From Fragmentation to Financial Integration in Europe

Chapter 19. European Insurance and Occupational Pensions Authority

Charles Enoch, Luc Everaert, Thierry Tressel, and Jianping Zhou
Published Date:
December 2013
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Rodolfo Wehrhahn

The European insurance industry writes more than a third of insurance premiums globally. The €1,074 billion in premiums written by more than 5,500 European insurers in 2011 accounted for about 36 percent of the global insurance market. More than 91 percent of European premiums are written in the European Union (EU), highlighting the leading role of the EU for the global insurance industry (Figures 19.1 and 19.2). During 2011, insurers paid about €1,000 billion in claims: life claims, benefits, and annuities amounted to €615 billion; €100 billion for motor claims; €85 billion for health claims; and more than €55 billion for property claims.

Figure 19.1Insurance Industry Global Market Share, 2011

(In percent)

Source: Swiss Re, “Sigma 3/2012, World Insurance in 2011.”

Figure 19.2Insurance Premiums by Country, 2011

Source: Insurance Europe, 2012, “European Insurance: Key Facts.”

Insurance penetration is among the largest in the world, although important differences between member countries exist. Notwithstanding the 5.9 percent drop in premiums in real terms experienced in the region in 2011, insurance consumption remains high. The average expenditure per capita in 2011 on insurance of €2,767 remains one of the highest in the world. Furthermore, with penetration of about 7.89 percent, the EU shows a penetration level close to that of the G7 (8.7 percent) but remains behind Japan’s 11.3 percent. However, important differences in the consumption of insurance are present among member countries, for instance, the Netherlands reported insurance penetration of 13.3 percent in 2011 as compared with Bulgaria’s level of about 2 percent. Also, the spread in written premiums is large, varying from more than €200 billion in the United Kingdom to about €300 million in several smaller country members (Figure 19.2).

The size of the top insurance corporations and occupational pension funds appears to be correlated with the GDP of the home country, but there are important outliers. The size of the top insurers in a country increases with the GDP of the given country, as depicted in Figures 19.3 and 19.4 showing a coefficient of determination of 0.415. However, the data show important exceptions of insurers that are three to four times larger than the expected average size corresponding to the correlation slope. With one exception, occupational pension funds follow the correlation slope of the home country much more closely. The presence of large insurers in relation to the GDP of the home country could pose a challenge to proper supervision, particularly if insufficient resources are available to be deployed for the required level of scrutiny based on the relevance of such insurers to the financial sector.

Figure 19.3Correlation between Top Insurance Corporations and GDP of Home Country, 2011

(In billions of euro)

Source: European Insurance and Occupational Pensions Authority; and IMF staff calculations.

Figure 19.4Euro Area: Correlation between Assets under Management of Top Occupational Pension Funds and GDP of Home Country, 2011

(In billions of euro)

Source: European Insurance and Occupational Pensions Authority; and IMF staff calculations.

Insurance investments have been increasing since 2008, and in 2010 reached their precrisis level. After the significant drop in value in 2007 from €7,300 billion to €6,600 billion, in 2011 the insurance industry invested about €7,500 billion or 60 percent of the EU’s GDP, as indicated in Figure 19.5. Life insurers’ investments have traditionally accounted for more than 80 percent of total insurers’ investments. The United Kingdom, France, and Germany together accounted for more than 60 percent of all European life insurers’ investments.

Figure 19.5Investments of the Insurance Sector

(In billions of euro)

Source: Insurance Europe, 2012, “European Insurance: Key Facts.”

The last impact study, using 2009 data, confirmed that the industry overall remained well capitalized under the draft provisions of the Solvency II Directive1 and options tested. However, balance sheets have deteriorated since 2009. Between 2005 and 2010, the Committee of European Insurance and Occupational Pensions Supervisors conducted five pan-European quantitative impact studies (QISs) at the request of the European Commission. These studies analyzed the impact on the insurance sector of the proposed Solvency II requirements. In March 2011, the European Insurance and Occupational Pensions Authority (EIOPA) delivered to the European Commission a report on the results of the fifth QIS, which covered more than 2,500 individual undertakings and 160 groups from the 30 members of the European Economic Area (EEA). On a global level, the surplus under QIS5 was roughly 12 percent lower than the 2011 surplus of about €400 billion. However, deterioration of the balance sheets since 2009 could have worsened this situation, and the introduction of Solvency II could call for additional capitalization.

Protracted slow economic growth and the continuing low interest rate environment is putting pressure on the insurance sector. Profits during 2011 were in the 3 percent range or negative.2 Solvency levels have been decreasing as a result of the poor investment climate, and the stagnating economy has resulted in lower production and higher claims in several member states. The high exposure to sovereign debt presents an additional vulnerability to the sector, in particular to the life industry. The long-lasting low interest rate environment prevailing in certain states (see Figure 19.6) coincides in most cases with insurance business models that provide long-term guarantees and that currently use solvency regimes that are less sensitive to market interest rates. The change to a market-consistent valuation in these countries is expected to have significant impacts on the liabilities of insurers and pension funds.

Figure 19.6Low Interest Rate Environment

Source: Bloomberg, L.P.

In addition to adverse market conditions, impending regulation adds uncertainty to the future of the industry. Besides Solvency II, initiatives such as the Common Regulatory Framework for Internationally Active Insurance Groups (ComFrame) and the Second Insurance Mediation Directive (IMD2) will affect investment preferences, legal structures, and distribution channels as well as the insurance business models, thus creating a high level of uncertainty about the future of the sector. These negative aspects are likely reflected in the share prices and credit default swap spreads observed across the industry (Figure 19.7).

Figure 19.7Market Cap (billions of euro) and Credit Default Swap Spreads (basis points) of Top European Insurers, 2007–12

Source: Bloomberg, L.P.

Institutional Structure

EIOPA has been assigned oversight, monitoring, and implementation roles in the insurance and occupational pension sectors. EIOPA’s stated objective is to protect public interests by contributing to the short-, medium-, and long-term stability and effectiveness of the financial system, for the EU’s economy, its citizens, and businesses, acting within the scope of various directives covering insurance and reinsurance undertakings, institutions for occupational retirement provision, and insurance intermediaries, as well as related issues not directly covered by these directives. EIOPA participates in the two joint bodies of the three European supervisory authorities: (1) the Joint Committee, which has the goal of strengthening cooperation between the European supervisory authorities, and (2) the Board of Appeal, which is independent of the European supervisory authorities’ administrative and regulatory structures and gives parties the right to appeal decisions of the European supervisory authorities.

A high level of transparency characterizes the EIOPA’s actions. EIOPA’s commitment to transparency and public consultation has been achieved by instituting stakeholder groups that include representatives of the industry, consumers, and beneficiaries, as well as academics. EIOPA has established the Insurance & Reinsurance Stakeholder Group and the Occupational Pensions Stakeholder Group, each comprising 30 members. There are five scheduled meetings per year. During 2012, EIOPA published 13 detailed opinions and feedback documents from the stakeholder groups. A review of the effectiveness of the stakeholder groups is currently been carried out.

Operational independence could be enhanced by removing possible sources of interference. The legal status of EIOPA is that of an independent advisory body accountable to the European Parliament and the Council of the European Union. However, its financing structure could hinder effective independence. National authorities contribute 60 percent of the budget, and the national authorities are the voting members of the Board of Supervisors. Thus, members of the Board of Supervisors may face conflicts of interest in agreeing on the implementation of EIOPA’s tasks and powers that affect their own powers and responsibilities as national supervisors. This conflict could be more important in crisis management or breach of union law situations. The remaining 40 percent of the budget is also not free from possible conflicts of interest, given that it is a subsidy from the EU embodied in the Directorate General Market Operations budget; but this directorate approves the standards drafted by EIOPA. This situation may make the dispositions in the EIOPA Regulation (EReg) on the adoption of regulatory technical standards less effective.

EIOPA applies an annual zero-based budgeting approach requiring each item of proposed expenditure to be justified with no automatic budget rollover. The rules and process steps for EIOPA’s budget planning are included in the EReg, the Financial Regulation applicable to the general budget of the European Commission, and the individual Financial Regulation of EIOPA Title III, Chapter 1. EIOPA’s budget planning is guided by Title II of the EIOPA Financial Regulation regarding budgetary principles in a context of sound financial management. This budgetary approach aims to ensure that EIOPA receives the appropriate annual amount to meet its annual operational objectives and that EIOPA optimizes its level of budgetary usage.

A two-year advance budget planning process complements the zero-based budgeting approach. The Executive Director submits the draft statement of estimates of revenue and expenditure for year N+2 to the Management Board and to the Board of Supervisors at the beginning of year N+1. This draft statement is built to cover the business needs and activities as expressed in the annual work program for year N+2. In parallel to the draft estimate, a staff establishment plan for EIOPA is drafted and submitted to the same boards. The Board of Supervisors, in turn, transmits the statement of estimates of revenue and expenditure for N+2 to the European Commission, together with the draft establishment plan as per Art 63 of EReg. After a consultation process, the budgetary authority (European Parliament, Council) adopts in November the establishment plan for EIOPA and authorizes the appropriations for the subsidy to EIOPA. The budget is finalized at the final adoption of the general EU budget. During the process, budget cuts can and have occurred, requiring a change in the priorities of the agency.

EIOPA has been able to attract qualified professionals. The number of employees is expected to rise from 57 in 2011 to 114 for 2013. Currently, the Chairman and Executive Director are supported by the Director of Regulations and the Director of Oversight and Operations, who lead a team of 64 staff members, 10 secondees, and 13 contract agents. The number of staff dropped by 10 percent in one year, but these employees were replaced by an increased number of secondees and contract agents. It appears that work continuity and institutional knowledge did not suffer from this attrition, considered natural in the current dynamic stage of development faced by EIOPA. Staff received an average of 0.58 days training in 2011 and 2.11 days in 2012.

Significant changes in the regulatory environment affecting insurance and occupational pensions are expected in the coming years. Solvency II is scheduled to be implemented in 2014, and revised legislation for occupational pensions should be in force. These major changes will affect the work required from EIOPA. A shift from developing technical standards, issuing guidelines and recommendations, and providing opinions toward monitoring, implementing, and enforcing will be necessary. EIOPA’s human resources framework, as well as its operational processes, will need to be realigned to the new challenges.

Budgetary framework flexibility supporting Solvency II implementation should be considered. Given the current stage of the European insurance framework, which is in the process of implementing Solvency II, special skills and expertise are required for the initial development of adequate tools to properly monitor harmonized implementation, including internal models for approval processes, reporting tools, and the like. Investing in this initial phase will require temporary access to special expertise that may not be within the payment framework that currently applies to EIOPA. Flexibility on a temporary basis in the salary scales and swift access to external consultants will allow the necessary high-level expertise to be gained for the creation of solid supervisory tools, especially in the modeling, information technology, and actuarial areas. Furthermore, should direct supervisory mandates be assigned to EIOPA, budgetary treatment similar to that which applies to the European Central Bank should be considered.

Powers and Mandates

The multiyear business plan for 2012–14 and the annual plan for 2013 focus on key deliverables that are aligned with EIOPA’s mandates. The tasks include the completion and monitoring of the implementation of Solvency II, the further development of supervisory colleges, and consumer protection issues as well as financial stability and crisis management actions. The plans also focus on adapting and further growing the internal organization to cope with the changing and growing assignments. The need for a centralized, efficient, information technology platform to allow for confidential information exchange with national authorities is recognized, and its development is accordingly planned. Some of the specific actions required to meet the new challenges are mentioned in EIOPA’s working plan document for 2012—14:

  • Establishment of the operational tasks required of EIOPA under Solvency II;

  • Enhancement of convergence in supervision by greater use of tools, for example, supervisory review processes, Q&A; and

  • Use of EIOPA’s existing tools for assessing the effects of regulatory changes, that is, regulatory impact assessments.

Powers granted to EIOPA appear sufficient to accomplish the current tasks. During the introductory and construction phase of Solvency II, the powers residing in the agency—including the development of draft regulatory and implementation technical standards and the issuance of guidelines and recommendations that need to be adopted or explained—have proved to be sufficient, albeit there were some delays and certain inefficiencies with respect to the initial implementation plan of Solvency II. In the area of contributing to a common supervisory culture, a soft approach based on peer reviews, training, and frequent engagement in the colleges of supervisors supported by the use of guidelines has been effectively taken.

The new challenges ahead for EIOPA will require revisiting its current powers. The implementation and monitoring of Solvency II will require more intrusive tools to prevent undue delays that could result in regulatory arbitrage and thus threaten to defeat the purpose of a harmonized supervisory regime in the EU. The power to collect the necessary information about financial institutions as provided for in Article 35 of the EReg has been challenged with respect to the level of detail. Considerable granularity in data collection appears to be fundamental to accomplishing tasks related to financial stability surveillance and emergency situations. The data collection powers need to allow for the necessary level of information gathering.

In the area of promoting effective colleges of supervisors, stronger powers would help accelerate the process; conflicting views among the participant supervisors will emerge that will require strong leadership for their efficient resolution. These additional powers could even go so far as to enhance the supervisory responsibility of the group, including the power to impose sanctions. The supervisory powers should, at a minimum, cover important large groups. However, such a change might require changes in numerous laws.

Systemic Risk and Stress Testing

EIOPA’s mandate includes working with the European Systemic Risk Board on identification of, measurement of, and response to systemic risk. EIOPA’s role is defined as a supporting role to the European Systemic Risk Board, as stated in Article 23(1) and Article 17 of Regulation (EU) No. 1092/2010.2. Due consideration of international approaches, including those established by the Financial Stability Board, the International Monetary Fund, the International Association of Insurance Supervisors (IAIS), and the Bank for International Settlements, is required. EIOPA’s work in this area includes the development and coordination of effective and consistent recovery and resolution plans, procedures for emergency situations. and preventive measures to minimize the systemic impact of any failure of insurers or occupational pension funds.

A framework for EIOPA’s action in a crisis situation has been developed. In mid-2011, a task force on crisis management was created to develop EIOPA’s institutional structures to discharge its crisis management responsibilities under Article 18 of EReg. The Board of Supervisors adopted a core crisis-management framework in December 2011. This framework sets out clear procedures for EIOPA’s action in the event of adverse developments as defined in Article 18 or of a declaration of an emergency situation by the council.

EIOPA has been engaged in a process of regular, structured dialogue with national supervisory authorities (NSAs) throughout the global financial crisis. EIOPA’s internal monitoring group is a key element supporting EIOPA in fulfilling its crisis prevention and management duties. The internal monitoring group comprises selected members from national supervisors and meets several times a year. It is at this venue that information and analysis can result in supervisory or other action by EIOPA and its members. The internal monitoring group, by drawing together analytical and other information from other EIOPA working groups, assesses whether responses are needed or prepares proposals for action that are put to the EIOPA Board of Supervisors for decision. Among the key activities carried out by the group during 2012 was the introduction of a bimonthly qualitative survey on significant balance sheet changes and exposures to sovereign and bank risk, liquidity risk, and cash flow risk, among other themes.

Further work is required in the area of crisis management to allow for efficient, swift actions by EIOPA. With the framework on crisis management, EIOPA has met an important operational requirement. However, relevant elements still need to be put in place, such as the missing sectoral legislation for consumer protection during emergency situations. An important gap relates to the requirement for a declaration of emergency by the European Council that would allow the agency to take decisive, effective action to combat matters affecting the orderly functioning and integrity of financial markets or the stability of the whole or a part of the financial system in the Union, or in those situations concerning directly applicable Union law. The possibility of allowing EIOPA to act in a decisive manner without an explicit declaration of an emergency should be evaluated.

Access to information and the use of such information for monitoring, analyzing trends, and preventing systemic risk need to improve. Financial stability data are collected from the 30 biggest cross-border insurance groups, including three Swiss groups and some of the solo institutions above a certain threshold of gross written premium. EIOPA, however, does not receive the data on an identifiable individual group level that would be necessary for performing the authority’s tasks. Furthermore, EIOPA does not have direct access to any national supervisory data, although data are submitted to EIOPA upon request (for example, data related to financial stability and crisis prevention). EIOPA should be granted the power to request supervisory data for any institution on a timely basis.

Stress testing is one of the explicitly indicated tools to be used by EIOPA for crisis prevention. In accordance with Article 32 of EReg, EIOPA uses stress testing as a tool to assess the resilience of financial institutions Union-wide. In particular, the systemic risk posed by financial institutions is evaluated under theoretical adverse market developments. Also, consistent use of stress testing across the NSAs is part of its mandate. For the 2011 exercise, covering 50 percent of all national markets measured by gross written premium, almost all risk drivers were included in the stress scenarios, and stress levels were determined based on a historic distribution analysis. The stress levels were approved by EIOPA’s Board of Supervisors. Results of the individual industry submissions were validated by the NSAs first and then again by a central validation team made up of NSA and EIOPA experts. The final report was approved by the Board of Supervisors. Disclosure of the results occurred on an aggregated basis.

EIOPA’s stress tests under the Solvency II regime should focus on EU-wide systemic vulnerabilities. EIOPA currently uses stress tests to analyze the effect of shocks adversely affecting the traditional areas of insurance vulnerability, such as mortality, lapse, and market exposures. A strong emphasis has been put on supporting the development of Solvency II through a series of qualitative impact assessments. Once the new solvency regime is in place, EIOPA’s stress test should move to enhance and harmonize the national stress-testing activity with a special focus on identifying cross-border systemic risk. This move will require consideration of single and multiple shocks affecting the relevant variables in the areas of financial market structure, interactions, and regulation and supervision responsible for the fallacies of composition, that is, situations in which the sum of the individuals does not describe the behavior of the whole group. Such stress tests should incorporate systemic feedback effects under macroeconomic scenarios, as well as allow for contagious shocks to spread rapidly through the whole financial sector.

Harmonizing Supervisory Practices

From March 2010 to April 2010, EIOPA’s predecessor, the Committee of European Insurance and Occupational Pensions Supervisors, carried out a survey of the level of preparedness of insurance supervisors with reference to the implementation of Solvency II. From the 27 supervisory authorities that answered the questionnaire, 11 are small supervisory authorities (with fewer than 40 employees dealing with insurance), 11 are medium-sized supervisory authorities (with 40–100 employees dealing with insurance), and 5 are larger supervisors (with more than 100 employees dealing with insurance). The number of staff varies widely, from 25 to more than 3,300, and depends on market size as well as the level of integration of the financial sector supervisory authorities. As to the number of supervised insurance and reinsurance undertakings subject to Solvency II in each country, the range is also wide: from 10 up to 625.

The evaluation of NSAs’ ability to implement the forthcoming solvency regime should take priority. The difference in resources among the NSAs presents an important challenge to EIOPA’s supervision harmonization efforts. Along with the review of capacity to implement Solvency II, a peer review of stress test practices is recommended.

To monitor and enhance supervisory convergence within the EEA, the Board of Supervisors established a review panel. The panel is a permanent group comprising representatives of the NSAs with the necessary independence, objectivity, seniority, knowledge of the community legislation and EIOPA measures, and expertise in supervisory practices to guarantee the credibility and the effectiveness of the peer review mechanism. The last peer review (so far, the only one completed) dates back to 2009 and comprised the application of the provisions of information exchange and supervisory cooperation in the context of the General Protocol, the Budapest Protocol, and the Helsinki Protocol. The peer review activity has recently been revived. EIOPA has started peer reviews in the areas of internal model application and supervision of branches, and for a few articles of the occupational pension directive.

Harmonization of supervision through the peer review exercise should be enhanced by having EIOPA in a role to challenge the outputs. The peer review panel issues best practices that need to be adopted or explained by each NSA; EIOPA’s independence and strong European view should add value to this process. EIOPA will accelerate supervisory harmonization by playing a role that goes beyond that played by the secretariat under current practice and by owning the process.

Supervisory Colleges and Group Supervision

In the area of group supervision, EIOPA’s tasks go beyond pure regulatory work. Following Article 242 of Directive 2009/138/EC, EIOPA is required to contribute to the proper functioning of colleges of supervisors; to make an assessment of the benefit of enhancing group supervision and capital management within a group of insurance or reinsurance undertakings, including possible measures to enhance sound cross-border management of insurance groups, in particular in respect of risks and asset management. In addition, EIOPA may report on any new developments and progress concerning practices in centralized group risk management and functioning of group internal models, including stress testing, intragroup transactions, and risk concentrations; a harmonized framework for asset transferability, insolvency, and winding-up procedures that eliminate the relevant national company or corporate law barriers to asset transferability; and an equivalent level of protection of policy holders and beneficiaries of the undertakings of the same group, particularly in crisis situations.

During 2011, 89 insurance groups with cross-border undertakings were registered in the EEA. Some 69 colleges of supervisors had at least one meeting or teleconference. A total of 14 national supervisory authorities acted as group supervisors to organize the events. During the setup phase in the first year after its establishment, EIOPA staff attended supervisory college meetings or teleconferences held by 55 groups. Important issues like crisis preparedness were introduced and some aspects were tested, confidentiality agreement templates were developed, and best practices on group supervision were presented.

EIOPA’s engagement in its oversight role of supervisory colleges has been intense, but much work remains to be done. A harmonized level of group supervision in the EU remains to be achieved for when the Level 3 legislation (implementation measures) comes into force. EIOPA’s engagement in colleges should go beyond the EU and encompass the larger international groups active in Europe. For financial stability purposes, consideration should be given to assigning EIOPA a supervisory role for the largest important groups.

Consumer Protection

EIOPA has been proactive in the area of consumer protection. Promoting transparency, simplicity, and fairness in the market for consumer financial products or services across the EU is a stated objective of EIOPA. The first guidelines applicable to NSAs under the “comply or explain” scheme have been issued on Complaints-Handling by Insurance Undertakings. In addition, a report on Good Practices for Disclosure and Selling of Variable Annuities as a tool to promote common supervisory approaches and practices has been published. A consumer strategy day takes place annually, when consumers, industry, and the NSAs discuss current issues under EIOPA’s leadership.

An initial report on consumer trends was published in June 2012. EIOPA does not yet collect statistics on the number or type of insurance complaints received from NSAs of member states; however, based on information collected from the NSAs, it has presented its first initial consumer trends overview. Three main trends were identified:

  • Consumer protection issues around payment protection insurance,

  • Development of unit-linked life insurance, and

  • Increased use of comparison websites by consumers.

In addition, EIOPA’s intention is to publish regular reports on consumer trends using a recently adopted enhanced methodology based on quantitative and qualitative data collection, including number and type of insurance complaints received.

EIOPA is engaged in the revision of the IMD2. The proposal provides that “all information, including marketing communications, addressed by insurance intermediaries and undertakings to customers or potential customers should be fair, clear and not misleading.” The IMD2 proposal also sets the expectation that EIOPA will periodically develop guidelines for the assessment and supervision of practices of tying an insurance product to an ancillary service or bundling an insurance product together with an ancillary service. Under the current text of the legislative proposals on packaged Retail Investment Products and the IMD2, EIOPA is expected to work on delegated acts ensuring that information about products is adequately disclosed and products are sold in a fair way to consumers, for example, to ensure suitability of the product to the customer and to mitigate conflicts of interest. EIOPA is in a position to highlight the particular aspects of insurance products and insurance distribution practices when cross-sectoral discussions take place.

EIOPA’s powers to restrict or ban certain products are limited. Warnings on, as well as prohibitions and restrictions of, certain financial activities can be issued by EIOPA should such activities pose a serious threat to the stability and effectiveness of the financial system. This power, however, can only be used if cross-sector legislation is enacted, setting out the specific cases and conditions under which EIOPA would be able to issue such temporary prohibitions and restrictions. A permanent prohibition or restriction of certain financial activities would require the European Commission’s authorization. A framework for the effective monitoring of products with the potential to impact financial stability and to severely affect consumers should be established as a first step toward justifying any prohibitions.

EIOPA’s initial findings on existing guarantee schemes show an urgent need for harmonization. EIOPA’s task force on insurance guarantee schemes has published two reports, the “Report on the Cross-Border Cooperation Mechanisms between Insurance Guarantee Schemes in the EU” in 2011, followed by the “Report on the Role of Insurance Guarantee Schemes in the Winding-Up Procedures of Insolvent Undertakings in the EU/EEA” in 2012. The first report is a mapping exercise of existing cross-border cooperation mechanisms and it resulted in five recommendations. The findings of the second report highlight the lack of harmonization in areas such as the ability to transfer portfolios, the lack of prewarning systems for when insurance undertakings are in difficulty, and the role of the supervisory authority when insurance undertakings become insolvent.

Occupational Pensions

EIOPA’s response to the call for opinions on the proposed new directive on occupational pension funds highlights the need for transparency in the level of protection and modernization of the existing regimes. EIOPA’s response evaluates the advantages of enhancing transparency through improved harmonization of reporting, stricter requirements on governance and risk management similar to the second pillar of Solvency II, and the use of a holistic balance sheet approach for measuring the solvency position of the different institutions for occupational retirement provision (IORPs). A QIS of IORPs using a holistic balance sheet valuation method was undertaken and the results were published in July 2013. The report shows wide dispersion in impacts using the holistic balance sheet method, ranging from surpluses in some member states to large shortfalls in other member states. The results underscore the need for further work toward guaranteeing the sustainability of pension funds and the protection of current as well future generations’ pensions.

The initial purpose of the new IORP directive—to remove impediments to the creation of a single market—has been relinquished in favor of creating more comparability in the solvency and resilience of the different IORPs. The lack of demand for cross-border activity—only a handful of IORPs currently provide cross-border pensions—as well as the fact that important aspects of cross-border activity, such as labor, social, and tax laws, remain within the national purview, has shifted the focus of the new IORP directive toward enhancing transparency of the level of resilience of the different IORPs. Greater transparency and a holistic balance sheet approach that takes into account both implicit and explicit guarantees of the sponsors will allow comparison of the various IORPs throughout the EU. This comparison is recognized as an important step toward the creation of a single market. Given the complexity of the current solvency regimes in the different jurisdictions, the results of the QIS exercise can only be seen as a first step before a final sound valuation methodology can be introduced.

Solvency II

The more than 75 percent of supervised insurers that produce about 85 percent of the EU’s gross written premiums will need to comply with Solvency II. Based on the last QIS exercise, of the 4,753 supervised entities, 3,680 are expected to be covered by the Solvency II directive, that is, they write premiums larger than €5 million or they have technical reserves in excess of €50 million. These entities are responsible for more than 95 percent of the aggregate technical reserves. The fact that several EU members have delegated most of the necessary updating of their existing national solvency regime to the efforts undertaken by EIOPA has increased the relevance of the proper and timely implementation of the new solvency regime for Europe.

The impact study highlighted the areas in which further work was needed: definition of contract boundaries in the valuation of technical provisions; the need to reduce complexity in certain areas; developments in the calibration of catastrophic risk; and the treatment of long-term guarantees in the context of Solvency II. This work has been initiated by EIOPA.

EIOPA is currently developing draft standards and guidelines in the following areas:

  • Solvency capital requirements for the standard formula as well as for internal model users; own funds; valuation of technical provisions; valuation of assets and liabilities;

  • Group supervision;

  • Supervisory transparency and accountability, reporting and disclosure, external audit;

  • Governance and own risk solvency assessment; and

  • Supervisory review process; capital add-ons; extension of recovery period (Pillar 2 dampener3); finite reinsurance; special purpose vehicles.

The implementation of Solvency II is now scheduled to take place in January 2014. The Solvency II Directive text is under revision as part of the Omnibus II Directive revision, which is still at the time of writing under discussion among the council, parliament, and the commission. The Omnibus II trialogue provisionally scheduled for October 1, 2012, did not take place. The main disagreement centers on extending the long-term guarantees package (especially the matching adjustment) to a wider range of products. A directive (2012/23/EU) was published as an interim measure to specifically revise the date of transposition and entry into force of the Solvency II Directive to June 30, 2013, and January 1, 2014, respectively. However, although the Omnibus II Directive remains a matter for discussion, the implementing measures (or delegated acts) remain in draft form with the commission.

In July 2012, the trialogue parties requested that EIOPA conduct an impact assessment on the long-term guarantee aspects of the Solvency II package. EIOPA was asked to run a technical assessment to collect both qualitative and quantitative information from insurance and reinsurance undertakings and supervisory authorities on the effects of the long-term guarantees package. EIOPA was to launch the exercise on October 15, 2012. Insurance and reinsurance undertakings would have eight weeks to provide the information requested to their NSAs. The final report was scheduled to be provided to the colegislators by March 31, 2013, by the commission based on the findings of EIOPA’s technical assessment. However, the terms of reference were only agreed upon by the trialogue parties at the end of 2012. The results of the technical assessment were published on June 14, 2013. Discussions of the final measures for addressing short-term volatility and ultimately properly regulating long-term guarantees were to happen in the subsequent months.

Important discussions on the final form of Solvency II are taking place, with a main focus on the proper treatment of long-term liabilities. A market-consistent valuation of liabilities, as required by Solvency II, in a low rate environment will require the use of a low interest rate discount curve. This will have a negative impact on the solvency position of insurers under Solvency II, and asset-liability matching needs must be developed to avoid distortionary or noncredible effects. However, adjustments to the discount curve for asset-liability matching must to be carried out without reducing the market-consistency principle of the new solvency framework. Adopting rules for the valuation of long-term liabilities that exaggerate solvency positions of insurers under current adverse market conditions will weaken the credibility of Solvency II as a market-consistent solvency regime.

Preparation for the implementation of Solvency II is the central task for EIOPA. Although EIOPA’s involvement is required in other areas, and resources have been dedicated to these areas, the lion’s share of the authority’s activities focuses on readiness for the implementation of Solvency II. Fundamental changes are needed in the supervisory methodology, tools, and procedures in all areas of insurance supervision—quantitative requirements (Pillar I), qualitative requirements (Pillar II), supervisory reporting and public disclosure, and group supervision—in nearly all NSAs.

Weaknesses in insurance supervision in several EU member states will remain in the absence of Solvency II. The implementation of Solvency II is critical because important aspects of prudential supervision, such as valuation, disclosure, and risk management, in several EU member states will remain out of compliance with IAIS principles (as reviewed in recent Financial Sector Assessment Program reports) in its absence. Consideration should be given to early implementation of as much as possible of Solvency II to allow more supervisors to raise their standards.

The approval of internal models is a crucial step in determining capital adequacy to ensure a solvent industry. The level of expertise and amount of work required is severely straining the NSAs. EIOPA agreed on a workflow process to be followed by the NSAs and insurers for both pre-application and approval. EIOPA has been holding monthly meetings, open to operational supervisors from all member states, to discuss particular issues related to pre-application and the review of internal models. EIOPA has also held meetings with the main external stakeholders concerned with internal models, including undertakings, consultations, and external providers. Following these discussions with external stakeholders, in May 2012 EIOPA issued an opinion on the use of external models. Finally, consideration should be given to introducing a centralized oversight mechanism for the approval of internal models that would make efficient use of highly qualified resources and would guarantee a consistent, elevated level of technical proficiency.

Solvency II Equivalence and International Representation

EIOPA’s work on Solvency II equivalence certification is intense and relevant. The Solvency II Directive gives the European Commission the authority to decide on the equivalence of a third country’s solvency and prudential regime. EIOPA provides advice to the European Commission on this matter. Such work promotes open international insurance markets and reduces regulatory burdens while simultaneously ensuring that policyholders are adequately protected globally. EIOPA equivalence assessments include desk and on-site work and have been carried out for the Swiss and the Bermudian supervisory systems under Article 172 (reinsurance supervision), Article 227 (inclusion of related third country insurance and reinsurance undertakings in group solvency calculation), and Article 260 (group supervision); and for the Japanese reinsurance supervisory system under Article 172. Although EIOPA’s assessments have concluded, it will need to revisit its advice once the final Level 2 implementing measures, including the equivalence criteria, are published.

Transitional equivalence measures for several countries are also being evaluated. If a third country’s solvency and prudential regime is currently not able to satisfy the equivalence criteria in full, but will be in a position to do so once the relevant changes to the regime have been made, transitional equivalence measures are in place. Transitional equivalence measures for professional secrecy and a gap analysis against the Solvency II framework for supervisory regimes in the following countries are currently been developed: Chile, China, Hong Kong SAR, Israel, Mexico, Singapore, and South Africa.

The mutual recognition work with the United States supervisory regime is under way. In early 2012, the European Commission, EIOPA, the National Association of Insurance Commissioners, and the Federal Insurance Office of the U.S. Department of the Treasury agreed to participate in a dialogue and a related project to contribute to an increased mutual understanding and enhanced cooperation between the EU and the United States to promote business opportunity, consumer protection, and effective supervision. The steering committee agreed on seven fundamentally important topics:

  • Professional secrecy and confidentiality;

  • Group supervision;

  • Solvency and capital requirements;

  • Reinsurance and collateral requirements;

  • Supervisory reporting, data collection and analysis;

  • Supervisory peer reviews; and

  • Independent third-party review and supervisory on-site inspections.

Seven technical committee reports were jointly drafted. Following the end-September 2012 public release of the reports for interested party analysis and comments, conclusions were reached by the steering committee on each of the seven topics, and it published an agreed-upon “Way Forward” document that defines common objectives and initiatives. The shared objectives expressed in the document are expected to lead to improved convergence and regulatory compatibility between the EU and the United States. Work streams will continue through 2017.

EIOPA has been engaged in creating a common EU voice for insurance and pension matters. Achieving a common EU view on selected international agenda topics such as the development of a Common Regulatory Framework for Internationally Active Insurance Groups (ComFrame) and the designation of global systemically important insurers was initiated through the establishment and functioning of an internal network with representatives from NSAs. EIOPA became a member of the executive committee of the IAIS in 2011 and is active in its financial stability committee. EIOPA has also submitted its application to become an IOPS governing member in 2012.

EIOPA’s representation role in international forums should increase. The actions taken in promoting a common European voice at the IAIS on key topics has been helpful in supporting the international agenda of achieving convergence of solvency and supervisory practices, as well as for designing a cross-border resolution framework. EIOPA should be allowed access to important documents of the Financial Stability Board and other international bodies to facilitate performing its assigned international role The participation on the IOPS governing board should have a strong priority.

EIOPA has an important role in representing the insurance sector in standards-setting bodies in the fields of accounting and auditing. EIOPA is an official observer and active participant at the European Financial Reporting Advisory Group meetings as well as at the Accounting Regulatory Committee meetings. EIOPA is involved on an ongoing basis in exchanges of views and interacts with the Federation of European Accountants and the International Accounting Standards Board. EIOPA also follows discussions within the accounting experts group at IAIS and maintains contacts with the U.K. Financial Reporting Council, the German Deutsches Rechnungslegungs Standards Committee, the U.S. Financial Accounting Standards Board, and the International Federation of Accountants. In addition, coordination among the accounting and financial reporting areas of the other European supervisory authorities takes place through the Joint Committee. Also, discussions are ongoing with the European Commission’s Directorate General Internal Markets Unit F3: Accounting and financial reporting and Unit F4: Audit.

Current accounting treatment of assets and liabilities in the EU varies. Comparison of the financial positions of insurers in different jurisdictions is severely affected by the different supervisory accounting regimes. This problem is particular relevant when assessing the financial position of active cross-border insurance groups. The implementation of Solvency II will address this issue for EU operating groups. However, for internationally active insurers, comparison of solvency regimes will remain difficult because liabilities valuation under Solvency II and under International Financial Reporting Standards currently exhibit important differences. EIOPA’s representation in the standards-setting bodies in the fields of accounting and auditing should be leveraged to gain convergence or at least higher transparency in the treatment of liabilities.

See the European Insurance and Occupational Pensions Authority (EIOPA) web page for details on QIS 5 results.

Insurance Europe, 2012, “European Insurance: Key Facts.”

Pillar 2 dampeners are any technical elements that allow deviations from market consistent valuation of the capital requirements.

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