A guide to Solvency II review

By Yannis Pitaras, Principal Consultant

and Jessica Ukendi, Associate Consultant

On 18th June 2019, The Official Journal of the EU has adopted a regulation amending Solvency II.
These changes are the results of the 2018 solvency review and aim at: 

• Removing unjustified constraints to the financing of the economy and incentivising long-term investments by, amongst other things, introducing the long-term equity investments which can benefit from a reduced shock at 22%
• Enhancing proportionality by providing additional simplifications for the calculation of capital requirements
• Removing inconsistencies between banking and insurance legislation as far as own funds are concerned
• Reducing divergent practices in the recognition of the loss absorbing capacity of deferred taxes by complementing the existing text
• Adjusting the calibration of the non-life premium and reserve risk, and of the health and non-life catastrophe risks
• Improving the recognition of insurance risk mitigation techniques
• Bringing more transparency on the calculation of the relevant risk-free interest rate term structure

The vast majority of the amendments will enter into force on the twentieth day following their publication. However, some provisions will only apply as from 1st January 2020.

These are neither the first nor last changes to the Solvency II legislation. In 2016, amendments were adopted to incentivise investments in infrastructure and STS securitisations. Currently, the Commission is in a consultation process which aims at bringing amendments to the Solvency II Directive itself by 2020. This is commonly referred to as the 2020 Solvency II review.
 

In the annex to this paper, you will find a list of the “2018 Solvency II review” changes, presented in a user-friendly way which should help you navigate the amendments and identify the changes relevant to your organisation in an easier way.
The changes introduced by the “2018 Solvency II review” either replace or amend existing articles of the Delegated Acts or introduce new articles.
 

The 2018 Solvency II review introduces a significant number of new articles on simplified approaches for the calculation of:

• the Non-Life SCR for Cat risk, Lapse risk and fire risk
• the NSLT and SLT Health lapse risks
• the Spread risk
• the concentration risk
• the risk mitigating effects of reinsurance
• the Counterparty Default risk on type 1 exposure

Other new articles brought about by the 2018 Solvency II review have been incorporated in:

• The equity risk SCR module, introducing the qualifying unlisted equity portfolios and long-term equity investments
• The spread risk SCR module incentivising furher the use of own internal credit assessment
• The counterparty risk SCR introducing specific capital requirements for exposure to clearing members
   

The 2018 Solvency II review includes amendments to:

• The calculation of the Spread Risk, Concentration Risk, Currency Risk, Counterparty Default Risk SCRs
• The requirements ensuring the transparency of the calculation of Risk-Free Rate Curve
• The definition of contract boundaries
• The calibration of the Marine, Aviation and Fire risk sub-modules in the Non-Life risk SCR
• The use of the look-through approach for investments in funds in the calculation of the Market risk SCR
• The recognition of the risk mitigating effects of reinsurance in the calculation of the SCR
• The calibration of the SCR for Non-life Nat Cat perils such as Windstorm, Earthquake, Flood, Hail in jurisdictions such as Greece, Finland, Hungary, Sweden, Slovenia, Romania, Slovakia and the Czech Republic
• The calculation of the adjustment for the loss-absorbing capacity of deferred taxes
   

It seems that the amendments brought by the 2018 Solvency II review partly achieve some of their stated objectives, in particular in terms of proportionality, removing inconsistencies between banking and insurance legislation, adjusting the calibration of some insurance risk modules and improving the recognition of insurance risk mitigation techniques.

However, many stakeholders expect more from the 2020 review, in particular in terms of incentivising long-term investments.

Furthermore, although the simplifications introduced for a number of risk modules are useful for many smaller insurers, they may come too late. Indeed, 3 years after the entry into force of Solvency II, it is thought that many of them would have already implemented the more complex approaches included in the Standard Formula. 

There is another matter of adjustment for the loss-absorbing capacity of deferred taxes: we wrote a whole paper on this very relevant topic 

A comprehensive overview of all the regulatory changes introduced by 2018 Solvency II review.

Download table as PDF