insurance regulation and supervision in the eu: initiatives and further expectations prof. karel van...

Insurance Regulation and Supervision in the EU: Initiatives and Further Expectations

Prof. Karel Van HulleKU Leuven and Goethe University FrankfurtChairman IRSG – EIOPACroatian Insurance Days 2015 Opatija, 5th November 2015

Prof. Karel Van Hulle: KU Leuven and Goethe University Frankfurt

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Agenda

• Introductory comments

• Solvency II

• Insurance distribution

• Supervision

• Closing comments


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Introductory comments


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Insurance regulation – difficult exercise

• Only major economic sector that does not yet have an agreed international accounting or solvency standard

• Insurance is complex: few people outside the insurance industry understand the insurance business model

• Insurance industry is not transparent and data on the industry are lacking

• Insurance is long term business and attracts a different set of people than banking

• Insurers are rarely good communicators

• Conclusion: it is difficult to put insurance regulation on the political agenda


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Solvency II


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Why Solvency II?

• Solvency I as designed in the 70’s is not sufficiently risk based

• Solvency I does not encourage insurers to better manage their risks

• Solvency I does not attach sufficient importance to the qualitative aspects of supervision

• Solvency I does not include an early warning signal

• Solvency I does not attach sufficient importance to group supervision

Solvency II: a remedy or a problem• There is a growing awareness across the globe that a risk

based solvency regime is needed

• The S II project was inspired by reforms within the EU (e.g. UK & NL) and outside the EU (e.g. CH & AUS)

• Because of a lack of international pressure (contrary to Basel III) the EU project has taken a lot of time

• Many insurers have improved their risk management, but the absence of a requirement to change – and the delays - have had a negative impact on the readiness and willingness of companies to change

Prof. Karel Van Hulle - KU Leuven and Goethe University Frankfurt

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Solvency II: 3 pillars and a roof

Pillar 1: quantitative requirements

1. Harmonised calculation of technical provisions

2. "Prudent person" approach to investments

instead of current quantitative restrictions

3. Two capital requirements: the Solvency Capital

Requirement (SCR) and the Minimum Capital

Requirement (MCR)

Pillar 2: qualitative requirements and

supervision

1. Enhanced governance, internal control, risk

management and own risk and solvency assessment

(ORSA)

2. Strengthened supervisory review, harmonised

supervisory standards and practices

Pillar 3: prudential reporting and public

disclosure

1. Common supervisory reporting

2. Public disclosure of the financial condition and

solvency report

(market discipline through transparency)

Group supervision & cross-sectoral convergence

Groups are recognised as an economic entity=> supervision on a consolidated basis

(diversification benefits, group risks)

Solvency II: a project in 4 stages

• Framework Directive containing the principles of the new solvency regime adopted by Council and EP (level 1)

• Implementation of the Framework Directive by the EC through a Delegated Act (Regulation): scrutiny of Council and EP (from 3 to 6 months) (level 2)

• Regulatory and Implementing Technical Standards developed by EIOPA which become legally binding after endorsement by the EC (level 3)

• Guidelines / Recommendations developed by EIOPA addressed to supervisors and/or insurers and which are applicable on a “comply or explain” basis (level 4)


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Original timing for Solvency II

• Framework Directive proposed in July 2007 and adopted in 2009 with date of first application: 1 November 2012

• Implementing measures (levels 2 and 3) prepared in draft by the EC during the course of 2009-2011

• Supervisory guidance (level 4) prepared by EIOPA during the course of 2011-2012

• Financial crisis required new legislation (Omnibus II) which was proposed in 2011

• Negotiation of Omnibus II became very difficult so that date of first application was postponed first to 2014 and then to 2015 and finally to 2016


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Causes for the delay

• QIS 5 (2011) showed high volatility in the solvency capital and in own funds as a result of market instability and valuation of technical provisions at market value

• Difficulty to define a risk free discount rate to apply to the valuation of long term liabilities

• Difference in life products required different solutions to remove “artificial” volatility

• Need for transitional measures and phasing-in: transition from Solvency I to Solvency II complex

• Disagreement on implementing powers, on proportionality, on equivalence


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Long term guarantee package

o Matching adjustment (cannot be combined with volatility adjustment or interest rate transitional)

o Extrapolationo Volatility adjustment (MS might require prior approval)o Extension of recovery period (7y)o Transitional measure on risk free interest rates (16y)o Transitional measure on technical provisions (16y)o Allowance for DA, RTS, ITS, annual reporting by EIOPA

and reporting by EC after 5 years with possible review


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Long term investments

• Governments want the insurance industry to continue its role as institutional investor

• How should the risks attached to various types of investment (equity, bonds, real estate, venture capital, sovereign debt, etc.) be calibrated?

• Should the calibration be different when the investment is held for a long term to match a long term liability?

• Is it possible to identify a specific calibration for infrastructure investments? See recent amendment of the Delegated Act (new investment category “infrastructure asset”) and new CfA on infrastructure corporates


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Investment in sovereign bonds

• As in banking, zero capital charge because international agreement that investing in own government is risk free

• Opposition against zero capital charge from EP and from industry during negotiations

• Problem: lack of diversification (systemic risk?), risk charge in internal models, respect of risk based approach

• Considerations: insurance should follow same treatment as banking; investing in own government can stimulate economic growth; increase of public debt; financial repression

• Should we accept that governments can fail?


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Sovereign bonds in other currency

• Same treatment as in banking

• Transitional regime for sovereign bonds held in the currency of another EAA MS (until 2020)

• Possible way forward to avoid problems in 2020:o Revision of standard formula in 2018o Supervisory action (co-ordinated by EIOPA?)o Phasing-out (rather than grandfathering)o Need to diversify investment portfolioo Rethink issue of bonds in other currencyo Prepare for negotiations now


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Where are we now? Level 1

• Framework Directive of 29 November 2009 was amended by Omnibus II adopted on 16 April 2014

• Main issues dealt with in Omnibus II: transitional measures, powers of EIOPA, of EC and EP, long term guarantees (discount rate), equivalence, proportionality, phasing-in of Solvency II

• Transposition date: 1 April 2015 (most MS have transposed the Directive)

• Date of first application: 1 January 2016


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• Commission Delegated Regulation (EU) 2015/35 of 10 October 2014 (published in the OJ on 17 January 2015), commonly referred to as the Delegated Act:o Long term guarantees packageo Calibration in standard formulao Securitisationo Equivalence

• Directly applicable in all MS: no need for transposition into national law

• Updated on 30 September 2015 (subject to non-objection of Council and EP)


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• 6 Commission Implementing Regulations with ITS (approval internal model, application group internal model, special purpose vehicles, USP, ancillary own funds, matching adjustment) published in March 2015

• 3 Commission Implementing Regulations with ITS to be published early November

• 3 further Commission Implementing Regulations with ITS containing the reporting templates (voluminous!) to be published in February with application date 1 January 2016

• Texts will be available on EC website beforehand

• Directly applicable: no transposition needed


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• First set of 19 EIOPA Guidelines (February 2015)

• Second set of 9 EIOPA Guidelines (September 2015)

• Most Guidelines will be applied by all national supervisory authorities in their entirety

• Guidelines are not legally binding but are binding in practice

• Most Guidelines are based upon specific authorisations in the Level 1 or Level 2 texts

• Some Guidelines are own initiative guidelines: avoid regulatory action at national level

Third countries• The EU needs to ensure that EU groups with a parent outside the EU

are subject to appropriate group supervision, i.e. the third country must require the supervisor of the parent to look at the solvency of the whole group and to operate a college of supervisors including the supervisors of the EU undertakings

• The EU needs to ensure that there is a mechanism in place which facilitates the calculation of the group SCR in the case of a subsidiary of an EU group operating in a third country

• EU insurers should be able to conclude reinsurance contracts with reinsurers based in a third countries

• The regulatory answer is an equivalence decision by the EC based upon advice from EIOPA (Omnibus II adds: temporal and provisional equivalence and makes EC decision subject to scrutiny)


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Commission Delegated Decisions on equivalence and provisional equivalence

• Delegated Decision of 5.6.2015 concerning Switzerland:o Applies from 1.1.2016 for unlimited period of time;o Recognises equivalence for reinsurance, group

supervision and solvency treatment of EU subsidiaries based in CH

• Delegated Decision of 5.6.2015 concerning Australia, Bermuda, Brazil, Canada, Mexico and the USA:o Applies from 1.1.2016 for a period of 10 years;o Recognises provisional equivalence for the purpose of

the solvency treatment of EU subsidiaries based in the countries concerned


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Equivalence continued

• Scrutiny of Council and EP for CH finished and Commission Decision published in OJ

• Scrutiny of Council and EP for Australia, Bermuda, Brazil, Canada, Mexico and USA prolonged until 7 December 2015

• Commission Decision on full equivalence concerning Bermuda to be adopted in November 2015

• Commission Decision on temporary equivalence (reinsurance) and provisional equivalence (group SCR) concerning Japan to be adopted in November 2015

Will there be further goldplating?

• With few exceptions, Solvency II introduces uniform rules

• What can EIOPA do to avoid goldplating?o Guidelines (cfr. different stage of preparedness in MS)o Monitoring of implementation in practice

• Single rulebook based upon EU Regulation• Supervisory handbook (convergence and consistency in

practice)• Investigations both for those below and those above the mark

o Benchmarking• Particularly important in the context of internal models• EIOPA has set up a center of excellence for internal models


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Strategic impact of Solvency II

• Responsibility is put back to where it belongs, i.e. insurers must learn to operate in a changed regulatory environment

• Interlinkage between risk and capital: ORSA

• Governance structure may have to be changed

• Risk management receives a central place in the new solvency regulation

• Transparency to the regulator and to the outside world requires new skills: insurers must become good communicators

• Some insurers might disappear from the market (consolidation, run-off)


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Insurance distribution


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Reasons for amendment of IMD I

• Very divergent implementation of IMD I

• EP requests amendment following adoption of Solvency II

• Consistency with other reforms (MifiD, PRIPs)

• Improve consumer protection:o Extending the scope (all sellers of insurance products)o Increasing transparency (mitigating conflicts of interest)o Introducing proportionate professional qualificationso Special rules for the sale of complex investment products (PRIPs)o Clearer provisions relating to cross-border sales, freedom of

establishment and freedom to provide services


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Insurance Distribution Directive• Commission proposal : 3 July 2012

• Trilogue concluded on 16 July 2015

• Most important changes:o Extension of scope of application to direct saleso Better regulation of division of competence between home and host MS supervisorso Professional requirements (continuous education, proportionality)o Requirement to set up out-of-court redress procedure for settlement of disputeso Disclosure of amount of fee (remuneration directly paid by the customer and not

included in the premium) o Cross-sellingo Product oversight and governanceo Additional requirements for insurance-based investment products o Sanctions and measures in the case of breaches


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Insurance product information document• Contents:

o Information about the type of insuranceo Summary of insurance covero Means of payment of premiums and duration of paymentso Main exclusions where claims cannot be madeo Obligations at the start of the contracto Obligations during the term of the contracto Obligations in case of a claim madeo Term of the contract including start and end dateo Means of terminating the contract

• Standardisation: ITS to be developed by EIOPA


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Insurance based investment products• Uniform rules introduced by Regulation 1286/2014 of 26 November

2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs)

• Additional rules on information to customers particularly on all costs and related charges if not already included in KID

• Fees or commissions or any non-monetary benefit can only be accepted by insurance intermediaries or insurance undertakings if:o No detrimental impact on quality of service;o No detrimental impact on compliance with duty to act honestly,

fairly and professionally in best interest of customer

• Stricter rules can be introduced by MS including the prohibition of further restriction of fees, commissions or non-monetary benefits from third parties


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Implementation

• Publication of IDD not before January 2016, i.e. application not before 2018 (24 months transposition date)

• Annex to the Directive includes minimum professional knowledge and competence requirements for the distribution of life -, non-life - and insurance based investment products

• Further implementation by delegated act (e.g. product oversight and governance), by RTS (e.g. amount of professional indemnity insurance), by ITS (e.g. product information document, by guidelines (e.g. cross-selling)


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Supervision


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Insurance supervision will change

• Solvency II introduces fundamental changes in the way supervision will be carried out

• It is in the interest of the insurance industry to have high quality supervision

• Supervisors will have more tools (on-site and off-site inspection, stress tests, supervisory ladder of intervention)

• EU supervisory handbook: best practice

• Your supervisor: your friend!

• Look at website of EIOPA


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EIOPA: a reality

• Technical adviser of the EC and the EP with leadership role for technical issues concerning insurance supervision (RTS and ITS)

• Represented in all (92) colleges of supervisors

• Responsible for developing common supervisory culture

• Binding mediation, peer reviews

• Cooperation with ESRB

• Clear mandate to further develop market conduct rules

• Assisted by two stakeholder groups (IRSG and OPSG)


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Closing comments


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New Commission: regulatory pause

• EC is unlikely to embark on a new series of regulatory initiatives in the area of insurance

• EC has launched a consultation on the impact of the regulatory changes in the financial services area

• EP is also examining the impact of financial services regulation (and the competences of the ESAs and the EC)

• Outstanding issues in insurance regulation: resolution and recovery; insurance guarantee schemes

• GP on consumer protection in retail financial services

• Monitoring of implementation in practice of Solvency II will be crucial in the years to come


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Prof. Karel VAN HULLE Research Center InsuranceFaculty of Economics and BusinessKU LeuvenNaamsestraat 69 Box 3525, B-3000 [email protected]

International Center for Insurance RegulationFaculty of Economics and Business Admin.Goethe University – House of FinanceGrüneburgplatz 1, D-60323 Frankfurt am [email protected]

mailto:[email protected]

insurance regulation and supervision in the eu: initiatives and further expectations prof. karel van...

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