Bernardino urges caution on proportionality under Solvency II

Captive owners in particular have become increasingly worried that their special case may be overlooked as attention is focused on bigger concerns as Solvency II nears completion. It is feared that captives may fail to benefit from the simplified treatment suggested in the original Framework Directive and be treated the same as standard commercial insurers after all. During an interview with Commercial Risk Europe at the end of October Karel Van Hulle, Head of Unit, Insurance and Pensions, Financial Institutions Internal Market Directorate—General, reassured captive owners and smaller insurers that they would benefit from proportional and simplified treatment under the new capital adequacy and reporting rules.hideBut during his opening speech at the EIOPA annual conference yesterday in Frankfurt, Mr Bernardino said that an over-zealous application of the proportionality principle in reporting terms would be self-defeating. Mr Bernardino was clearly not talking with captives in mind, but it is clear that he for one will not advise the Commission, European Parliament and Council of Ministers that national supervisors should be given too free a hand when dealing with smaller and simpler insurers. Mr Bernardino said that EIOPA has been working hard on a set of harmonised templates that will substitute the 27 different reporting systems in the EU. He said that this would represent a huge achievement and generate ‘enormous’ benefits for the industry and for supervisors. Bigger insurers that operate in many different European countries would certainly welcome a more consistent system of reporting as many have complained of the time and cost involved with reporting to so many different supervisors using different systems in recent times. But smaller insurers may not be so pleased to hear that Mr Bernadino does not sound like he will support the kind of flexible approach to their supervision and reporting requirements that they desire. “While the concrete application of proportionality both on the frequency and on the nature of the information is still under discussion, let me reiterate that any limitations at the level of the reporting of the detailed lists of assets and on the access to basic quarterly information will have severe consequences on the effectiveness of the preventive micro and macro supervision at the EU level and would limit drastically the capacity of EIOPA and the ESRB (European Systemic Risk Board) to perform their roles,” he said. And in a thinly veiled point to the politicians who will be lobbied on this topic he added: “I am sure that the different EU political bodies will recognise the relevance of this point and will decide according to the best interest of consumer protection and financial stability.” During the interview with Mr Van Hulle, the EC man stressed that recent complications such as questions raised by Burkhard Balz, the Rapporteur for Omnibus II, the directive created to enable Solvency II to be implemented, would not be allowed to further delay the process. He is determined to ensure that Solvency II is implemented on January 1, 2014. Mr Bernardino echoed Mr Van Hulle’s comments. He said that EIOPA plans to start public consultation on technical standards and accompanying guidelines that are essential for the implementation of Solvency II in May 2012 regardless of Omnibus II. “This does not mean that we are disregarding the negotiations currently going on at the political level. We await with high interest the outcome of the vote on Mr Balz’s report on the Omnibus II Directive in the ECON and the forthcoming trialogue meetings. However, from our side, we also need to be sure that we will not be pressed for time at the final stage and that we do not run the risk of not delivering,” he explained. There are also some key technical matters that need to be sorted out before the process can be concluded. Mr Van Hulle told CRE that these were all based around the long-term guarantees that lie at the heart of much of the insurance business. “We are aware that the Directive needs to make sure that it takes account of the fact that insurers need to hold long-term investments in order to offer long-term guarantees to policyholders. Also that the rules do not overly limit their ability to do this by not taking account of the long-term nature of the investments and perhaps being too focused on the short-term fluctuations in market prices. We have been working on this issue for the last seven months through a working party that was created and is chaired by the Commission and a number of solutions have been realised,” said Mr Van Hulle. The solutions he listed as: A matching premium designed to deal with annuity business and provide protection when markets are extremely volatile. This would mean that long-term contracts can still be maintained in such periods in an ‘organised and economically viable’ manner. A proposed counter-cyclical premium that takes care of volatility in spreads of corporate or government bonds which is such a hot topic today currently. Volatility is clearly not helpful for long-term contracts. A proposal that deals with the extrapolation of the curve of the discount rate. Mr Bernardino felt moved to discuss the countercyclical premium yesterday stating that it would be useful but also warning that EIOPA and the market as a whole cannot use this as a way to try and ‘play God’ during a crisis. He pointed out that Solvency II already includes various tools to deal with the risk of pro-cyclicality. These include elements such as an ‘equity dampener’ under Pillar I, a supervisory ladder of intervention, and the Pillar II extension of the recovery period. All these, if calibrated properly, have the potential to mitigate pro-cyclical behaviour. Mr Bernardino said that the discussions have now, however, ‘evolved’ to the proposal of a counter cyclical premium to add on top of the risk-free interest rate when discounting insurance liabilities during times of crisis to effectively give insurers more breathing space. “While accepting that it is important to have a range of tools to use in crisis situations, I believe that we should be extremely cautious when designing this new tool. First of all I don’t believe that a complete formulaic approach is desirable or even possible. We should not pretend to play God and believe that we can decide in advance how the next crisis will look like,” warned Mr Bernardino. “Nevertheless, on top of a more flexible approach, I would support the definition of a set of clear criteria and indicators that should be constantly monitored by EIOPA and that would lead to a decision on the application of the counter cyclical premium, by EIOPA on a European basis, when certain defined thresholds would be exceeded,” he added. Mr Bernardino said that the design of the counter cyclical premium cannot incentivise insurers to invest in higher risky assets and should not be used to maintain unsustainable business models in an on-going situation. “It should be crystal clear that the counter cyclical premium is a crisis tool and that it will not be used to diminish the level of protection of policyholders,” he said. One other topic touched upon by Mr Bernadino that may spark interest in the European corporate insurance market was the promotion of ‘responsible business conduct’. The Insurance Mediation Act will be updated next year and his words may suggest a tougher line in broker transparency. Mr Bernadino said that one of the consequences of the global financial crisis was the increased level of scrutiny on corporate ethics. He added that market participants certainly recognise that good conduct of business is an essential element to regain the trust and confidence of consumers. “After all, ethical practices make good business sense,” he said. “However, self-regulation proved not to be sufficient. There are areas where obvious conflicts of interest have the potential to create problems and put in question the credibility of business operations. In this line I would certainly favour a serious and courageous approach to the conflicts of interest in the intermediation chain in the financial system,” said Mr Bernardino.

Bernardino urges caution on proportionality under Solvency II

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