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04

Solvency II 'is an object lesson in how not to make law'

Open-access content Monday 29th April 2013 — updated 9.21am, Tuesday 5th May 2020

The delayed implementation of new rules governing Europe's insurance industry, Solvency II, has come under fire from MPs and the head of the UK's Prudential Regulation Authority.

Pensions legislation MPs Commons

30 APR 2013 | THE ACTUARY NEWSDESK: NICK MANN

In a series of letters published today by the House of Commons Treasury committee, PRA managing director Andrew Bailey labels the history of the European Union process on Solvency II 'shocking'. The costs arising from delays in its introduction are 'staggering', Bailey adds.

Solvency II, which places new capital requirements on insurers across Europe, was originally scheduled to be introduced by June 2013 and come into effect on January 1 2014. However, delays in reaching political agreement on Omnibus II, the legislation underpinning the rules, mean the new system is now not expected to be fully implemented until at least 2016.

In a letter sent to Treasury committee chair Andrew Tyrie in February, Bailey raised particular concerns over the limited flexibility that the PRA and other national supervisory authorities will have under Solvency II to deal with 'more idiosyncratic risks'.

Solvency II's need for maximum harmonisation 'will be a battleground of the future as the judgmented approached of the PRA comes up against narrow interpretations of EU law', he writes.

In a separate letter sent to Tyrie this month, he stresses that the PRA needs the flexibility to deal with these risks - which include liquidity and sovereign risk - effectively.

He also raises concerns over the potential approach Solvency II will take to requiring equivalence in other regulatory regimes. If the EU deems the regulatory regime of a non-EU country to be not equivalent to Solvency II, European firms operating in those countries will have to hold more capital.

This could potentially make them uncompetitive in those markets, Bailey writes. 'This is a big issue, and one where we will need if necessary to resist narrow interpretations, bearing in mind the UK's large presence in the global insurance industry.'

Bailey notes that, in light of there being no concrete timetable for Solvency II being implemented, the PRA has scaled back its work on implementation, and has also told insurance firms to not expect implementation until at least 2016.

This enabled the PRA's predecessor, the Financial Services Authority, to scale back the cost of its work for implementing Solvency II from up to £150m to £88m, or between £5-7m a year. Given this work was to be financed by a levy on the insurance industry, Bailey noted the reduction had been 'warmly received' by major insurers.

However, Bailey noted that even if Solvency II had been implemented on time, the FSA had estimated it would cost insurers £400m between 2008 and 2013, while the cost of maintaining compliance thereafter had been estimated at around £200m a year. This would add around 0.1% to the cost of insurance to consumers, he noted.

Due to the delays, these numbers were subject to 'substantial uncertainty', Bailey said.

Commenting on the letters, Tyrie said Bailey was right to label the EU decision-making process for Solvency II as shocking. 'For the best part of ten years it has been mired in uncertainty, at great cost to the regulators, insurers and, ultimately, consumers. Solvency II is an object lesson in how not to make law.

'Strengthening and harmonising the prudential regulation of the insurance sector across the EU could bring significant benefits. But we haven't seen any yet. Even now, no one can be sure what it will add.'

Tyrie welcomed the PRA's plans to use 'early warning indicators' to assess potential threats to insurers' solvency when they had opted to calculate their capital requirements using bespoke internal models rather than the standard approach being set out in Solvency II.

'This is probably necessary; complex models are all too easily gamed. A strong UK backstop must be in operation,' he said. 'It is the role of the regulator to make sure that insurance companies, just like the banks, are adequately capitalised.'

.

This article appeared in our April 2013 issue of The Actuary.
Click here to view this issue
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