Solvency II preparation guidelines: EIOPA is not for turning

In April we posted several blog articles about EIOPA’s guidelines for national regulators covering how they should be ensuring that firms were preparing for Solvency II.

EIOPA has now published its response to feedback received during the consultations and published final guidelines. National regulators have until 31 December 2013 to decide whether they will comply with these.

An area that caused that a lot of confusion in the industry when the draft guidelines were published was the use of wording that said that national regulators should take the steps specified 'from 1 January 2014'. This led many to assume that on 1 January 2014 firms would have to comply with all of the provisions set out in the guidelines.

The consultation reports clarify the situation. The aim of the guidelines is that firms gradually increase their levels of compliance such that they comply with essentially all of the Solvency II requirements by 31 December 2015 (EIOPA is assuming that Solvency II will come into force on 1 January 2016). The date 1 January 2014 was included only because, up until this date, national regulators are free to choose not to require anything of firms in terms of Solvency II preparation.

This does rather raise the question of what exactly the guidelines are trying to achieve. In the UK firms were already discussing implementation plans with their supervisors from the PRA. These plans were based on the ideas that firms would need to fully comply with Solvency II from the day it came into force. It is therefore not immediately obvious what changes adoption of the guidelines will bring. It could perhaps be argued that the guidelines focus efforts in certain areas: for example, whilst firms probably would use dry runs to test their reporting systems, they might not have been intending to send the results to the PRA until these guidelines were produced.

The theme that runs through EIOPA’s report on the consultations is that most of the guidelines are things that firms should have been planning to do anyway. This does however mean that very few changes have been made to the guidelines as a result of the consultation.

Some key highlights from the consultation report and the final guidelines are given below

The guidelines themselves do not lead to capital requirements

EIOPA have made it clear that they expect firms to take account of any information gained through carrying out the “Forward-Looking Assessment of Own Risks” (FLAOR) and to discuss the results with regulators if appropriate. However EIOPA also point out that the guidelines do not require national regulators to make firms raise additional capital or otherwise manage their capital requirements on the basis of the information gained from the FLAOR. Whether or not to take action on the back of the results of the FLAOR will be a judgement for national regulators.

Similarly, firms are required to carry out dry runs of Solvency II reporting during the preparatory phase. However EIOPA have said that there is no requirement for regulators to take action if the reports produced show that a firm has not met its SCR during the preparatory phase.

Pillar 1 will be ready in time for firms to carry out the tasks in the guidelines

In the blogs we wrote at the time that the draft guidelines were published, we commented that a number of the proposed requirements would lead to firms needing to calculate their solvency position under Pillar 1 of Solvency II. This is currently difficult as Pillar 1 has not been finalised and key elements such as the long-term guarantees package are under lengthy discussion, so firms would need to carry out multiple runs.

EIOPA’s response to this has been essentially to say that Pillar 1 will be finalised in time. They point out that the first dry runs of reports of Solvency II balance sheets will be as at 31 December 2014 and that firms will have the first 22 weeks (up from 20 weeks in the draft guidelines) to report results. Therefore, the argument goes, Pillar 1 will not be needed until early 2015.

Similarly, EIOPA have clarified that the FLAOR carried out during 2014 needs only to be an assessment of a firm’s risks and capital needs and does not need to assess the firm’s ability to continuously meet the regulatory SCR: this will be an additional requirement for the FLAOR carried out in 2015.
In any case, EIOPA have promised to review the situation regarding Pillar 1 at the end of 2013 and to adjust the dates in the guidelines if insufficient progress has been made towards finalising Solvency II.

Over-zealous national regulators are not EIOPA’s concern

EIOPA has acknowledged the industry’s concerns that some national regulators may implement preparation regimes that go beyond the guidelines in order to make absolutely sure that they are seen to comply. There may be inconsistent application of the guidelines across Europe. However EIOPA’s response is that this is a matter for national regulators and is not an issue relating to the guidelines themselves.

Many of the requirements will be needed under Solvency II anyway

The guidelines require various things that have been criticised by the industry in responses to the consultation. EIOPA’s response has largely been to hold firm and to say that these are all things that will be required under Solvency II and so firms will have to comply with them at some point, regardless of what preparatory guidelines say. Specifics include:

• Criticisms that the responsibilities of each key function in the system of governance are too prescriptive.
• The requirement to have sub-policies of the risk management policy in place.
• The requirement to set tolerance limits for operational risk and to collect and monitor operational risk events.
• The requirement that key risk indicators should not depend solely on information provided by other financial institutions, asset managers and ratings agencies. 
• The industry requested that various parts of the FLAOR be postponed until full implementation of Solvency II, specifically the FLAOR policy, the record of the assessment and the supervisory report.

The role of the Actuarial Function is not limited to producing the numbers

The industry has argued for fewer requirements of the Actuarial Function during the preparatory phase, since the technical provisions cannot be calculated until Omnibus II has been settled. EIOPA have responded that “undertakings should not underestimate the work required to get the Actuarial Function ready for Solvency II” and have stated that this is not limited to helping with reporting to national regulators.

Some parallel running is unavoidable

This was a particular concern regarding reporting information to regulators: firms pointed out that they would have to carry out dry runs of Solvency II reporting alongside business-as-usual reporting under Solvency I. EIOPA acknowledged that this will be a drain on resources, but say that they can see no way to avoid it if there is to be seamless transition from Solvency I to Solvency II.

Firms made similar criticisms about projecting their position under the Solvency II regime for the FLAOR at a time when Solvency I remained in force. EIOPA’s response is that the FLAOR should be an important part of the way in which the business is managed and they do not see that it is possible for firms to take business decisions without considering how it will affect their solvency position under the new regime.

I think it is fair to say that, at the moment, many companies are taking decisions with only scant regard to possible changes under Solvency II. This is understandable given the lack of faith that Solvency II will come into effect.

Firms shouldn’t count on internal models being approved

The industry criticised the requirement for IMAP firms to have to perform the FLAOR using the standard formula. This obviously creates extra work. EIOPA’s response is that “Proper preparation for Solvency II involves taking into account contingencies [sic]. Undertakings and groups which are under the pre-application process for an internal model cannot be sure that their internal model will meet all the necessary requirements for supervisory approval by the time Solvency II starts.”

Preparing for Solvency II reporting will take 18 months

The industry feedback was that it was not sensible for firms to develop systems for Solvency II reporting at the moment, given that the numbers that will be reported and the way they are calculated may change by the time that Omnibus II is finalised. EIOPA’s response is that the industry has already told it in previous consultations that preparation will take 18 months and so, if Solvency II is to come into force on 1 January 2016, preparation for reporting will have to start very soon.

Line-by-line asset data for unit-linked business is necessary

The industry argued that reporting line-by-line asset data for unit-linked business was unduly burdensome, given that it is the policyholder who bears the investment risk. EIOPA rejects this argument, saying that unit-linked business presents specific risks such as conflicts of interest.

Commentary

The final guidelines have not included any additions but EIOPA have provided some clarity. Concerns for the industry will include:

• Will there be enough time to prepare if Solvency II is implemented on 1 January 2016?
• Will the PRA go beyond the requirements of the guidelines?
• Solvency II has been subject to a number of delays and firms have been reluctant to commit any more resources to it until there is more certainty about whether it will eventually be implemented. There may be challenges persuading boards or management to re-engage with the project.

References:

1: /comment-insight/blog/2014/03/15/applying-eiopas-preparatory-guidelines-pre-app/

2: /comment-insight/blog/2014/03/15/applying-eiopas-preparatory-guidelines/

3: /comment-insight/blog/2014/03/15/applying-eiopas-preparatory-guidelines-flaor/