The Solvency II review, Brexit, equivalence and calibrations
On 23 June 2020, the UK Chancellor of the Exchequer gave a written statement in which he announced plans on the update of prudential requirements in several areas of the financial sector. Regarding Solvency II, the Chancellor made it clear that the UK will review certain features of the regime. Rishi Sunak mentioned the risk margin, the matching adjustment, the operation of internal models and the reporting requirement for insurers. The statement added that this list was not limited. It should be noted that, after all, Solvency II was very much inspired by the UK’s prudential regime. The list of the items the European Commission plans to consider in its first major Solvency II review exercise is much longer and overlaps gently with the hitherto limited list of the British Chancellor, eager “to take back control of the rules governing our world-leading financial services sector”. In a recent webinar, Didier Millerot, head of the Insurance and Pensions Unit of the European Commission mentioned as areas: the risk margin, the long term guarantee measures – the reason why the 2020 review after all was planned in the Omnibus II amendments of 2014 – and proportionality. But he also mentioned many other points such as the recovery and resolution process, a minimum level of national insurance guarantee schemes’ harmonisation, cross-border supervisory quality and supervisory cooperation – important in a cross-border freedom of services situation for the reputation of the Single Market -, green assets and the contribution of the insurance sector to the new sustainable economy. Nobody can be jealous of such a long list of items on which the Commission will have to ponder carefully whether to propose amendments and how.
According to Article 77f of the Solvency II directive, the Commission shall submit a report on the long-term guarantee measures by 1 January 2021, accompanied if necessary by legislative proposals. But as EIOPA has, in agreement with the Commission, announced a delay of 6 months in the delivery of its advice and its holistic impact assessment on the combined impact of the draft advice for the review of Solvency II once the first implications of the Covid-19 pandemic started to unfold, this shifts the timetable of the Commission too. A proposal can be expected June-July next year, said Didier Millerot in that same webinar. The consultation which it issued 1 July and which runs till 21 October allows to broaden the perspective, and to take, if necessary, thus the Commission, preliminary Covid-19 lessons into account.
It would be good to use the additional time provided by the Covid-19 examination to also reflect on the implications of Brexit. Does it make sense to continue using the calibrations of the SCR risk modules, knowing that some of these calibrations are highly influenced by data from the UK market? British data are in some cases even quite determining, given the size of the British market. This is especially an issue for the calibration of real estate market risk, where the influence of UK commercial real estate is quite high, and dating from before 2007. But the same may be true for underwriting risk and potentially some other areas. Does the inclusion of non-EU data fit the EU27 market? Is the continued inclusion of British data post-Brexit still justified? To which extent are the EU27 calibrations which continue to include UK data (legally) still valid? Would a calibration without UK data not be more beneficial for the EU? Although the calibrations are currently not part of the Solvency II review – strictly speaking calibrations are a level 2 issue– it would be useful to consider also this element, especially since the UK has rejected a Brexit transition extension. Calibrations are also, as level 2 issue, not part of any potential equivalence decision. And there is nothing which prevents the UK to embark on a similar exercise and to review some of the calibrations which are too much influenced by data from EU countries.
“To the extent that calibrations are not reflective of real market data, they may be either too conservative or not adequate. This is not in the interest of the insurance industry and consumers” commented Karel Van Hulle, professor at KULeuven and ICIR, Frankfurt, and architect of Solvency II. As a start, EU consumers deserve more transparency on the use of the different market data used for today’s calibrations, ultimately reflected in prices. EIOPA did provide this to some extent when proposing the review of the premium and reserve risk recalibration in 5 lines of business in 2017 and 2018. But would a complete report on calibrations which use specific country market data not be the right start?
It might therefore be appropriate to add a re-examination of the calibrations in the standard formula to the list of items to be covered by the Solvency II review in order to avoid the system to be amended again soon after the 2021 review.
Lieve Lowet
