October 14th, 2009

Solvency II – Did CEIOPS Overdo It?

Posted at 1:01 AM ET

achtert_frank_bioFrank Achtert, Managing Director, Financial Intelligence Team
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The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) published its second set of Consultation Papers on Level 2 implementation measures for the Solvency II Directive in July 2009. These papers were open for comment until September 11, 2009. CEIOPS received more than 20,000 comments from 105 stakeholders, demonstrating the importance (and explosiveness) of the ongoing Solvency II discussion.

The common theme of CEIOPS’s first and second sets of draft advice is “prudence,” a response by CEIOPS to a critical review of the measures used in the Quantitative Impact Study 4 (QIS 4) against the background of the financial crisis. CEIOPS has proposed that the calibration of some Solvency Capital Requirement (SCR) parameters be increased significantly. In some cases, CEIOPS even doubled the factors — e.g., for life underwriting risk and operational risk. Further, the draft advice limits recognition of risk diversification and makes the recognition of risk mitigation techniques “excessively prescriptive and unduly burdensome,” as pointed out by the European Insurance and Reinsurance Association (CEA) in its general comment letter to CEIOPS.

In conjunction with the increases in required capital, CEIOPS has proposed more rigid requirements for “own funds” eligible to cover the upcoming capital requirements. The suggested own funds definition restricts the capital elements that can be considered core capital, questioning even the future eligibility of hybrid capital in its existing form. According to the CEA, this restrictive definition “could seriously damage the capability of insurance companies to attract any eligible element of capital other than ordinary equity.”

All in all, there is a broad perception in the industry that the prudence incorporated in the various draft advice elements as they stand could result in substantially higher capital requirements and capital shortfall, thereby making the proposal unlikely to survive unmodified because of its rigidity. On the other hand, the continued (and accelerating) lobbying efforts of the past several months indicate that all stakeholders are endeavoring to work together to achieve a sensible outcome. The months ahead will be pivotal in getting the balance right between “lessons learned” from the financial crisis to protect policyholders’ interests and enabling (re)insurers to manage their businesses in an economically sensible way with the appropriate amount of capital to bear the risks assumed.

Statements concerning accounting, legal, regulatory or tax matters should be understood to be general observations based solely on the author’s experience in the reinsurance industry, and may not be relied upon as accounting, legal, regulatory or tax advice which he is not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas.

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