A year on from the Solvency II Directive taking effect, where are insurers in the implementation process?
By Russell Ward, Principal, Milliman.
Solvency II has taken so long to come to agreement, it seems to have been with us forever. So it’s easy to forget that it has only been fully effective since the beginning of 2016.
As a result, insurance firms across Europe are still deep into the implementation phase, and are committing significant resources to the technical calculations and creation of internal models.
The challenge for insurers in 2017 will be to “operationalise” Solvency II, so that they have sustainable, lean, and cost-efficient approaches to calculating the numbers and reporting them to regulators and senior management. Only then will we see more clearly how the directive will reshape product portfolios.
The hope is that once Solvency II is business as usual, insurers can start to mine the business benefits of common standards, and an improved linkage between risk, capital management, and decision making.
At that point, insurers will also press European and national regulators to address some of the emerging issues that result from the directive.
The strict rules governing the matching adjustment and the relative capital requirements given to different assets have already started to have an impact. Some insurers are already pulling back from products offering guarantees. If this continues, the danger is that, as guarantees cease to be readily available to consumers, asset management will be all that’s left for consumers seeking a return on policies. This might not appeal to everyone, so consumers could opt to exit the parts of the market that aren’t served by products they trust, leaving insurers with just a portfolio of products, such as term assurance, based entirely on biometric risks.
The rules on risk matching and asset-specific capital requirements have been a hot topic from the outset. Insurers have argued that some assets are not treated fairly, with infrastructure often given as an example. Insurers claim that, in its various forms, infrastructure is an ideal asset to hold, in order to underpin the long-term benefits that life and pensions policies provide. But regulators do not give it sufficient credit in their portfolios, they argue.
Given the current political enthusiasm for infrastructure investment, now could be the right time for insurers to press for a more generous regulatory regime.
Should regulators continue to take a strict line on the assets they favour, there is a risk that insurers will concentrate their holdings in fewer asset classes. That could create the sort of market conditions that lead to pro-cyclicality, as an asset class turns south, and insurers all head for the exit at the same time. Pro-cyclicality is a key regulatory concern.
Most insurers would also like greater clarity over the transitional arrangements, and how they will be firmed up, especially for technical provisions. At some stage, most of them will have to recalculate their provisions, which can have a major impact on their solvency margins and balance sheets.
Just how big that impact might be—particularly for UK insurers—was revealed in the recent 2016 Stress Test Report from the European Insurance and Occupational Pensions Authority (EIOPA). In the EU and European Economic Area as a whole, solvency margins could decline from 196% to 136%, once transitional and long-term guarantee measures are eliminated.
In the UK, the collapse could be dramatic: margins could fall from 142% to just 51%. Greece and Portugal are also significantly more dependent on transitional arrangements than most markets. EIOPA estimates that market-wide solvency would fall from 141% to 71% in Greece and from 112% to 63% in Portugal.
With figures like these, there is no time to lose in starting the transitional process in the business. The air will be leaking from the transitional lifebelt for a number of years to come.
Before it deflates completely, insurers will need to satisfy themselves and the regulators that they can swim. Incorporating a plan to manage this transition must be a major priority as insurers start to operationalise Solvency II.