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    ESRB Responds to EC Proposal on Solvency II Review

    February 03, 2022

    The European Insurance and Occupational Pensions Authority (EIOPA) published the technical information on the symmetric adjustment of the equity capital charge as well as the technical information on relevant risk-free interest rate term structures for Solvency II with reference to the end of January 2022. In addition, the European Systemic Risk Board (ESRB) issued a letter, which is addressed to both members of the European Parliament and the Council Working Party, on the European Commission proposal on Solvency II review. In the letter, the European Systemic Risk Board (ESRB) outlines ways to strengthen the proposal to fully close important gaps in the Solvency II Directive.

    The letter explains that the following elements require further strengthening:

    • Failing to address solvency risks that arise from the low levels of interest rates and volatile capital markets will result in solvency ratios being overstated, leading to fragile insurers with a higher risk of failure. The application of a more market-based method for deriving risk-free discount rates for insurers, which sets the last liquid point for the euro to 30 years and extends the convergence period from the last liquid point to the ultimate forward rate from 40 years to 100 years, is an important tool with which to address this risk.
    • Risks from distributions, such as dividends or share buybacks, can lead to a depletion of capital and insurers might try to conserve capital elsewhere by de-risking. Such de-risking strategies can amplify exceptional market-wide shocks.
    • Risks from mortgage lending are closely related to real estate risks and insurers in certain European countries invest up to 14% of their total assets in mortgage loans. Despite continuing concerns about rising real estate prices in the European Union, insurers in many countries may engage in mortgage lending by applying lower capital requirements than banks. ESRB welcomes the intention of EC to better align the prudential treatment of mortgage loans in Solvency II with the credit risk framework for the banking sector. However, the provisions for borrower-based measures for mortgage lending that apply independently of which part of the financial sector provides a loan are lacking. These measures are important to address the risks of residential real estate bubbles and rising foreclosures when the bubbles burst.
    • Risks from procyclical investment behavior can arise when insurers are forced to sell commonly held or correlated assets during times of stress. During the market turmoil in March 2020, insurance supervisors in some countries resorted to the existing transitional measures to smooth the impact of the sharp falls in asset prices. These measures, however, were not designed for this purpose, and this is problematic, as they will continue to provide capital relief for the next ten years. Improving existing mechanisms in Solvency II, including by making the countercyclical mechanism more symmetric, is therefore important.

    The European Commission had, in July 2020, launched a consultation on the review of Solvency II Directive, with ESRB having responded to this consultation in October 2020. Then, in September 2021, the European Commission issued a proposal on the review of Solvency II incorporating many important issues flagged by ESRB in its earlier response. The annex to this recent ESRB letter includes an overview table that summarizes which of the elements set out in the ESRB response to the European Commission’s consultation on the Solvency II review were largely incorporated in the European Commission proposal and which of them were not or only partially incorporated.

     

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    Keywords: Europe, EU, Insurance, Solvency II, Solvency II Review, Dividend Distribution, Mortgage Lending, Lending, Credit Risk, EIOPA, ESRB, EC, RRE, CRE

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