Solvency II standard formula – U-turn from the Commission on operational risk module capital for unit linked business

On 10th October 2014 the European Commission adopted a Delegated Act containing implementing rules for Solvency II. This Delegated Act has now been sent to the European Parliament and Council for approval which could take up to a maximum of 6 months.

A recent draft version of the Delegated Act (dated 28th July 2014) contained a suggested controversial change to the operational risk capital for unit linked business. The operational risk capital for unit linked business under the standard formula is set at 25% of unit linked expenses. However, the definition of expenses had been adjusted to include acquisition expenses (including initial commission). It was expected that this change would lead to large increases in capital requirements for many unit linked insurers particularly as commission payments could be a multiple of expenses for some companies.

Insurers of unit linked business may now breathe a sigh of relief as the Commission have since revoked this change. Note 67 of the opening remarks of the Delegated Act adopted this week refers to the operational risk module and states:

“In view of the fact that acquisition expenses are implemented heterogeneously in different insurance business models, these expenses should not be taken into account in the volume measure for the amount of expenses incurred during the previous 12 months.”

Acquisition expenses are defined in EIOPA Consultation paper on the proposal for Guidelines on Solvency II relating to Pillar 1 requirements dated 2 June 2014 as: “2.52 Acquisition expenses include expenses which can be identified at the level of individual insurance contract and have been incurred because the undertaking has issued that particular contract. These are commission costs, costs of selling, underwriting and initiating an insurance contract that has been issued.”

If you have any questions or comments on this eAlert or any other aspect of Solvency II, please contact your usual Milliman consultant.

To read our past eAlerts, click here, or visit our Solvency II documents here.

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