Solvency II

The New Era of Insurance Regulation Is Getting Closer

What is different this time?

We believe there are two key differences from past deadlines:

1. the level of commitment by all parties to resolving Omnibus 2; and

2. the effective soft launch of certain elements of SII through the preparatory guidelines just released.

KPMG believes that, despite some big challenges in the months to come, 1 January 2016 will finally see SII in force.

Background

Solvency II (SII) has been in development since the start of the century, but the project has been plagued by delays. Now that the Commission has just pushed implementation back to January 2016, the question is whether this really will see the end of the Solvency II journey.

Omnibus 2

The existing Solvency II directive was passed in [2009] before both the [Lisbon Treaty] and the establishment of the European Supervisory Authorities, including the creation of the European Insurance and Occupational Pensions Authority (EIOPA). These developments meant that a number of articles in the directive needed to be amended, and hence the need for the Omnibus 2 directive.

The opportunity was taken to build in additional amendments to deal with genuine market needs, such as smoothing the transition from current regulation and reflecting the illiquid nature of insurance liabilities. It is these aspects that have caused the delays.

One of the most challenging aspects has been determining an approach to the reserving for insurance liabilities that include provision for long-term guarantees (LTG) within them.

The reserving for such guarantees under the original SII rules did not take sufficient account of the long-term nature of the products, which mitigates the need for insurers to sell the covering assets in times of market distress. In addition, the close matching of insurance assets and liabilities means that insurers are not exposed to the full extent of market volatility, leading to demands for a greater allowance for this in the capital assessment.

One of the biggest challenges has been the range of insurance contracts sold in Europe, which means there is no one solution that deals with the concerns of all insurance markets.

The EIOPA study into LTG earlier this year has provided more clarity around the issues, and there is a strong political will to now see a compromise agreement reached before the European elections next May.

S olvency II: the new era of insurance regulation is getting closer

Preparatory Guidelines

In order to maintain momentum and gain some benefit from the work undertaken to date by all parties, the Commission agreed that EIOPA should use its powers under the EIOPA Regulations to issue guidelines to national competent authorities (regulators) in relation to the most stable aspects of SII – notably pillar 2 (internal governance, risk management and forward looking assessment of own risks and solvency) and pillar 3 (reporting to regulators). EIOPA consulted on its draft guidelines in March and the final preparatory guidelines were issued at the end of September.

Although addressed to regulators, these are phrased in a way that will also require industry to take action. In theory, regulators have two months to decide which of the individual guidelines to comply with and to explain why not for the others. However, the EIOPA Regulations require national regulators to make “every effort to comply”, so the expectation is that the vast majority of the guidelines will be introduced by every regulator and exceptions will be limited.

The guidelines are preparatory in nature, meaning that regulators are not subjecting the insurance industry to compliance with the requirements of two different regimes. Nevertheless, there is a strong expectation that regulators will review progress and provide feedback to firms, so this is as much a test for regulators as industry.

These guidelines will apply from 1 January 2014, with development throughout the period to Solvency II ‘go-live’ date, including clear milestones for reporting to the regulators.

Next steps and challenges to completion

Omnibus 2

The next step is for the negotiating parties to reach agreement at the trilogue meeting later this month on both the compromises to address LTG products and all other areas of difference within Omnibus 2. Once an agreed position is reached, Omnibus 2 should be approved at the European Parliament plenary meeting currently scheduled for February 2014.

Two of the non-LTG considerations that we believe are key to this negotiation are equivalence and transitional measures.

Equivalence

Equivalence relates to the recognition of a non-European insurance regulatory regime as providing the same level of protection for policyholders, enabling European regulators to rely on that supervision for certain aspects of SII. These relate to reinsurance, third country insurers within the context of group supervision and worldwide group supervision.

There have been some challenges around why European sub-group supervision should be required if the worldwide group is subject to equivalent group supervision and also

questions about whether equivalence should be extended to cover European branches of an equivalently supervised insurer. These areas need to be addressed in the Omnibus 2 negotiations, although the formal decision on whether Bermuda and Switzerland will be deemed equivalent (as widely expected given the reviews already undertaken) will come later.

In addition, eight other countries originally expressed interest in being recognised as temporarily equivalent for a transitional period while their regimes are developed, and the criteria for recognition still need to be agreed.

Notably, this list did not include the USA. Work has been on-going through the EU-US dialogue to develop plans for mutual recognition, but the equivalence rules will need to be amended to incorporate this mutual recognition.

Transitional measures

A number of the transitional measures originally proposed will need to be revisited in the light of the preparatory guidelines, in particular what information will be required to be submitted to regulators regarding the opening SII position.

Solvency II development post Omnibus 2

Omnibus 2 will see the SII legal framework finalised. Work must then commence on finalising the supporting Delegated Acts, Technical Standards and Guidelines that expand on this framework.

Each of these must build on, and be consistent with, the higher-level requirements. The draft Delegated Acts were last seen in October 2011 (a non-public document that nevertheless has been widely seen within the industry) and work is on-going to redraft these for release quickly after the framework is set. Once available, EIOPA must finalise, then consult on, the Technical Standards before it can pass these to the Commission for approval. These will then be followed by the Guidelines.

Although much work has taken place behind the scenes in each of these areas, 2014 and 2015 will see a vast amount of detail made available to the insurance industry for the first time. Although there is no public timetable for completion of these steps, it is easy to envisage the later stages not being completed until late in 2015, just a few months before the implementation date.

Any slippage in timeline runs the risk of delaying the start of SII. Nevertheless, as stated at the start of this paper, there is a very strong desire by all parties to achieve this date, and we therefore believe that any slippage would more likely result in additional transitional measures than full deferral.

Industry and regulators must now move forward with the preparatory guidelines from January 2014 in the full belief that compliance with all aspects of Solvency II will be required from 1 January 2016.

For more information, please contact

Rob Curtis

Global Insurance Regulatory

Lead

KPMG in the UK T: +44 20 7694 8818 E: rob.curtis@kpmg.co.uk

Janine Hawes

Director

KPMG in the UK T: +44 20 7311 5261 E: janine.hawes@kpmg.co.uk

www.kpmg.com

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