Politicians in the EU reached an agreement on Solvency II in November 2013, finally paving the way for the introduction of the legislation in January 2016...
Politicians in the EU reached an agreement on Solvency II in November 2013, finally paving the way for the introduction of the legislation in January 2016.
The deal was agreed between the European Commission, the European Parliament and the Council of the EU after protracted negotiations.
The legislation was originally intended to harmonise the EU insurance industry, and to create a single market for insurance in Europe with a common floor of regulation. Since the financial crisis of 2008, it has also been touted as a way to protect taxpayers from exposure to the risks in the insurance sector. The commission aimed to establish EU-wide requirements for the industry on similar lines to those for banks, to negate the risk of a financial crisis emanating from the insurance sector.
The EU has come under criticism from several firms in relation to Solvency II. In August 2013, Tidjane Thiam, chief executive of Prudential, said that the proposed Solvency II regulatory framework represents “one of the biggest threats to UK jobs and growth”. He said that the legislation could prevent the insurer and similar companies from investing in infrastructure and property.
Why is Solvency II required? Tim Edwards, a director at PricewaterhouseCoopers who was previously a part of the UK financial services authority’s Solvency II team, believes that it is essential for the functioning of the single market.
“Solvency II started from a pretty simple place. Any consumer anywhere in Europe under freedom of services can buy insurance from any insurer anywhere in Europe. It therefore makes sense to have consistent standards for governance, risk and capital management, capital management, and some kind of public reporting regime so that there is at least a common floor of standards from a consumer protection perspective.”
“Beyond that you can equally argue that the EU market is greatly helped by having commonality of regulations. If you are an insurer looking to set up elsewhere in Europe, you are under the same regulatory regime as you would be in the UK, in France, Denmark or anywhere else. Solvency II helps the single market in that respect by helping insurers to compete internationally. This is very different to captive domiciles, which effectively compete with each other from a regulatory perspective”.
Big money
Insurers are Europe’s largest institutional investors, with $11.3 trillion in assets under management. Unlike banks, insurers have no framework in place to mitigate against a repeat of the financial crisis, and this is one of the arguments that propelled Solvency II forward. With the implementation date fast approaching, transitional measures have been instated as of 1 January.
But are reinsurers ready to produce the Solvency II-compliant financial reports that they are now required to? Edwards thinks not.
“Nobody is ready yet as far as I am aware. There is a lot of work that needs to go in to be able to prepare for the reports. Most firms will need as much time as they have left in order to achieve it. However, there is no reason to think that reinsurers are going to have to do more than anyone else.”
Many journeys
One of the problems for any piece of legislation going through the motions in the EU is the amount of individual nations that have to be satisfied before progress can be made. As each and every member state has the power to veto new legislation under the current treaties, lawmaking is notoriously slow. The solution that the EU has found to this is exceptions.
In December 2013, France rejected interim measures on governance during the two-year preparatory phase, with a promise to increase the pressure on firms to be compliant by 2016. Edwards does not see this as a major problem.
“My understanding is that this is basically a procedural thing. You need to bear in mind that the preparatory guidelines are just preparing us for Solvency II in a couple of years. Every single country has certain limitations around what they can and can’t do during that period. My understanding is that France informed the other member states that it can’t actually enforce the preparatory guidelines, but nonetheless it has given a very clear instruction to their industry that they are expected to respect them and prepare in the way that the spirit of the regulations require.”
“Whilst we are trying to bring in a common system of regulation there are, of course, as many different legal and political systems as there are member states, and so there are bound to be a few wobbles between them. There is no indication that the French are not committed to Solvency II, in fact quite the opposite. Whilst it is the same destination, there are a lot of different journeys.”
Market indifference
Given that a political agreement has now been reached on the legislation, many commentators expected this to be reflected in the results of equity markets.
Thus far, the reaction has been fairly muted. Edwards explains the lack of reaction by saying that analysts have done their job extremely well.
“Whilst it was quite a big moment when we realised that Solvency II was actually going to happen, I think analysts understood that the political direction was positive for quite some time. Throughout the second half of last year there was an expectation that the agreement was going to be reached, and so it wasn’t really a one-off blinding light moment. Analysts will have taken account into the expectation of Solvency II over a period of time at which point it gets lost in a number of other things going on around the industry, whether that is issues in the international markets or local issues with individual firms.”
