Bigger capital requirements hang over EU insurance sector in Solvency review

Commissioner for Financial Services, Mairead McGuinness, said that “we need to be sure that there are no unnecessary obstacles to sustainable investments in Solvency II”.

EU regulators and the insurance sector disagree over whether the review of the rules for the industry (Solvency II) should include higher capital requirements to deal with risks of interest rate changes, which insurers say would mean less money to support recovery.

The COVID-19 outbreak has shaken up the EU rules policing national budgets and the bloc’s finance sector. Billions of euros were freed to cope with the economic fallout of the pandemic, as the European Commission and EU regulators eased the legal framework controlling public spending or capital buffers for banks.

A more silent change is being prepared for insurance companies, one of the main long-term investors in the economy.

The European Commission is working on a review of Solvency II, the EU rules for insurance firms introduced in 2016. They include the capital insurers must set aside to cover unexpected loses in a crisis period, as well as robust internal risk assessments and the disclosure of some relevant information. 

Following a public consultation that ended in October, the Commission is expected to put forward a proposal in the third quarter of 2021.

The EU executive also received an opinion from the European Insurance and Occupational Pensions Authority (EIOPA) in December, and organised several debates among member states and expert groups on insurance matters, a Commission spokesperson told EURACTIV.

The insurance sector and EIOPA agreed that the introduction of Solvency II has been a success. There’s no need for a revolution but an evolution, they said, to ensure that the framework remains fit for purpose in the post-pandemic world and capable of sustaining the EU’s overarching goals, including the ‘green’ transition. 

But the two sides clashed over the elements that need to be reviewed, especially the capital requirements. 

EIOPA highlighted in its opinion that “there are areas of significant concern, which the review should address”. The regulator considered that insurance companies should add more capital provisions to deal with the risk of interest rate changes.

Almost two-thirds of the investment portfolio of insurance companies is made of fixed-income assets (including sovereign bonds). As a result, the continuing low-interest rate regime is damaging the sector’s financial situation. 

“The current interest rate requirement does not reflect the steep fall of interest rates experienced during the last years and ignores the existence of negative interest rates. This mistake should be corrected,” EIOPA wrote in its opinion.

The Commission signalled that increasing capital requirements to tackle this economic scenario would not have an adverse impact.

But the industry is warning that consumers could end up being affected and that less money would flow to support the recovery.

Increasing capital requirements for interest rate risk shocks “can have significant negative impacts including hindering insurers’ ability to offer products with long-term guarantees and pushing them to shift risk to policyholders,” said Insurance Europe.

In addition, the industry is concerned about the impact of demanding bigger buffers from the European insurance sector in comparison with firms primarily based in other countries. 

The Solvency II framework has been copied all over the world. But in the UK, where the EU rules remain in place after Brexit, the Association of British Insurers is calling on the government to loosen the capital requirements included in the EU framework.

According to British insurers, around £95 billion (€110 billion) could be unlocked with more relaxed capital requirements.

Another open issue is whether the Commission will introduce favourable treatment for sustainable infrastructures or green bonds, as part of its efforts to support the European Green Deal. 

The Commissioner for Financial Services, Mairead McGuinness, said in a speech in February that the risk-based nature for capital requirements in Solvency II “will always remain its basic principle”, to ensure high-level protection of the clients. 

But “we need to be sure that there are no unnecessary obstacles to sustainable investments in Solvency II”, the Irish Commissioner said.

McGuinness also pointed out that the Commission will look into whether insurers are or may become exposed to climate and environmental risks and if the capital requirements need to be adjusted accordingly.

[Edited  by Zoran Radosavljevic]

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