European Systemic Risk Board
Solvency II Review - ESRB publishes letters on Liquidity Risk Management - 16 November 2022
The European Systemic Risk Board (ESRB) has published two letters sent from the ESRB Secretariat to the Council Working Party and European Parliament (the Parliament) setting out its concerns in relation to liquidity risk amendments in the proposed Directive amending the Solvency II Directive (2009/138/EC).
The ESRB states in its (duplicate) letters that:
- the views expressed in its earlier letters to the Parliament and Council of the EU - regarding areas where EU co-legislators could strengthen and enhance the proposed Directive to better address systemic risks - remain valid. Thus far, these views have not been reflected in proposals; and
- the ESRB is concerned about amendments to the European Commission’s draft proposals, which weaken or remove powers aimed at enabling national competent authorities (NCAs) to identify and mitigate liquidity risks. This is a particular concern given the increasing risks to European financial stability.
The ESRB observes that recent market developments in the UK should be heeded by the European insurance sector, for the following reasons:
- liquidity risk is pervasive and may even affect financial institutions that do not engage in liquidity transformation or which have long-term liabilities and pursue liability-driven investment (LDI) strategies; and
- prevention is more efficient and less costly than crisis management, such that it is important for supervisors to be able to act pre-emptively to protect financial stability.
Finally, NCAs must be able to identify insurers who may have a vulnerable liquidity profile and act before liquidity risk materialises. The ESRB also notes that its emphasis on liquidity issues in its letters should not be interpreted as being at the expense of solvency.
In an Annex to the letters, the ESRB sets out its suggested amendments to the European Commission’s draft proposal.
ESRB Letter to Members of the Council Working Party on the Solvency II Review and Liquidity Risk Management
ESRB Letter to Members of the European Parliament on the Solvency II Review and Liquidity Risk Management
European Insurance and Occupational Pensions Authority
Challenging times for insurers - EIOPA publishes speech - 16 November 2022
The European Insurance and Occupational Pensions Authority (EIOPA) has published a speech by Petra Hielkema, EIOPA’s Chair.
Ms Hielkema highlights various matters, including:
- inflation remains a “force to be reckoned with” for the foreseeable future and insurers must set their reserving and pricing accordingly. The most direct impact of inflation on insurers themselves is through rising claims costs;
- higher claims may result in rising premiums for policyholders;
- a modest, gradual rise in interest rates is generally positive for insurers. There is likely to be some portfolio rebalancing, with a shift away from alternative asset classes into more traditional investments; and
- there are high levels of uncertainty as a result of the Russian invasion of Ukraine, the energy crisis, the effects of the COVID-19 pandemic and the recent turmoil in the UK gilt market. If market movements are intense and fast, liquidity can be a risk for long-term investors such as pension funds and insurers.
A similar situation is less likely to materialise in the EU for various reasons. For example, EU pension funds and insurers hedge against interest rate risks to a lesser extent than their UK counterparts. Nonetheless, liquidity management is an important aspect for insurers to consider in the current market environment. The still sizeable spread between inflation and interest rates might motivate insurers to take risks and invest in less liquid assets with higher returns. This could be a source of vulnerability for the sector.
EIOPA Speech: Trying times and their effect on insurers
HM Treasury
Solvency II Review - HM Treasury publishes consultation response - 17 November 2022
HM Treasury has published its response to its Consultation Paper on the review of the UK Solvency II prudential regime for insurers. This follows publication of the consultation in April 2022.
In its response, HM Treasury summarises the feedback received from respondents to the Consultation Paper and sets out the government’s final reform package, introducing a ‘simpler, clear, and much more tailored regime’. In particular, the response notes:
- the evidence collected supported the majority of the proposals as set out in the consultation, so the government will take these proposals forward;
- the most challenging element is in relation to the matching adjustment, including both its eligibility requirements and fundamental spread component. The government has concluded that the eligibility requirements for the matching adjustment should, in addition to the proposals set out in the consultation document, be broadened to allow the inclusion of assets with highly predictable cash flows, subject to a number of safeguards set out by the PRA;
- as set out in the Consultation Paper, there has been no consensus about the best approach to reform of the fundamental spread. The government has decided to leave the design and calibration of the fundamental spread in its original form. However, it will increase the risk sensitivity of the current fundamental spread approach to allow different notched allowances to be made within major credit ratings; and
- the government will review whether the calibration of the fundamental spread remains appropriate in five years’ time. Prior to the government’s review, the PRA will assess the impact of the Solvency II reforms on its statutory objectives. It will also take forward a review jointly with the FCA to assess whether changes may be needed to the Financial Services Compensation Scheme (FSCS) levy for insurers.
For further information on this item, please see our standalone briefing.
HM Treasury: Review of Solvency II: Consultation - response
Updated webpage
Prudential Regulation Authority
Solvency II - PRA publishes Feedback Statement (FS1/22) - 17 November 2022
The PRA has published a Feedback Statement (FS1/22) on potential reforms to the Solvency II risk margin and matching adjustment, including feedback received to its Discussion Paper (DP2/22) published in April 2022.
DP2/22 set out the PRA’s position and sought views on key aspects of the potential reforms to Solvency II, as covered in HM Treasury’s consultation. These included:
- a potential formulation for a Credit Risk Premium (CRP), an allowance for uncertainty around credit risk in the matching adjustment framework to correct a weakness in the current design;
- a potential new suggested design and calibration of the risk margin; and
- the extent to which combined potential reforms to the matching adjustment and risk margin might result in a package that is compatible with the PRA’s statutory objectives.
The Feedback Statement summarises the feedback received and, while it does not include the PRA’s views in response, it does include clarification points where feedback indicated a potential misunderstanding of the proposals. The PRA indicates that it took the feedback into account in its discussions with the Treasury on the reforms, which the Treasury has now confirmed will be taken forward (see item above in this section).
PRA Feedback Statement: Potential reforms to risk margin and matching adjustment within Solvency II (FS1/22)
