EIOPA Consults On New Proportionality Regime Under Solvency II

RegCORE Client Alert | Insurance Union

QuickTake

Insurers operating in the EU and under the Solvency II Directive's legislative and regulatory framework come in different shapes and sizes. The proportionality principles included in and otherwise foreseen for Solvency II aim to reduce regulatory burdens and costs for those firms that qualify as small and non-complex (insurance) undertakings (SNCUs), ensuring that compliance is attainable and reflective as well as relevant of the firm's risk profile.

On 2 August 2024 the European Insurance and Occupational Pensions Authority (EIOPA) published a public consultation¹ (the EIOPA Proportionality Consultation) that runs until 25 October 2024 assessing the future implementation of the new proportionality framework under Solvency II. As discussed in this Client Alert, EIOPA's Proportionality Consultation covers two aspects, firstly, the fine-tuning of the methodology for classifying SNCUs – who would stand to benefit from proportionality measures – as well as secondly, the conditions for proportionality measures and thus reduced Solvency II requirements to those insurers that, by default, do not qualify as SNCUs.

EIOPA's new proposed framework is a pivotal development in the insurance regulatory landscape, aiming to (i) refine the classification of insurance undertakings and groups as SNCUs and (ii) to establish conditions for granting or withdrawing supervisory approval for proportionality measures to undertakings not classified as such i.e., non-SNCUs.

Key takeaways from EIOPA's Proportionality Consultation

EIOPA's Proportionality Consultation follows as a result of the recent review of the Solvency II Directive. The political agreement on that review introduced amendments to the existing legislative framework aimed at addressing concerns regarding the limited and inconsistent application of proportionality principles in the first years of Solvency II. The proposed revised proportionality framework sets clear criteria for categorising SNCUs according to their nature, scale and complexity of their risks and empowers national competent authorities (NCAs) to grant and withdraw similar proportionality decisions to other non-SNCUs where their risk profile nevertheless justifies some use of the proportionality measures. Non-SNCUs must meet and maintain compliance with certain conditions for a NCA to be able to approve a proportionality measure decision for that non-SNCU.

EIOPA's Proportionality Consultation outlines a methodology for classifying undertakings as SNCU. This involves a notification process where undertakings must demonstrate compliance with the SNCU criteria, including evidence of compliance, a declaration of no planned strategic changes that would lead to non-compliance within three years and identification of the proportionality measures they expect to implement.

The methodology for classifying undertakings as SNCUs is based on quantitative and qualitative criteria. The quantitative criteria include thresholds for technical provisions and gross written premium income, while the qualitative criteria assess the complexity of the business model and the stability of the undertaking's business strategy. Undertakings that meet these criteria can benefit from reduced reporting and governance requirements, among other simplifications.² A key issue will be about how NCAs view and assess the complexity of a business applying for a SNCU categorisation or in the alternative a non-SNCU seeking proportionality measures.

For undertakings not classified as SNCUs i.e., non-SNCUs, EIOPA proposes "conditions" for granting or withdrawing supervisory approval for the use of proportionality measures. These conditions include an assessment of the undertaking's risk profile, solvency position, governance system and market share. These conditions are designed to ensure that only undertakings with a risk profile not materially different from an SNCU can be approved for such measures.

Under the current proposal, non-SNCUs, that satisfy the conditions, would only be permitted to use the following proportionality measures (as applicable to Solvency II articles) upon approval by the NCA:

(a) Article 35(5a): Information to be provided for supervisory purposes – Regular Supervisory Report (RSR) every three years or more frequently, if deemed necessary, upon request of the NCA;

(b) Article 41: General governance requirements – Combination of key functions;

(c) Article 41: General governance requirements – Update of written policies every five years (instead of annually);

(d) Article 45(1b): Own risk and solvency assessment (ORSA) – Waiver from macroprudential analysis in the ORSA;

(e) Article 45(5): Regular Own risk and solvency assessment – ORSA at least every two years (instead of annually);

(f) Article 77(8)4: Calculation of technical provisions – Prudent deterministic valuation of the best estimate for immaterial obligations with options and guarantees;

(g) Article 144a(4): Liquidity risk management – Exemption from liquidity risk management plan; and

(h) in addition, non-SNCUs may request approval for the application of one proportionality measure that will be introduced in the Delegated Regulation, likely to be related to the exemption of the remuneration requirement to defer a significant portion of the variable remuneration in accordance with Article 275(2)(c).

Depending on how EIOPA proceeds with the respective policy options in the consultation paper and fine-tuning of the conditions (discussed in more detail below), it can be reasonably be expected that EIOPA will need to release further supervisory guidance, addressed to the NCAs and the market, so as to ensure a harmonised approach is adopted on how the conditions are actually applied when evaluating how, when and to what extent to grant proportionality measures and to whom.

Key considerations and challenges for firms

Firms classified as SNCU may be able to benefit from reduced regulatory requirements. This may lead to lower operational costs and administrative burdens. However, firms must carefully assess their compliance with the SNCU criteria and ensure that they can maintain this classification over time. The classification process may require some firms to provide substantial evidence of their compliance and a commitment to maintaining a stable risk profile.

Firms classified as non-SNCUs face a more complex scenario. They must seek supervisory approval to use proportionality measures, which involves demonstrating that their risk profile is compatible with the conditions and justify the proportionality measures. This process requires firms to engage in a detailed assessment of their risks and governance systems, potentially increasing their administrative burden. This may necessitate enhanced internal controls and risk management processes, potentially leading to increased administrative costs and operational complexities.

The supervisory approval process for proportionality measures requires undertakings to submit evidence of compliance with the relevant conditions. NCAs will assess this evidence as part of their supervisory review process. The approval process is intended to be robust yet flexible, allowing NCAs to exercise judgment based on the specific circumstances of each undertaking and how it meets the conditions. While a number of principles in the conditions should not catch any insurer by surprise, the fact on how they are under closer scrutiny may mean some non-SNCUs will want to consider how they evidence they meet and maintain compliance with what the conditions call for:

1. Financial health and capital requirements: Non-SNCUs must maintain a solvency capital requirement (SCR) exceeded by an appropriate margin, reflecting their financial resilience. This condition underscores the importance of a strong capital base for non-SNCUs, which may influence their strategic decisions, investment policies, and risk appetite.
2. Market share and business model complexity: The market share and complexity of an undertaking's business model are critical factors in determining eligibility for proportionality measures. Non-SNCUs with significant market presence or complex operations may find it challenging to meet the conditions for reduced regulatory requirements, thereby facing a competitive disadvantage compared to smaller, simpler undertakings.
3. Operational simplicity and cost efficiency: Non-SNCUs that engage in simple business activities may still benefit from proportionality measures despite exceeding quantitative thresholds. This provides some flexibility for larger undertakings with straightforward operations to reduce regulatory burdens where justified.
4. Governance system concerns: The absence of serious concerns regarding an undertaking's governance system in the past three years is a prerequisite for obtaining supervisory approval for proportionality measures. Non-SNCUs must therefore ensure that their governance structures are robust and free from "significant issues" (undefined – thus leaving discretion) to qualify.
5. Quality of reporting: The quality and completeness of RSRs and ORSAs are indicative of an undertaking's risk management capabilities. Non-SNCUs must maintain high standards in their reporting practices to meet the conditions for proportionality measures.
6. Decision-making procedures and organisational structure: Effective decision-making procedures and a solid organisational structure are essential for non-SNCUs seeking supervisory approval for proportionality measures. This condition emphasises the need for clear governance frameworks within larger undertakings.
7. Knowledge, skills and experience of key function holders: Non-SNCUs must ensure that individuals responsible for key functions possess the requisite expertise to perform their duties effectively. This is particularly important when functions are combined, as it could impact governance and decision-making processes.
8. Administrative expenses and employee numbers: The cost of maintaining separate functions relative to total administrative expenses and employee numbers is a consideration for non-SNCUs. This condition seeks to balance efficiency gains against potential risks associated with consolidating roles.
9. Liquidity risk management: Non-SNCUs must demonstrate that they do not have material exposures to liquidity risk to be exempt from maintaining a liquidity risk management plan. This condition highlights the importance of liquidity management in larger undertakings.
10. Counterparty exposures: Non-SNCUs with material concentrations of counterparty exposures to reinsurance undertakings may face challenges in obtaining approval for proportionality measures due to increased liquidity risk.
11. Economic and macroeconomic market trends: The liquidity position of non-SNCUs should not raise concerns stemming from economic or macroeconomic market trends. This condition ensures that larger undertakings can withstand external financial shocks.
12. Fungibility and availability of liquid funds in groups: For insurance groups not classified as SNCUs, the ability to transfer liquidity across group entities is crucial. This condition addresses liquidity risk at the group level, which is particularly relevant for larger insurance conglomerates.
13. Remuneration policies: The waiver from mandatory deferral of a significant portion of variable remuneration is subject to specific conditions related to remuneration levels. Non-SNCUs must align their remuneration policies with these conditions to benefit from this measure.

At this stage the statements in EIOPA's Consultation paper concludes that EIOPA's technical advice is not to call for further specifications beyond what is already prescribed in the Solvency II Directive. Nevertheless, EIOPA believes that any additional specifications should be addressed at the national level during the transposition of the amendments to the Directive. What those national measures might be, how this might fuel fragmentation and thus hamper greater harmonisation of this part of the Single Rulebook for financial services as applied to the insurance sector and SNCUs specifically remains to be seen.

Outlook and next steps

The new proportionality framework under Solvency II represents a significant (and very welcome) shift towards a more nuanced regulatory approach that considers the specific characteristics of insurance undertakings and groups. The framework aims to balance the need for robust regulation with the recognition that a one-size-fits-all approach may not be appropriate for all entities.

While SNCUs enjoy certain regulatory reliefs due to their limited risk profiles, non-SNCUs are subject to more rigorous conditions to ensure that their larger scale and complexity do not undermine financial stability or policyholder protection. The conditions set out by EIOPA aim to foster a level playing field where proportionality measures are granted based on an undertaking's risk profile rather than its size alone.

Insurance undertakings and groups should closely examine the proposed rules and assess their potential impact on their operations. They should also consider participating in the consultation process to provide feedback on EIOPA's technical advice and contribute to shaping a regulatory environment that is both effective and efficient. Crucially, firms will want to assess how any additional specifications that are set at the national level during the transposition of the amendments to the Solvency II Directive may add-on jurisdiction-specific considerations that could alter a SNCU categorisation or one or more proportionality measures for non-SNCUs.

Footnotes

1 Available here.

2 This includes those specified in Solvency II's Article 35(5a), Article 41, Article 45(1b), Article 45(5), Article 45a(5), Article 51(6), Article 51a(1), Article 77(8) and Article 144a(4) and any measure provided for in the Solvency II Delegated Acts adopted pursuant to Solvency II explicitly applicable to SNCUs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.