation strategy, but also EIOPA’s approach to the impact assessment of its proposals. A specific debate took place on the Commission’s approach in relation to recovery and resolution and to insurance guarantee schemes.

·On 26 May 2020, Member States were asked whether the Covid-19 outbreak required urgent changes to the framework, ahead of the Solvency II review. The majority view was that the situation of the insurance sector appeared so far stable and under control and that quick fixes were not needed. However, it was agreed that a careful monitoring of market developments would be needed in close cooperation with EIOPA.

·On 10 November 2020, the Commission services asked feedback to Member States about the priorities of the review, including the main problem that the initiative should aim to tackle and the objectives of the review of Solvency II. In addition, the European Commission shared the preliminary results of the feedback to its public consultation, which was followed by a debate. The European Commission also consulted the Member States on specific elements related to recovery and resolution.

·On 16 December 2020, the Commission services invited Member States to provide their views on the possible technical features for insurance guarantee schemes

·Finally, on 1 February 2021, the Commission services invited Member States to provide their views on the main components of EIOPA’s advice: The Capital Markets Union and the Sustainable Finance Strategy, risk sensitivity and volatility, proportionality, quality of supervision and finally systemic risks.

In addition, Member States were consulted specifically on recovery and resolution and on IGS items through a targeted survey that was circulated following the 19 February 2020 meeting. Member States were also asked to complete a template on the design and funding of existing IGS schemes following the 16 December 2020 meeting.

The input provided by Member States has been integrated throughout the impact assessment.

Annex 3: Who is affected and how?

1.Practical implications of the initiative

The objective of this Annex is to set out the practical implications for the main stakeholders affected by this initiative, mainly the insurance sector and their shareholders, supervisory authorities and consumers. The initiative aims to simultaneously address the following problems:

·Problem 1: Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy

·Problem 2: Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of insurers’ solvency position 

·Problem 3: Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs 

·Problem 4: Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures

·Problem 5: Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector

In order to address the issue of limited incentives for insurers to contribute to the long-term financing and the greening of the European economy (Problem 1), the preferred options are to facilitate long-term investments in equity by revising the eligibility criteria of the existing regulatory asset class for long-term equity investments (Option 2) and to strengthen “Pillar 2” requirements in relation to climate change and sustainability risks (Option 4) without changing capital requirements depending on the green/brown nature of investments.

Insurers and their shareholders would benefit from those options, as insurance companies by being allowed to take additional risks (i.e. investing more in equity) with limited impact on capital requirements, would be in a position to generate a higher return on investments to their shareholders at limited additional costs. They would be also incentivised to better integrate climate change and sustainability risks in their investment and underwriting practices, which increases compliance costs but strengthens the risk management system of insurance companies. Also, in the long run, insurance companies and their shareholders would benefit from this enhanced monitoring and management of sustainability risks. Even in the short run, the implementation costs of those options (both one-off and ongoing) would be moderate.

Policyholders would also benefit from a higher level of protection due to better management of environmental and climate risks in insurers’ investment and underwriting activities. This means that the risk of insurance failure due to those risks would be reduced. They may be more exposed to the likely increase risk-taking by insurance companies as a result of the changes on the treatment of equities 108 , but they would also benefit from such a change in investment strategy through the possibility for insurance companies to provide higher returns through profit-sharing mechanisms with policyholders.

Supervisors would also benefit from clearer and less complex rules in relation to both equity and climate change risks.

Finally, businesses, in particular SMEs and those conducting green activities, would benefit from easier access to funding by insurance companies thanks to those options, as the prudential framework would be more conducive of long term investments, while at the same time ensuring that insurers appropriately capture the longer-term risks of climate change.

Next to this, the overall society welfare could increase in case the proposed options would result in a significant change in insurers investment activities in the directions envisaged. In this case, both the economy would grow stronger and negative effects on the environment by investments by insurers would be mitigated. Clearly, in case insurance companies would make too risky equity investments this could undermine policyholder protection and also possibly financial stability.

In order to address the issue of insufficient risk sensitivity and limited ability of the framework to mitigate volatility of insurers’ solvency position (Problem 2), the preferred option is to address issues of risk sensitivity and volatility while balancing the cumulative effect (on capital requirements) of the changes (Option 3). This implies in particular better reflecting the low-interest rates environment in capital requirements and in the valuation of insurers’ long-term liabilities towards policyholders, but also ensuring that the mechanisms aiming to mitigate volatility (notably the volatility adjustment) are fit for purpose. However, in order to ensure that the overall impact of those changes remains balanced (and does not become market disruptive), the changes would be only progressively implemented over time (phasing-in periods) and the changes affecting insurer’s capital ratio negatively would be compensated by additional changes which would have a positive effect on insurers’ solvency ratio, notably the reduction of the cost-of-capital rate underlying the risk margin calculation from 6% to 5%. Overall, the implementation of Option 3 would lead to an increase in capital surplus.

The implementation of Option 3 would largely benefit policyholders, as insurers would more appropriately capture in capital requirements a material risk to which they are exposed and which is currently underestimated under standard formula capital requirements. They would also benefit from the reduced volatility of the framework, as insurers would be in a better position to offer products with guarantees and less incentives to simply shift market risks to policyholders. The improved mitigation of volatility is also contributing to insurers’ international competitiveness which can follow a longer-term approach when making decisions of international expansion.

Option 3 would also benefit insurers, thanks to the mitigated volatility and the greater ability to make long-term decisions. Obviously, the tightening of rules in relation to interest rates (although partly compensated) would be a cost for insurers’ shareholders. However, this cost remains moderate and justified by the need to better capture a material macroeconomic risk to which insurers are exposed. In addition, they would be given time to implement those changes due to the introduction of a phasing-in. Finally, there would be implementation costs as the new framework would be more complex than under current rules. However, the additional level of complexity stemming from Option 3 is such that it tries to strike a balance between the need to improve the technical robustness of the framework and the objective of avoiding excessive complexity of prudential rules.

Finally, Option 3 would affect supervisors as they would have to ensure that insurers comply with a more complex framework. In addition, during the phasing-in period, they would have to carry out additional monitoring activities in order to ensure that insurers are managing the risks stemming from the low-yield environment even if not fully integrated in capital requirements in the short run.

In order to address the issue of insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs (Problem 3), the preferred option is to give priority to enhancing the proportionality principle within to Solvency II and make a lower change to the exclusion thresholds than what is proposed by EIOPA (Option 3). Concretely speaking, the threshold of exclusion from Solvency II in relation to volume of business activities would be multiplied by two as proposed by EIOPA (from € 25 million to € 50 million), but the threshold in relation to revenues would be multiplied by three and not by five as proposed by EIOPA (from € 5 million to € 15 million). In addition, the eligibility criteria for classification as “low-risk profile insurer” would be slightly less strict than under EIOPA’s proposals with the aim of allowing more firms to automatically benefit from a list of proportionality measures, which would also be slightly extended compared to what EIOPA proposed (notably in relation to public disclosure requirements).

Option 3 would generate material reduction in compliance costs for the estimated 186 insurance companies which would no longer be subject to Solvency II. Unless they want to benefit from the “passporting” or they are required to comply with Solvency II under national law, they would not be required to comply with any Solvency II requirement which would generate a reduction of 2.2% of operating costs. Obviously, this benefit would be partly compensated by the cost of implementing national prudential rules (including the one-off cost of changing IT systems and the sunk costs of developing systems to comply with Solvency II), which cannot be quantified. In addition, at least 249 insurers would be classified as low-risk profile and as such would benefit from automatic proportionate rules. For those firms, this would result in an immediate benefit and reduction of compliance costs, which cannot be clearly quantified although it can be estimated to be above 0.2% of total operating expenses, taking into account the reduced frequency of submission of narrative reporting to supervisors.

Policyholders could benefit from the reduced compliance costs as it would imply higher ability for insurers to innovate and supply policyholders with a well-diversified range of insurance products. Shareholders might benefit from higher profits. The reduced level of public disclosure for insurers that are low-risk profile would imply lower transparency towards specialised stakeholders (financial market participants, analysts). However, the insurers concerned would still represent a minor share of total insurers’ liabilities towards policyholders (0.06%) or insurers’ revenues (0.07%). Therefore, the loss of information is expected to have a limited impact.

For supervisors, Option 3 would imply that additional insurers would be subject to national prudential rules, which means that supervisory authorities would have to maintain competencies so that supervisors have knowledge on both Solvency II rules and national prudential rules. Solvency II supervisors would also have to adapt from less frequent of regular supervisory reports and own risk and solvency assessment reports by low-risk profile insurers which would reduce the information received to exercise ongoing supervision. In addition, in the short run, supervisors would receive and have to process a high number of notifications from insurers that want to be classified as low-risk profile and indicate which proportionality measures they intend to use, which represents a material one-off cost. Finally, EIOPA would also receive less information (as insurers excluded from Solvency II would no longer report in accordance with the Solvency II quantitative reporting templates). However, this should have limited impact on EIOPA’s ability to monitor market trends and the arising of systemic risk in the insurance sector due to the very limited market shared that the excluded insurers would represent.

In order to address the issue of deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures (Problem 4), the preferred options are to improve the quality of supervision by strengthening or clarifying rules on certain aspects, in particular in relation to cross-border and to group supervision (Option 2), to introduce minimum harmonising rules to ensure that insurance failures can be better averted or managed in an orderly manner (Option 3) and to introduce minimum harmonising rules to protect policyholders in the event of an insurer’s failure (Option 4).

The main beneficiaries would be policyholders. Option 2 would ensure that the quality and consistency of supervision, including for cross-border insurers, is improved, while Options 3 and 4 would ensure that the (near-)failure of an insurer is appropriately managed and that policyholders are protected in case an insurer fails. More precisely, the (further) harmonised recovery and resolution framework would contribute to reducing the negative social and welfare impact of an insurer’s failure. The minimum harmonisation of IGSs would not only safeguard the confidence of consumers in the Single Market but would also contribute to market discipline, as the insurance guarantee scheme of the Home Member State of the failing insurer would be used to compensate policyholders of that insurer. Progressive ex-ante funding of IGSs (over a 10-year period) would imply a maximum annual contribution of around 0.233% of gross written premiums by each contributing policyholder (i.e. about EUR 2.33 per yearly policy of EUR 1000) which appears to be, in absolute terms, a moderate cost to ensure an adequate level of protection in case of insurance failure 109 .

Insurers would also benefit from clearer rules and improved level-playing field stemming from those options. They would also be better prepared to react to a deterioration in their solvency position. The ex-ante funding of IGS would have a capital cost, which, in absolute terms, appears to be moderate – the Commission services estimate it to be 0.12% of annual premiums 110 .

Finally, supervisors would benefit from those changes, with more legal clarity and a better preparedness for insurers’ financial distress. On the other hand, the enhanced quality of cross-border supervision and the new planning requirements imply that supervisory authorities allocate sufficient resources to such new activities, although those additional costs remain contained.

Finally, in order to address the issue of limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector (Problem 5), the preferred option is to make targeted amendments to prevent financial stability risks in the insurance sector (Option 2). More concretely, supervisors would be granted new supervisory powers and insurers would have to comply with some new requirements aiming to prevent the build-up of systemic risks stemming from or amplified by the insurance sector, which could be detrimental to financial stability. This would include in particular ensuring that insurers better incorporate macro-prudential considerations in their investment and risk management activities, enhancing liquidity requirements on insurers and introducing the power for supervisors to temporarily freeze redemption rights on life policies, aligning prudential rules on loan origination with the banking sector, and granting supervisors the possibility to suspend or restrict dividend distributions of specific firms in exceptional situations for financial stability reasons.

Policyholders would benefit as improved financial stability would have no direct effect on policyholder protection in the short run but could benefit them in the long run as the risk of insurance failures would decline. In addition, financial instability risks and possible spill-over effects on the real economy could affect policyholders both as taxpayers (since business failures and economic recession may require public intervention) and as workers (since EIOPA demonstrates that there is a correlation between financial instability and unemployment). In addition, while some of the tools embedded in Option 2 may seem harmful to policyholders in the short term if used (e.g. the power for NSAs to freeze the exercise of surrender options on life insurance contracts ), they would be a last resort measure to avoid the failure of an insurer, which may result in financial losses for policyholders in the longer run.

Option 2 would have a cost for insurers’ shareholders because of the possibility of dividend restrictions in exceptional situations. However as such restrictions may strengthen the solvency position of insurers and thus their probability of survival, shareholders would benefit from those measures in the medium term. Similarly, insurers conducting banking-type loan origination activities may face a slight increase in capital requirements due to a convergence with banking rules but this might benefit the economy as the risk of not adequately regulated shadow banking is reduced. Also, insurers would be less prone to liquidity risks, both because they would be required to better plan for liquidity risk and due to the last-resort possibility to freeze redemption rights. Of course, liquidity planning is an additional compliance cost, but this cost is supposed to be limited as insurers are already expected to monitor and manage liquidity risk as part of the own risk and solvency assessment (ORSA). The other implementation costs in relation to the enhanced risk management and reporting system are also expected to be moderate as a number of insurers already embed such requirements in their processes, and the costs for those which do not apply it yet would remain limited.

Finally, Option 2 would also strengthen the power and duties of supervisory authorities in relation to financial stability. This slight increase in supervisory costs is fully justified by the fact that preserving financial stability is an explicit objective of the Solvency II framework, and generates overall welfare gain (when compared with a counterfactual financial stability crisis).

The following tables summarize the impact of the different preferred options.

2.Summary of costs and benefits of the combined set of options

3.Summary of costs and benefits per problem

3.1.Problem 1: Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy 

Preferred Option: Facilitate long-term investments in equity

Preferred Option: Strengthen “Pillar 2” requirements in relation to climate change and sustainability risks

3.2.Problem 2: Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of insurers’ solvency position 

Preferred option: address issues of risk sensitivity and volatility while balancing the cumulative effect of the changes

3.3.Problem 3: Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs 

Preferred option: Give priority to enhancing the proportionality principle within to Solvency II and make a lower change to the exclusion thresholds than what is proposed by EIOPA