Capital relief in times of exceptional market-wide shocks

In the proposals the Commission tabled in September 2021 reviewing the current Solvency II directive, a series of new macro-prudential tools have been introduced. Among those, a new Article 144 c has been put forward. According to its title, the article concerns “Supervisory measures to preserve the financial position of undertakings during exceptional market-wide shocks”. The current Solvency II directive only has provisions regarding supervisory powers in deteriorating financial conditions of individual (re)insurance undertakings (article 141). To avoid a repetition of the regulatory bricolage witnessed during (the early days of) the COVID-19 pandemic, and the ink spilled on this topic, the Commission has now provided this solution.

The tool proposed is of exceptional and temporary nature. It is aimed at preserving the solvency position of individual (re)insurance undertakings during periods of exceptional sector-wide shocks such as adverse economic or market events affecting large parts of the whole insurance market. These shocks should have the potential to threaten the financial position of the undertaking concerned or the stability of the financial system (par.1). What precisely the conditions are to use the application of “exceptional sector-wide shock” will be further defined in implementing technical standards developed by EIOPA after consulting the ESRB (par. 7).

Member States shall empower supervisors to take measures to preserve the financial position of individual (re)insurance undertakings. Paragraph 2 of the proposed Article 144c details this competence further: it relates only to undertakings with a particularly vulnerable risk profile. Although one could regret that no more precise reference is made to the SCR or the MCR, these new proposals do no longer allow for indiscriminate measures across the board. But they do prevent the de-capitalisation of own funds of particularly vulnerable (re)insurance undertakings via dividends or bonuses in times of crises.

The minimum measures proposed are that supervisors can restrict or suspend dividend distribution or other payments to shareholders and other subordinated creditors as well as restricting or suspending share buy-backs and repayment or redemption of own fund items and of bonuses and other variable remuneration.

To be able to restrict or suspend all the above, five elements need explicitly to be considered by the supervisors (par. 3&4):

• proportionality criteria referred to in Article 29(3);
• the existence of any preventively agreed risk tolerance limit;
• thresholds for internal capital planning of the undertaking,
• the evidence resulting from the supervisory process; and
• the forward-looking assessment included in the undertakings’ ORSA.

Whereas Article 29a was there all along the pandemic, the elements now explicitly suggested to be taken into account will hopefully prevent further blunt axe approaches.

How long can these exceptional measures last? Par. 5 of the new article states: “As long as the underlying reasons to justify these measures are present”. I believe this relates to two conditions: the external, generic one, i.e., as long as the sector-wide shocks last, and the internal, undertaking-specific one, as long as the vulnerability of the undertaking last. In any case, the measures taken shall be reviewed every three months and be removed asap if the underlying conditions are no longer present.

In the case of groups, significant intra-group transactions such as intra-group dividends, shall only be suspended or restricted where they are a threat to the solvency or the liquidity position of the group or one of its (re)insurance undertakings. In case the supervisor of a related undertaking wants to suspend or restrict transactions with the rest of the group, the group supervisor shall be consulted (par. 6). Whereas in the rest of the Article, no explicit reference is made to the solvency or liquidity position, but only to the “vulnerability” of the undertaking, the Commission’s approach in the case of intra-group dividends is different, and  par. 3, 4 and 5 on the conditions for exceptional measures and their duration seem not to be applicable to the distribution of intra-group transactions.

Lieve Lowet