ESRB Responds to EC Consultation on Review of Solvency II

To better reflect macro-prudential considerations in Solvency II, in an earlier report and in this letter, ESRB advocated the use of solvency tools for preventing and mitigating procyclical investment behavior and liquidity tools. The framework for liquidity risk should be enhanced by better reporting and measurement, stress-testing requirements and Pillar 2 provisions that enable supervisors to require the insurers that have been identified as having a vulnerable liquidity profile, to maintain a liquidity buffer. ESRB also sets out tools for addressing risks stemming from the provision of credit to the economy, for example, when insurers originate mortgage loans or invest in corporate bonds. ESRB also believes that the provisions of Article 138 of Solvency II Directive (2009/138/EC) on the extension of the recovery period could be clarified with respect to the role of ESRB. The recovery and resolution framework, along with additional harmonization in the area of insurance guarantee schemes, would contribute to adequately protect policyholders as well as maintain financial stability in EU. ESRB also sees the need to adjust the risk-free interest rate term structure, particularly given the persistent low interest rate environment. ESRB explains that, based on the lessons learned from the pandemic, the Solvency II review should consider: 

• Strengthening micro-prudential framework with a macro-prudential toolkit to ensure the provision of critical insurance services as well as the insurance functions that might have a significant impact on the financial system or the real economy
• The need to build-up a buffer of capital ex-ante that provides additional resilience when needed
• Granting, to supervisors, the power to block or suspend dividend payouts or equivalent activities when insurers are not breaching their solvency capital requirements
• Measures to address volatility of the solvency ratio by, for example, increasing the cap for symmetric adjustment for equity risk in a symmetric way and by transforming the Volatility Adjustment (VA) into a symmetric VA that would form an additional own funds item to mitigate some of the credit spread volatility.
• Enhancing the liquidity risk management requirements for insurers by establishing proportionate and systematic reporting requirements and granting supervisors the power to impose liquidity buffers for insurers with a vulnerable risk profile (in addition to the need to reinforce the risk management provisions of Solvency II on liquidity risks)

In the Annex to the response letter, ESRB addresses the topics of long-termism and sustainability of insurers’ activities and priorities of the European framework, proportionality of the European framework and transparency toward the public, and improving trust and deepening the single market in insurance services. ESRB also emphasizes the need for requiring insurers to explicitly reflect climate change risks and cyber risks in their risk management practices and to adequately address the situation of negative interest rates in Solvency II.

Related Link: Response Letter (PDF)

Keywords: Europe, EU, Insurance, Solvency II, Solvency II Review, COVID-19, Reporting, Liquidity Risk, Solvency Capital Requirement, Climate Change Risk, ESG, EC, EIOPA