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    ESRB Report Discusses Enhancing Macro-Prudential Tools in Solvency II

    February 26, 2020

    ESRB published a report that examines tools to enhance the macro-prudential dimension of Solvency II for the insurance sector. This report is intended to inform the review of Solvency II in such a way as to enable it to enhance the regulatory framework for the insurance sector with tools that reflect macro-prudential considerations. The report sets out solvency, liquidity, and horizontal tools based on macro-prudential considerations. These tools are a subset of the broader set of tools identified in an earlier ESRB report and focus on the types of risk that are not necessarily specific to the insurance sector and reflect the risk profile and the business model of insurers and reinsurers in some way.

    In line with its strategy for expanding macro-prudential policy beyond banking, ESRB believes that the review of the Solvency II regulatory regime for insurance in EU, which is to be completed by the end of 2020, should result in a revised framework that better reflects macro-prudential considerations. To deal with systemic risk in the insurance sector, the report considers three types of tool that competent authorities should be able to use:

    • Solvency tools to prevent and mitigate procyclical investment behavior of insurers. The volatility adjustment should be reviewed and made symmetric, so that it can also build up resilience when the prices of fixed income assets are rising. A symmetric volatility adjustment may also counter procyclical investment behavior in all phases of the financial cycle.
    • Liquidity tools to address risks arising on the assets and liabilities side. Enhanced Solvency II reporting would allow authorities to measure liquidity risk stemming from these activities. Such reporting could be provided on an annual, semi-annual, or quarterly basis, depending on the vulnerability of the liquidity risk profile. The provisions on managing liquidity risk should also be reinforced, in particular by requiring vulnerable (re)insurers to carry out internal stress testing. The financial stability implications of liquidity risk should also be assessed via supervisory stress tests. Supervisors should have the power, through new Pillar 2 provisions, to require insurers with a vulnerable liquidity profile to hold a liquidity buffer. 
    • Horizontal tools to address risks stemming from the provision of credit to the economy. Capital-based tools targeting (sub-)sectoral exposures would complement the treatment of credit risk under Solvency II and correct inconsistencies between the insurance and banking frameworks. For residential mortgage loans, the report suggests setting an loss given default, or LGD, floor that could be modified by authorities for financial stability reasons. For other loans and for corporate bonds, authorities should have the power to impose a (sub-)sectoral systemic risk buffer.

    These proposals, in addition to the previous work of ESRB on insurance, were summarized in the response of ESRB to EIOPA consultation on the review of Solvency II, which ESRB submitted in January 2020. The response focuses on three areas that ESRB considers most pertinent in terms of their systemic impact. These include the need to better reflect macro-prudential considerations in Solvency II, establish a harmonized recovery and resolution framework in EU, and continue ensuring that risks are appropriately captured in Solvency II. 


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    Keywords: Europe, EU, Insurance, Macro-Prudential Policy, Solvency II, Solvency II Review, Stress Testing, Systemic Risk, Capital Requirements, Systemic Risk Buffer, Reporting, Liquidity Risk, EIOPA, ESRB

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