The final frame – Karel Van Hulle

“The insurance industry recognised that this project would cost money to implement. But, insurers understood that they needed it as it would enable them to manage and measure their capital on a real economic basis and so be much closer to how they really run their businesses. It was welcomed because it would also allow companies to enjoy a dialogue with their national supervisors, which is quite innovative,” explained Mr. Van Hulle. The positive start was soon overshadowed, however, by a major dispute over the group support element of the proposed Directive. Under group support, companies with subsidiaries in other Member States would not have to hold the same amount of dedicated capital in each national subsidiary but could rely on (generally lower) group capital to back those units.hide“We introduced group support to allow for a better allocation of capital throughout the insurance groups to the benefit of those companies and policyholders. We felt strongly that parent companies should be able to replace part of the solvency capital of subsidiaries through a promise to deliver that capital if required from the group and that this would allow for a better organisation of overall capital,” explained Mr. Van Hulle. The European Parliament was fully supportive of this. But many of the national supervisors were worried that the capital may not arrive once called from the parent company. “We fought a difficult battle and lost. Member States were afraid that capital promised would not come in the end,” said Mr. Van Hulle. Despite the loss of this battle, the Commission with the help of the European Parliament, however, managed to insert a clause within the framework Directive approved by Parliament and the Council of Ministers in the spring of last year that stated that the issue would be revisited in three year’s time. The next big step was for the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) to carry out further consultation to enable it to work out proposals for the detailed implementing measures to make Solvency II work in practice. The committee made the bulk of its recommendations in November of last year and launched the final set of consultation papers at the same time with a very tight consultation deadline of December 11. CEIOPS gave its final advice to the Commission this month. The proposed technical specifications for the final quantitative impact study (QIS 5) will be published for consultation in March and the study will run from August to November. The information gathered from this study will give CEIOPS and the Commission a good idea of how much capital will be needed. At the end of October 2010 the Commission will publish the Draft Level 2 Implementing Measures, the QIS 5 results will be published in April of 2011 and the Level 2 measures will be adopted in the second half of next year. If this all occurs then the Directive will be in force by October 31, 2012. The consultation papers issued by CEIOPS last summer and again in October are very detailed and the committee received about 20,000 responses to the first batch with a huge range of opinions on a large number of issues, not least the treatment of captive insurance companies that merited its own consultation paper in October. The third wave of advice issued last November caused uproar in the insurance industry because CEIOPS had toughened up its advice considerably since QIS 4 was carried out in late 2008. Key changes included tougher market risk and insurance risk calibrations, changes in the calculation of the discount rate, correlations and diversification matters and restrictions on the allowance of hybrid debt as part of core eligible capital. CEIOPS argued that the basic formula for the solvency calculations had to be toughened up because the credit crisis and subsequent financial downturn had proven that earlier assumptions were too optimistic. The insurance industry argued that CEIOPS had caved in to pressure from politicians and central bankers that simply did not understand that the insurance industry is very different to the wider financial services industry. They argued that insurers had not caused the crisis and had actually weathered the storm very well apart from a couple of high profile cases (AIG being the most obvious) where direct investments in the credit market had caused the problems, not their core insurance business. The Comité Europeén des Assurances made this point very strongly to CEIOPS during its 5th annual conference in Frankfurt towards the end of November. But recently installed CEIOPS Chairman Gabriel Bernadino, who is also General Director, Directorate for Development & Institutional Relations at the Portuguese Insurance Supervisor, the Instituto de Seguros de Portugal (ISP), said that the experience of the crisis proved that the tougher rules were needed. For Mr. Van Hulle there are two major outstanding issues that need to be settled as the Directive nears fruition at the technical level. The first key matter, he said, is the standard formula for the calculation of the Solvency Capital Requirement (SCR) that determines how much capital is needed by the company. The SCR can also be calculated by the use of a full or partial internal model, so long as they are approved by the supervisors. Model Plan “Companies that use their own models will generally require less capital as the basis of the standard model will be more conservative to allow for the lower level of sophistication of those companies that use it. “QIS 5 starts in August and we hope that there will be a very large participation from all sectors of the industry because this is the last chance for the industry to tell us where we may have gone wrong with the SCR. There is a lot of work to ensure that the technical specifications are adequate and not overly prudent,” he explained. The second big concern is the calculation of technical provisions, particularly for life insurance companies that underwrite annuity business. “There has been a lot of discussion about annuity business and the calculation of technical provisions and particularly how it affects annuity business in the United Kingdom. This is a critical issue and we still have to work very hard to find a solution that is acceptable to most people. Products are very different from Member State to Member State. In addition, there are important cultural differences. For instance, German insurance companies tend to be more conservative than U.K. insurance companies,” explained Mr. Van Hulle, pointing to the huge difficulty faced by the Commission when it attempts to satisfy the often different national approaches and views. The other big issue that still needs to be decided is the approval of internal models. Internal models are important because they will help ensure that Solvency II is applied as closely to how insurance companies are actually run as possible. But, just as group support foundered on the rocks of national interest, there is a danger that some national supervisors will seek to set the bar for the use of internal models so high that their benefits will be lost. Indeed internal models are a good example of how group supervision will work under Solvency II. Cross border groups will be subject to a group supervisory system whereby the group supervisor will verify compliance with the group internal model. Once approved by the group supervisor it will then have to be accepted by the supervisors of the subsidiaries in other states. If disputes arise then CEIOPS—which is to be transformed into a more powerful body that can settle any disputes called the European Insurance and Occupational Pensions Authority (EIOPA)—can sort them out. “Many people think that because we have no group support, we have no group supervision, which is not correct. But those who opposed group support may want group supervision to be less significant. The creation of EIOPA will definitely help in this regard,” said Mr. Van Hulle. Another big outstanding area that needs to be sorted out over the next couple of years is how Solvency II fits with other solvency regimes outside of the European Union. Solvency II’s principles-based and risk based solvency regime is regarded by many within international supervisory circles as state of the art and the basis upon which an international solvency regime for the insurance industry should be built. Insurance supervisors in what the E.C. terms third countries (the term used by the E.C. to describe countries outside the E.U.) such as Bermuda are working hard to ensure that their supervisory systems are as similar as possible to Solvency II. The benefit for insurance companies based in third countries that have operations in Europe should be considerable. This is because their supervisory regime will be granted equivalent status that means that their group supervision will be accepted as such in the E.U. and they will not have to undergo special arrangements such as the need to set up a European holding company for their European operations. In December CEIOPS published a consultation paper on how this system could work for international companies. The biggest debate will inevitably occur over whether the U.S. regulatory regime can gain equivalence status. There are three big hurdles to overcome in this case. First, from an insurance regulatory perspective, the U.S. is not a nation state because insurance regulation is state-based. Second, U.S. insurance supervision is rules not principles-based and only takes a partial economic view. And third, the U.S. still operates a system whereby foreign reinsurers have to lodge collateral to cover potential liabilities in case the parent company does not honour its U.S. liabilities. Mr. Van Hulle hopes that many of these problems can be overcome through the offices of the International Association of Insurance Supervisors. “The ball is now in the court of the IAIS. It will not be easy for the IAIS to develop an international solvency regime for the insurance industry, although the Joint Forum has just asked them to do so. It is more difficult for the IAIS than it was for the Basle Committee because the Basle Committee (the equivalent banking body that created the Basle II supervisory and capital adequacy system which served as inspiration for Solvency II) has greater influence, not least because it has the ear of the central banks and finance ministers,” he said. Efficiency “Nevertheless the IAIS could use Solvency II as a basis not because we believe it is the best but it really would help the whole insurance world to adopt a risk-based solvency regime. If we could cooperate on this basis then so much efficiency would be achieved to the benefit of the industry and policyholders,” added Mr. Van Hulle. Mr. Van Hulle is also working to try and win over the Americans. “I do wish the Americans would participate more actively in the process as the lack of an international level playing field is a problem for us all, for all kinds of reasons. The U.S. insurance regulatory system is much more complicated than what we have here in Europe which makes it difficult for the U.S. to really engage at an international level. In the end, it should also be in the interest of the U.S. to be more proactive on this matter,” said Mr. Van Hulle. This will be a particularly tough nut to crack over the next couple of years as the U.S., European and global economy hopefully stumbles out of recession. The loss of the group support mechanism and tougher risk charges suggested last year by CEIOPS showed very graphically how the state of the wider economy can and will influence the form of this groundbreaking Directive. National financial supervisors in Europe let alone the United States and elsewhere are under intense pressure from politicians to get tough with the financial institutions that are rightly blamed for the crisis. It would, however, be a shame for buyers of insurance if the Commission was unable to resist such pressures where they are excessive and not relevant to the insurance sector and wind up hitting insurers with a significantly higher cost of capital that will inevitably be passed onto policyholders.

The final frame – Karel Van Hulle

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