Saturday, 28 February 2015

The European Commission’s Impact Assessment of Solvency II: Some Useful Points

The European Commission recently published a draft of the Solvency II ‘implementing measures’.  The ‘implementing measures’ expand on the requirements set out in the Solvency II directive.  Alongside the ‘implementing measures’, the European Commission also published a draft impact assessment.  This is one the many procedural requirements that apply to the policy-making process in the Commission. 

I thought it would be interesting to review the impact assessment.  As a user, I want to consider the extent to which the impact assessment can help me to understand Solvency II. 

What did I learn from this exercise?

1.    The importance of objectives in the EU policy-making process

The impact analysis is structured around a definition of problems that the policy making will address.  During the discussions about the directive, these objectives were enhancing policyholders’ protection and the integration of insurance markets in the EU. 

The Commission’s impact analysis acknowledges that there is now a third objective that has been taken into account: fostering growth and recovery in Europe by promoting long-term investment.  In the case of insurance, the main challenges that arise relate to the low interest rate environment and the volatility of asset prices. 

2.    A useful summary of how the calibration of asset risk has evolved

The third objective mentioned above has shaped the structure and calibration of capital requirements for assets risk which has evolved over a number of years.  However, it is not easy to see in a succinct way the end product where the answer is set out over a number of articles in the implementing measures.  Surprisingly, this can be summarised in a simple table (below).

3.    The scope of impact analysis remains a tricky issue

The Commission seems to have overcome the challenge of undertaking an impact analysis that seeks to cover the impact of all rules.  The Commission states,

“The options assessed have been selected to cover the most important and representative issues from each of the three pillars of Solvency II and each of the areas of the objectives and problem trees. The areas that are merely technical, have been settled in the Directive or are uncontroversial are not assessed in detail …”

This is reasonable and can result in a more productive use of scarce analytical resources but it can also have unintended consequences.  As far as I can see, the impact analysis did not cover the treatment of long-term guarantees.  I am frankly not sure if this is because it was settled in the Directive or because it turned out to be uncontroversial.

4.    The relative priorities of the Commission: the importance of reducing over-reliance on ratings

The concern about over-reliance on ratings is not new if you have been following the development of Solvency II.  However, given the breadth of Solvency II and the focused impact assessment, I found it surprising that the Commission went out of its way to include a full two-page annex summarising the requirements aimed at reducing reliance on external ratings in the risk management of insurance “such as

          ▪ external ratings shall not prevail in risk management;
          ▪ as part of their investment risk management policy, insurers and 
          reinsurers should have their own assessment of all counterparties;
          ▪ as part of their reinsurance (or other risk mitigation techniques) policy, 
          insurers and reinsurers should have their own assessment of all 

5.    And finally, a puzzle about policy making

The Commission’s impact assessment notes that one of the issues that emerged from the QIS5 was the application of a limit to the amount of Tier 2 capital (i.e. debt) that would be allowed.  This issue has remained unclear since then. 

Interestingly, if all you read is the relevant section of the impact analysis on pages 38 to 46 which also summarises EIOPA’s recommendations, you could be forgiven for thinking that the limit would not apply.  It is only the summary on pages 50 to 51 that suggested that I might need to reconsider my initial views.  Indeed, the draft implementing measures clarify that the sum of Tier 2 and Tier 3 capital must not exceed 50% of the SCR, which is an interesting development. 

This illustrates one of the key operational challenges of impact analysis: the need to keep up with the policy.

This was a selective but nonetheless in-depth reading of the impact assessment.  Have you read the impact assessment?  Did you learn any useful points from it?

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