Ciara Russell contributed to the writing of this blog post.
EIOPA have released the first set of technical standards for Solvency II. As a regulatory tool, the technical standards are open for public consultation with responses due by 30 June 2014. Additionally, we can expect EIOPA to perform a cost benefit analysis (Impact Assessment) and consult relevant stakeholder groups.
Set 1 of the ITS is relevant to firms planning on using any of the following features in the Solvency II process.
The ITS sets out the procedures for the approval process of:
- Matching adjustment
- Internal Models
- Group Internal Models
- Undertaking-Specific Parameters
- Ancillary Own Funds
- Special Purpose Vehicles
A summary of the information provided on each of these in the ITS follows.
These processes will contribute to the preparation by insurers and Supervisors for the approval process, which is due to start in 1 April 2015. EIOPA will submit the ITS to the European Commission by 31 October 2015, allowing three months for final endorsement before the Solvency II implementation date of 1 January 2016. Following this, the Commission can amend or reject the proposed ITS. If endorsed, the Commission will publish the Technical Standard, which will then be part of the implementing measures and become binding legislation.
Summary of key features
Matching adjustment (MA)
Where the cashflows of assets and liabilities have similar characteristics, the MA can be used to adjust the risk free rate term structure used to calculate technical provisions. It aims to mitigate short-term volatility of the Solvency II balance sheet in view of the long-term nature of liabilities.
The ITS outlines the approval process and how insurers can demonstrate they meet the desirable criteria for its use. These include demonstrating:
- assets and liabilities cashflows are matched
- assets can be replaced to achieve matching (where cashflows change)
- assets can be held to maturity
- impact of the MA on the financial position
Firms can opt to use the internal model instead of the standard formula for calculating capital. Regulatory supervisors are required to approve insurers’ internal models and any subsequent changes to them.
The ITS provides information of the approval process, including:
- content of the application for approval to the supervisor
- policy for changing or extending the scope of the model
- supervisor’s criteria for assessment
- decision by supervisors
Group internal models
Groups can opt to use an internal model to calculate a consolidated SCR. Again, approval is required but in the case of a Group, multiple Supervisors are involved. The ITS sets out the provisions for a joint decision process.
Undertaking Specific Parameters (USP)
Firms can use the standard formula approach with parameters specific to their risk profile in certain modules.
These modules are:
- Non-Life Premium Reserve
- Health Non-SLT Premium Reserve
- Health SLT Revision
- Life Revision
Relevant processes within the ITS include:
- firms demonstration of requirements for data quality and their risk profile, including justification of parameters
- reversion to prescribed standard formula parameters
- supervisors request for insurers to use USP
Ancillary Own Funds
These are funds other than basic own funds that can be used to mitigate losses. Supervisors must approve the amount of these. The ITS outlines the application process and information required for approval.
Special Purpose Vehicles (SPVs)
SPVs are separate legal entities used for the transfer of risks and assets. The ITS processes focuses on effective risk transfer, policyholder protection and the processes for providing information when using SPVs.
As a European wide standard, with multiple Supervisors and entities involved, it is important that the approached are consistent. The cover note to the ITS outlines how the steps to approval have been aligned:
Confirmation of receipt by Supervisor
Declarations on applications
Consequences of an absence of decision
Possibilities for further information requests or submission of further information from insurer
Proportionality, as always, remains important in these processes. EIOPA has considered if more criteria are required or where requirements could be differentiated for smaller firms. They note that proportionality is implicit in the proposed approaches in terms of the nature and complexity of the documentation and information requested. For example, in the approval of changes to an internal model for a smaller, less complex insurer, the level of documentation is likely to be less.
The consultation paper and templates for comments can be viewed here.
Set 2 of the Implementing Technical Standards will cover the three Pillars and is due to be released in December. We will provide information on this once available.