On 13 November 2013 the European trilogue parties, comprising the European Parliament, the European Commission and the Council of the European Union reached a provisional agreement on the Omnibus II Directive allowing Solvency II to move forwards towards implementation. The Directive will now be subject to a final approval from the European Council and a Plenary vote by the European Parliament, currently expected to be held on 3 February 2014, before it can be approved into European legislation.
A press statement from the Presidency of the Council of the European Union stated that the agreed new rules contain “so-called “long term guarantees” (LTG) measures which adjust current Solvency II framework to cope with “artificial” volatility and low interest rate environment, and allow for the smooth transition from the Solvency I regime to Solvency II.”
In addition, the Omnibus II Directive is understood to include enhanced requirements for risk management, supervisory review process, public disclosure and the possibility to review the LTG measures, in order to ensure prudence and transparency of the framework.
At a press conference held on 14 November 2013 by Burkhard Balz MEP, the European Parliament economic and monetary affairs committee (ECON) rapporteur for Omnibus II, and Sharon Bowles MEP, Chair of the European Parliament’s ECON Committee, Balz noted that the Omnibus II text should present an “efficient and practical solution” under Solvency II for firms offering long-term guarantee products and should ensure that these firms can continue to operate in difficult market conditions and in low interest rate environments. Specifically, Balz noted that the solutions set out in the Omnibus II Directive should allow firms to continue to offer these products and to maintain their role as long-term investors.
The press conference confirmed a number of details of the content of the approved text, including:
• A matching adjustment (MA) to be applied to the discount rate used to value annuity-style liabilities meeting specific requirements in relation to the liability cashflows and the assets held to match these. The value of the MA looks set to be calculated as the spread over risk-free rates on the matching assets less an allowance for defaults (the fundamental spread). The fundamental spread is expected to have a floor of 30% of long-term average spreads for government bonds and 35% of long term spreads for other eligible assets.
• A volatility adjustment to be applied to the discount rate used to value all other business, calibrated as 65% of the risk-adjusted spread of assets in a representative portfolio.
• Transitional arrangements for existing life insurance business to adjust to Solvency II over a period of 16 years.
While the package of measures has deviated from that set out by the European Insurance and Occupational Pensions Authority (EIOPA) following the long-term guarantees assessment (LTGA) run earlier this year, in particular with less onerous calibrations on a number of the measures, Bowles and Balz noted that this has been balanced by the introduction of important qualitative requirements relating to the governance and disclosure of these measures. The press conference highlighted the need for firms to maintain a liquidity plan, for proper supervision of the LTG measures and for these measures to be applied in a transparent way.
While Balz acknowledged that the new rules were ambitious he highlighted the importance of respecting the principle of proportionality when applying them. In particular, he noted that while the reporting obligations will include asset-by-asset reporting and annual reporting, exemptions for certain parts may be available for smaller firms.
Significantly for European groups, the approved text includes an extended provision for transitional equivalence for third countries. This would allow the European Commission to grant provisional equivalence to third countries for a period of 10 years, at which point it would be reviewed with the option to extend for a further 10 years (and potentially indefinitely). The approval of this provision would allow the US to be considered as an equivalent regulatory regime, allowing European firms with US subsidiaries to use local regulatory methods when calculating group solvency requirements. While this provision has been developed as a specific response to the US regulatory situation it has been stressed that this will provide flexibility to develop pragmatic solutions for other regulatory regimes to ensure that European groups are not disadvantaged when operating in third countries.
Balz confirmed that the expected timeline is for Solvency II to be operational for firms from 1 January 2016 with transition into national regulation required by 31 March 2015. These dates are expected to be confirmed at an EP Plenary session in Strasbourg later this month.
Copies of Solvency II summary papers, together with copies of papers on other topics published by Milliman, can be found here.
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