Overview on EIOPA Consultation Paper on the Opinion on the 2020 review of Solvency II

The Solvency II Directive provides that certain areas of the framework should be reviewed by the European Commission at the latest by 1 January 2021, namely:

  • long-term guarantees measures and measures on equity risk,
  • methods, assumptions and standard parameters used when calculating the Solvency Capital Requirement standard formula,
  • Member States’ rules and supervisory authorities’ practices regarding the calculation of the Minimum Capital Requirement,
  • group supervision and capital management within a group of insurance or reinsurance undertakings.

Against that background, the European Commission issued a request to EIOPA for technical advice on the review of the Solvency II Directive in February 2019 (call for advice – CfA). The CfA covers 19 topics. In addition to topics that fall under the four areas mentioned above, the following topics are included:

  • transitional measures
  • risk margin
  • Capital Markets Union aspects
  • macroprudential issues
  • recovery and resolution
  • insurance guarantee schemes
  • freedom to provide services and freedom of establishment
  • reporting and disclosure
  • proportionality and thresholds
  • best estimate
  • own funds at solo level

EIOPA is requested to provide technical advice by 30 June 2020.

Executive summary

This consultation paper sets out technical advice for the review of Solvency II Directive. The advice is given in response to a call for advice from the European Commission. EIOPA will provide its final advice in June 2020. The call for advice comprises 19 separate topics. Broadly speaking, these can be divided into three parts.

  1. Firstly, the review of the long term guarantee measures. These measures were always foreseen as being reviewed in 2020, as specified in the Omnibus II Directive. A number of different options are being consulted on, notably on extrapolation and on the volatility adjustment.
  2. Secondly, the potential introduction of new regulatory tools in the Solvency II Directive, notably on macro-prudential issues, recovery and resolution, and insurance guarantee schemes. These new regulatory tools are considered thoroughly in the consultation.
  3. Thirdly, revisions to the existing Solvency II framework including in relation to
    • freedom of services and establishment;
    • reporting and disclosure;
    • and the solvency capital requirement.

Given that the view of EIOPA is that overall the Solvency II framework is working well, the approach here has in general been one of evolution rather than revolution. The principal exceptions arise as a result either of supervisory experience, for example in relation to cross-border business; or of the wider economic context, in particular in relation to interest rate risk. The main specific considerations and proposals of this consultation paper are as follows:

  • Considerations to choose a later starting point for the extrapolation of risk-free interest rates for the euro or to change the extrapolation method to take into account market information beyond the starting point.
  • Considerations to change the calculation of the volatility adjustment to risk-free interest rates, in particular to address overshooting effects and to reflect the illiquidity of insurance liabilities.
  • The proposal to increase the calibration of the interest rate risk submodule in line with empirical evidence. The proposal is consistent with the technical advice EIOPA provided on the Solvency Capital Requirement standard formula in 2018.
  • The proposal to include macro-prudential tools in the Solvency II Directive.
  • The proposal to establish a minimum harmonised and comprehensive recovery and resolution framework for insurance.

A background document to this consultation paper includes a qualitative assessment of the combined impact of all proposed changes. EIOPA will collect data in order to assess the quantitative combined impact and to take it into account in the decision on the proposals to be included in the advice. Beyond the changes on interest rate risk EIOPA aims in general for a balanced impact of the proposals.

The following paragraphs summarise the main content of the consulted advice per chapter.

Long-term guarantees measures and measures on equity risk

EIOPA considers to choose a later starting point for the extrapolation of risk-free interest rates for the euro or to change the extrapolation method to take into account market information beyond the starting point. Changes are considered with the aim to avoid the underestimation of technical provisions and wrong risk management incentives. The impact on the stability of solvency positions and the financial stability is taken into account. The paper sets out two approaches to calculate the volatility adjustment to the risk-free interest rates. Both approaches include application ratios to mitigate overshooting effects of the volatility adjustment and to take into account the illiquidity characteristics of the insurance liabilities the adjustment is applied to.

  • One approach also establishes a clearer split between a permanent component of the adjustment and a macroeconomic component that only exists in times of wide spreads.

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  • The other approach takes into account the undertakings-specific investment allocation to further address overshooting effects.

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Regarding the matching adjustment to risk-free interest rates the proposal is made to recognise in the Solvency Capital Requirement standard formula diversification effects with regard to matching adjustment portfolios. The advice includes proposals to strengthen the public disclosure on the long term guarantees measures and the risk management provisions for those measures.

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The advice includes a review of the capital requirements for equity risk and proposals on the criteria for strategic equity investments and the calculation of long-term equity investments. Because of the introduction of the capital requirement on long-term equity investments EIOPA intends to advise that the duration-based equity risk sub-module is phased out.

Technical provisions

EIOPA identified a larger number of aspects in the calculation of the best estimate of technical provisions where divergent practices among undertakings or supervisors exist. For some of these issues, where EIOPA’s convergence tools cannot ensure consistent practices, the advice sets out proposals to clarify the legal framework, mainly on

  • contract boundaries,
  • the definition of expected profits in future premiums
  • and the expense assumptions for insurance undertakings that have discontinued one product type or even their whole business.

With regard to the risk margin of technical provisions transfer values of insurance liabilities, the sensitivity of the risk margin to interest rate changes and the calculation of the risk margin for undertakings that apply the matching adjustment or the volatility adjustment were analysed. The analysis did not result in a proposal to change the calculation of the risk margin.

Own funds

EIOPA has reviewed the differences in tiering and limits approaches within the insurance and banking framework, utilising quantitative and qualitative assessment. EIOPA has found that they are justifiable in view of the differences in the business of both sectors.

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Solvency Capital Requirement standard formula

EIOPA confirms its advice provided in 2018 to increase the calibration of the interest rate risk sub-module. The current calibration underestimates the risk and does not take into account the possibility of a steep fall of interest rate as experienced during the past years and the existence of negative interest rates. The review

  • of the spread risk sub-module,
  • of the correlation matrices for market risks,
  • the treatment of non-proportional reinsurance,
  • and the use of external ratings

did not result in proposals for change.

Minimum Capital Requirement

Regarding the calculation of the Minimum Capital Requirement it is suggested to update the risk factors for non-life insurance risks in line with recent changes made to the risk factors for the Solvency Capital Requirement standard formula. Furthermore, proposals are made to clarify the legal provisions on noncompliance with the Minimum Capital Requirement.

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Reporting and disclosure

The advice proposes changes to the frequency of the Regular Supervisory Report to supervisors in order to ensure that the reporting is proportionate and supports risk-based supervision. Suggestions are made to streamline and clarify the expected content of the Regular Supervisory Report with the aim to support insurance undertakings in fulfilling their reporting task avoiding overlaps between different reporting requirements and to ensure a level playing field. Some reporting items are proposed for deletion because the information is also available through other sources. The advice includes a review of the reporting templates for insurance groups that takes into account earlier EIOPA proposals on the templates of solo undertakings and group specificities.

EIOPA proposes an auditing requirement for balance sheet at group level in order to improve the reliability and comparability of the disclosed information. It is also suggested to delete the requirement to translate the summary of that report.

Proportionality

EIOPA has reviewed the rules for exempting insurance undertakings from the Solvency II Directive, in particular the thresholds on the size of insurance business. As a result, EIOPA proposes to maintain the general approach to exemptions but to reinforce proportionality across the three pillars of the Solvency II Directive.

Regarding thresholds EIOPA proposes to double the thresholds related to technical provisions and to allow Member States to increase the current threshold for premium income from the current amount of EUR 5 million to up to EUR 25 million.

EIOPA had reviewed the simplified calculation of the standard formula and proposed improvements in 2018. In addition to that the advice includes proposals to simplify the calculation of the counterparty default risk module and for simplified approaches to immaterial risks. Proposals are made to improve the proportionality of the governance requirements for insurance and reinsurance undertakings, in particular on

  • key functions (cumulation with operational functions, cumulation of key functions other than the internal audit, cumulation of key and AMSB function)
  • own risk and solvency assessment (ORSA) (biennial report),
  • written policies (review at least once every three years)
  • and administrative, management and supervisory bodies (AMSB) ( evaluation shall include an assessment on the adequacy of the composition, effectiveness and internal governance of the administrative, management or supervisory body taking into account the nature, scale and complexity of the risks inherent in the undertaking’s business)

Proposals to improve the proportionality in reporting and disclosure of Solvency II framework were made by EIOPA in a separate consultation in July 2019.

Group supervision

EIOPA proposes a number of regulatory changes to address the current legal uncertainties regarding supervision of insurance groups under the Solvency II Directive. This is a welcomed opportunity as the regulatory framework for groups was not very specific in many cases while in others it relies on the mutatis mutandis application of solo rules without much clarifications.

In particular, there are policy proposals to ensure that the

  • definitions applicable to groups,
  • scope of application of group supervision
  • and supervision of intragroup transactions, including issues with third countries

are consistent.

Other proposals focus on the rules governing the calculation of group solvency, including own funds requirements as well as any interaction with the Financial Conglomerates Directive. The last section of the advice focuses on the uncertainties related to the application of governance requirements at group level.

Freedom to provide services and freedom of establishment

EIOPA further provides suggestions in relation to cross border business, in particular to support efficient exchange of information among national supervisory authorities during the process of authorising insurance undertakings and in case of material changes in cross-border activities. It is further recommended to enhance EIOPA’s role in the cooperation platforms that support the supervision of cross-border business.

Macro-prudential policy

EIOPA proposes to include the macroprudential perspective in the Solvency II Directive. Based on previous work, the advice develops a conceptual approach to systemic risk in insurance and then analyses the current existing tools in the Solvency II framework against the sources of systemic risk identified, concluding that there is the need for further improvements in the current framework.

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Against this background, EIOPA proposes a comprehensive framework, covering the tools initially considered by the European Commission (improvements in Own Risk and Solvency Assessment and the prudent person principle, as well as the drafting of systemic risk and liquidity risk management plans), as well as other tools that EIOPA considers necessary to equip national supervisory authorities with sufficient powers to address the sources of systemic risk in insurance. Among the latter, EIOPA proposes to grant national supervisory authorities with the power

  • to require a capital surcharge for systemic risk,
  • to define soft concentration thresholds,
  • to require pre-emptive recovery and resolution plans
  • and to impose a temporarily freeze on redemption rights in exceptional circumstances.

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Recovery and resolution

EIOPA calls for a minimum harmonised and comprehensive recovery and resolution framework for (re)insurers to deliver increased policyholder protection and financial stability in the European Union. Harmonisation of the existing frameworks and the definition of a common approach to the fundamental elements of recovery and resolution will avoid the current fragmented landscape and facilitate cross-border cooperation. In the advice, EIOPA focuses on the recovery measures including the request for pre-emptive recovery planning and early intervention measures. Subsequently, the advice covers all relevant aspects around the resolution process, such as

  • the designation of a resolution authority,
  • the resolution objectives,
  • the need for resolution planning
  • and for a wide range of resolution powers to be exercised in a proportionate way.

The last part of the advice is devoted to the triggers for

  • early intervention,
  • entry into recovery and into resolution.

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Other topics of the review

The review of the ongoing appropriateness of the transitional provisions included in the Solvency II Directive did not result in a proposal for changes. With regard to the fit and proper requirements of the Solvency II Directive EIOPA proposes to clarify the position of national supervisory authorities on the ongoing supervision of propriety of board members and that they should have effective powers in case qualifying shareholders are not proper. Further advice is provided in order to increase the efficiency and intensity of propriety assessments in complex cross-border cases by providing the possibility of joint assessment and use of EIOPA’s powers to assist where supervisors cannot reach a common view.

Click here to access EIOPA’s detailed Consultation Paper

EIOPA outlines key financial stability risks of the European insurance and pensions sector

The global and European economic outlook has deteriorated in the past months with weakening industrial production and business sentiment and ongoing uncertainties about trade disputes and Brexit. In particular, the “low for long” risk has resurfaced in the EU, as interest rates reached record lows in August 2019 and an increasing number of countries move into negative yield territory for their sovereign bonds even at longer maturities in anticipation of a further round of monetary easing by central banks and a general flight to safety. Bond yields and swap rates have since slightly recovered again, but protracted low interest rates form the key risk for both insurers and pension funds and put pressure on both the capital position and long-term profitability. Large declines in interest rates can also create further incentives for insurers and pension funds to search for yield, which could add to the build-up of vulnerabilities in the financial sector if not properly managed.

Despite the challenging environment, the European insurance sector remains overall well capitalized with a median SCR ratio of 212% as of Q2 2019. However, a slight deterioration could be observed for life insurers in the first half of 2019 and the low interest rate environment is expected to put further pressures on the capital positions of life insurers in the second half of 2019. At the same time, profitability improved in the first half of 2019, mainly due to valuation gains in the equity and bond portfolios of insurers. Nevertheless, the low yield environment is expected to put additional strains on the medium to long term profitability of insurers as higher yielding bonds will have to be replaced by lower yielding bonds, which may make it increasingly difficult for insurers to make investment returns in excess of guaranteed returns issued in the past, which are still prevalent in many countries.

THE EUROPEAN INSURANCE SECTOR

The challenging macroeconomic environment is leading insurance undertakings to further adapt their business models. In order to address the challenges associated with the low yield environment and improve profitability, life insurers are lowering guaranteed rates in traditional products and are increasingly focusing on unit-linked products. On the investment side, insurers are slowly moving towards more alternative investments and illiquid assets, such as unlisted equity, mortgages & loans, infrastructure and property. For non-life insurers, the challenge is mostly focused on managing increasing losses stemming from climate-related risks and cyber events, which may not be adequately reflected in risk models based on historical data, and continued competitive pressures.

Despite the challenging environment, the European insurance sector overall gross written premiums slightly grew by 1.6% on an annual basis in Q2 2019. This growth is particularly driven by the increase in non life GWP (3.7%), in comparison to a slightly decrease in life (-0.5%). This reduction growth rate in life GWP is associated to the slowdown in the economic growth; however this does not seem to have affected the growth of non-life GWP to the same extent. Overall GWP as a percentage of GDP slightly increased from 9% to 11% for the European insurance market, likewise total assets as a share of GDP improved from 70% to 74%. The share of unit-linked business has slightly declined notwithstanding the growth expectations. Even though insurers are increasingly trying to shift towards unit-linked business in the current low yield environment, the total share of unit-linked business in life GWP has slightly decreased from 42% in Q2 2018 to 40% in Q2 2019, likewise the share for the median insurance company declined from 34% in Q2 2018 to 31% in Q2 2019. Considerable differences remain across countries, with some countries still being plagued by low trust due to misselling issues in the past. Overall, the trend towards unit-lead business means that investment risks are increasingly transferred to policyholders with potential reputational risks to the insurance sector in case investment returns turn out lower than anticipated.

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The liquid asset ratio slightly deteriorated in the first half of 2019. The median value for liquid asset increased by 1.5% from 63.3% in 2018 Q2 to 64.8% in 2018 Q4, and after slightly decreased to 63.8% in Q2 2019. Furthermore,  the distribution moved down (10th percentile reduced in the past year by 6 p.p. to 47.9%). Liquid assets are necessary in order to meet payment obligations when they are due. Furthermore, a potential increase in interest rate yields might directly impact the liquidity needs of insurers due to a significant increase in the lapse rate as policyholders might look for more attractive alternative investments.

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Lapse rates in the life business remained stable slightly increased in the first half of 2019. The median value increased from 1.34% in Q2 2018 to 1.38% in Q2 2019. Moreover, a potential sudden reversal of risk premia and abruptly rising yields could trigger an increase in lapse rates and surrender ratios as policyholders might look  for more attractive investments. Although several contractual and fiscal implications could limit the impact of lapses and surrenders in some countries, potential lapses by policyholders could add additional strains on insurers’ financial position once yields start increasing.

The return on investment has substantially declined further over 2018. The investment returns have significantly deteriorated for the main investment classes (bonds, equity and collective instruments). The median return on investment decreased to only 0.31% in 2018, compared to 2.83% in 2016 and 1.95% in 2017. In particular the four main investment options (government and corporate bonds, equity instruments and collective investment undertakings) – which approximately account for two-thirds of insurers’ total investment portfolios – have generated considerably lower or even negative returns in 2018. As a consequence, insurers may increasingly look for alternative investments, such as unlisted equities, mortgages and infrastructure to improve investment returns. This potential search for yield behaviour might differ per country and warrants close monitoring by supervisory authorities as insurers may suffer substantial losses on these more illiquid investments when markets turn sour.

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Despite the challenging investment climate, overall insurer profitability improved in the first half of 2019. The median return on assets (ROA) increased from 0.24% in Q2 2018 to 0.32% in Q2 2019, whereas the median return on excess of assets over liabilities (used as a proxy of return on equity), increased from 2.8% in Q2 2018 to 4.9 % in Q2 2019. The improvement in overall profitability seems to stem mainly from valuation gains in the investment portolio of insurers driven by a strong rebound in equity prices and declining yields (and hence increasing values of bond holdings) throughout the first half of 2019, while profitability could be further supported by strong underwriting results and insurers’ continued focus on cost optimisation. However, decreased expected profits in future premiums (EPIFP) from 11% in Q1 2019 to 10.3% in Q2 2019 suggest expectations of deteriorating profitability looking ahead. Underwriting profitability remained stable and overall positive in the first half of 2019. The median Gross Combined Ratio for non-life business remained below 100% in the first half of 2019 across all lines of business, indicating that most EEA insurers were able to generate positive underwriting results (excluding profits from investments). However, significant outliers can still be observed across lines of business, in particular for credit and suretyship insurance, indicating that several insurers have experienced substantial underwriting losses in this line of business. Furthermore, concerns of underpricing and underreserving remain in the highly competitive motor insurance markets.

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Solvency positions slightly deteriorated in the first half of 2019 and the low interest rate environment is expected to put further pressures on the capital positions in the second half of the year, especially for life insurers. Furthermore, the number of life insurance undertakings with SCR ratios below the 100% threshold increased in comparison with the previous year from 1 in Q2 2018 to 4 in Q2 2019 mainly due to the low interest rate environment, while the number of non-life insurance undertakings with SCR ratios below 100% threshold decreased from 9 in Q2 2018 to 7 in Q2 2019. The median SCR ratio for life insurers is still the highest compared to non-life insurers and composite undertakings. However, the SCR ratio differs substantially among countries.

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The impact of the LTG and transitional measures varies considerably across insurers and countries. The long term guarantees (LTG) and transitional measures were introduced in the Solvency II Directive to ensure an appropriate treatment of insurance products that include long-term guarantees and facilitate a smooth transition of the new regime. These measures can have a significant impact on the SCR ratio by allowing insurance undertakings, among others, to apply a premium to the risk free interest rate used for discounting technical provions. The impact of applying these measures is highest in DE and the UK, where the distribution of SCR ratios is signicantly lower without LTG and transitional measures (Figure 2.16). While it is important to take the effect of LTG measures and transitional measures into account when comparing across insurers and countries, the LTG measures do provide a potential financial stability cushion by reducing overall volatility.

On October 15th 2019, EIOPA launched a public consultation on an Opinion that sets out technical advice for the 2020 review of Solvency II. The call for advice comprises 19 separate topics. Broadly speaking, these can be divided into three parts.

  1. The review of the LTG measures, where a number of different options are being consulted on, notably on extrapolation and on the volatility adjustment.
  2. The potential introduction of new regulatory tools in the Solvency II framework, notably on macro-prudential issues, recovery and resolution, and insurance guarantee schemes. These new regulatory tools are considered thoroughly in the consultation.
  3. Revisions to the existing Solvency II framework including in relation to
    • freedom of services and establishment;
    • reporting and disclosure;
    • and the solvency capital requirement.

The main specific considerations and proposals of this consultation are as follows:

  • Considerations to choose a later starting point for the extrapolation of risk-free interest rates for the euro or to change the extrapolation method to take into account market information beyond the starting point.
  • Considerations to change the calculation of the volatility adjustment to risk-free interest rates, in particular to address overshooting effects and to reflect the illiquidity of insurance liabilities.
  • The proposal to increase the calibration of the interest rate risk sub-module in line with empirical evidence, in particular the existence of negative interest rates. The proposal is consistent with the technical advice EIOPA provided on the Solvency Capital Requirement standard formula in 2018.
  • The proposal to include macro-prudential tools in the Solvency II Directive.
  • The proposal to establish a minimum harmonised and comprehensive recovery and resolution framework for insurance.

The European Supervisory Authorities (ESAs) published on the 4th October 2019 a Joint Opinion on the risks of money laundering and terrorist financing affecting the European Union’s financial sector. In this Joint Opinion, the ESAs identify and analyse current and emerging money laundering and terrorist financing (ML/ TF) risks to which the EU’s financial sector is exposed. In particular, the ESAs have identified that the main cross-cutting risks arise from

  • the withdrawal of the United Kingdom (UK) from the EU,
  • new technologies,
  • virtual currencies,
  • legislative divergence and divergent supervisory practices,
  • weaknesses in internal controls,
  • terrorist financing and de-risking;

in order to mitigate these risks, the ESAs have proposed a number of potential actions for the Competent Authorities.

Following its advice to the European Commission on the integration of sustainability risks in Solvency II and the Insurance Distribution Directive on April 2019, EIOPA has published on 30th September 2019 an Opinion on Sustainability within Solvency II, which addresses the integration of climate-related risks in Solvency II Pillar I requirements. EIOPA found no current evidence to support a change in the calibration of capital requirements for “green” or “brown” assets. In the opinion, EIOPA calls insurance and reinsurance undertakings to implement measures linked with climate change-related risks, especially in view of a substantial impact to their business strategy; in that respect, the importance of scenario analysis in the undertakings’ risk management is highlighted. To increase the European market and citizens’ resilience to climate change, undertakings are called to consider the impact of their underwriting practices on the environment. EIOPA also supports the development of new insurance products, adjustments in the design and pricing of the products and the engagement with public authorities, as part of the industry’s stewardship activity.

On the 15th July 2019 EIOPA submitted to the European Commission draft amendments to the Implementing technical standards (ITS) on reporting and the ITS on public disclosure. The proposed amendments are mainly intended to reflect the changes in the Solvency II Delegated Regulation by the Commission Delegated Regulation (EU) 2019/981 and the Commission Delegated Regulation 2018/1221 as regards the calculation of regulatory capital requirements for securitisations and simple, transparent and standardised securitisations held by insurance and reinsurance undertakings. A more detailed review of the reporting and disclosure requirements will be part of the 2020 review of Solvency II.

On 18th June 2019 the Commission Delegated Regulation (EU) 2019/981 amending the Solvency II Delegated Regulation with respect to the calculation of the SCR for standard formula users was published. The new regulation includes the majority of the changes proposed by EIOPA in its advice to the Commission in February 2018 with the exception of the proposed change regarding interest rate risk. Most of the changes are applicable since July 2019, although changes to the calculation of the loss-absorbing capacity of deferred taxes and non-life and health premium and reserve risk will apply from 1 January 2020.

RISK ASSESSMENT

QUALITATIVE RISK ASSESSMENT

EIOPA conducts twice a year a bottom-up survey among national supervisors to determine the key risks and challenges for the European insurance and pension fund sectors, based on their probability and potential impact.

The EIOPA qualitative Autumn 2019 Survey reveals that low interest rates remain the main risks for both the insurance and pension fund sectors. Equity risks also remain prevalent, ranking as the 3rd and 2nd biggest risk for the insurance and pension funds sectors respectively. The cyber risk category is now rank as the 2nd biggest risk for the insurance sector, as insurers need to adapt their business models to this new type of risk both from an operational risk perspective and an underwriting perspective. Geopolitical risks have become more significant for both markets, along with Macro risks, which continue to be present in the insurance and pension fund sectors, partially due to concerns over protectionism, trade tensions, debt sustainability, sudden increase in risk premia and uncertainty relating to the potential future post-Brexit landscape.

The survey further suggests that all the risks are expected to increase over the coming year. The increased risk of the low for long interest rate environment is in line with the observed market developments, particulary after the ECB’s announcement of renewed monetary easing in September 2019. The significant expected raise of cyber, property, equity, macro and geopolitical risks in the following year is also in line with the observed market developments, indicating increased geopolitical uncertainty, trade tensions, stretched valuations in equity and real estate markets and more frequent and sophisticated cyber attacks which could all potentially affect the financial position of insurers and pension funds. On the other hand, ALM risks and Credit risk for financials are expected to increase in the coming year, while in the last survey in Spring 2019 the expectations were following the opposite direction.

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Although cyber risk is ranking as one of the top risks and expected to increase in the following year, many jurisdictions also see cyber-related insurance activities as a growth opportunity. The rapid pace of technological innovation and digitalisation is a challenge for the insurance market and insurers need to be able to adapt their business models to this challenging environment, nonetheless from a profitability perspective, increased digitalisation may offer significant cost-saving and revenue-increasing opportunities for insurance companies. The increase of awareness of cyber-risk and higher vulnerability to cyber threats among undertakings due to the increased adoption of digital technologies could drive a growth in cyber insurance underwriting.

The survey shows the exposure of an sudden correction of the risk premia significantly differs across EU countries. In the event of a sudden correction in the risk premia, insurance undertakings and pension funds with ample exposure to bonds and real estate, could suffer significant asset value variations that could lead to forced asset sales and potentially amplify the original shock to asset prices in less liquid markets. Some juridictions, however, confirm the limited exposure to this risk due to the low holding of fixed income instruments and well diversified portfolios.

The survey further indicates that national authorities expect the increase of investments in alternative asset classes and more illiquid assets. Conversely, holdings of governement bonds are expected to decrease in favour of corporate bonds within the next 12 months. Overall this might indicate potential search for yield behaviour and a shift towards more illiquid assets continues throughout numerous EU jurisdictions. Property investments – through for instance mortgages and infrastructure investment – are also expected to increase in some jurisdictions, for both insurers and pension funds. A potential downturn of real estate markets could therefore also affect the soundness of the insurance and pension fund sectors.

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QUANTITATIVE RISK ASSESSMENT EUROPEAN INSURANCE SECTOR

This section further assesses the key risks and vulnerabilities for the European insurance sector identified in this report. A detailed breakdown of the investment portfolio and asset allocation is provided with a focus on specific country exposures and interconnectedness with the banking sector. The chapter also analyses in more detail the implications of the current low yield environment for insurers.

INVESTMENTS

Insurance companies’ investments remain broadly stable, with a slight move towards less liquid investment. Government and corporate bonds continue to make up the majority of the investment portfolio, with only a  slight movement towards more non-traditional investment instruments such as unlisted equity and mortgage and loans. Life insurers in particular rely on fixed-income assets, due to the importance of asset-liability matching of their long-term obligations. At the same time, the high shares of fixed-income investments could give rise to significant reinvestment risk in the current low yield environment, in case the maturing fixed-income securities can only be replaced by lower yielding fixed-income securities for the same credit quality.

The overall credit quality of the bond portfolio is broadly satisfactory, although slight changes are observed in 2018. The vast majority of bonds held by European insurers are investment grade, with most rated as CQS1 (AA). However, the share of CQS2 has increased in the first half of 2019, and significant differences can be observed for insurers across countries.

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INTERCONNECTEDNESS BETWEEN INSURERS AND BANKS

The overall exposures towards the banking sector remain significant for insurers in certain countries, which could be one potential transmission channel in case of a sudden reassessment of risk premia. The interconnectedness between insurers and banks could intensify contagion across the financial system through common risk exposures. A potential sudden reassessment of risk premia may not only affect insurers directly, but also indirectly through exposures to the banking sector. This is also a potential transmission channel of emerging markets distress, as banks have on average larger exposures to emerging markets when compared to insurers.

Another channel of risk transmission could be through different types of bank instruments bundled together and credited by institutional investors such as insurers and pension funds.

Insurers’ exposures towards banks are heterogeneous across the EU/EEA countries, with different levels of home bias as well. Hence, countries with primary banks exposed to emerging markets or weak banking sectors could be impacted more in case of economic distress. On average, 15.95% of the EU/EEA insurers’ assets are issued by the banking sector through different types of instruments, mostly bank bonds.

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Click here to access EIOPA’s Dec 2019 Financial Stability Report

EIOPA Insurance Risk Dashboard: Risk exposures for the European insurance sector – July 2019

Risk exposures for the European insurance sector remain overall stable.

Macro and market risks are now at a high level due to a further decline in swap rates and lower returns on investments in 2018 which put strain on those life insurers offering guaranteed rates. The low interest rate environment remains a key risk for the insurance sector.

Credit risks continue at medium level with broadly stable CDS spreads for government and corporate bonds.

Profitability and solvency risks increased due to lower return on investments for life insurers observed in year-end 2018 data; SCR ratios are above 100% for most undertakings in the sample even when excluding the impact of the transitional measures.

Market perceptions were marked by a performance of insurers’ stocks broadly in line with overall equity markets, while median CDS spreads have slightly increased. No change was observed in insurers’ external ratings and rating outlooks.

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Macro risks are now at a high level. Since the April 2019 assessment, swap rates have further declined for all the currencies considered (EUR, GBP, CHF, USD). The indicator on credit-to-GDP gaps has deteriorated due to a more negative gap in the Euro area. Key policy rates remained unchanged and the rate of expansion of major central banks’ (CB) balance sheets is now close to zero. Recent monetary policy decisions suggest that some degree of monetary accomodation is still to be expected for the forseeable future.

Credit risks remained stable at medium level. Since the previous assessment, spreads have remained broadly stable for all corporate bond segments except financials (unsecured). The average credit quality of insurers’ investments remained broadly stable, corresponding to an S&P rating between AA and A, while the share of below investment grade assets remains limited.

Market risks are now at a high level. Volatility of the largest asset class, bonds, remained broadly stable compared to the January’s assessment, whereas equity market volatility spiked in June 2019. Newly available annual information shows a decline in the spread of investment returns over the guaranteed rates to negative values in 2018, mainly due to lower investment returns. The mismatch between the duration of assets and liabilities remained broadly stable in the same period.

Liquidity and funding risks remained stable at medium level. Liquidity indicators have remained broadly unchanged since the previous quarter, while funding indicators such as the average ratio of coupons to maturity and the average multiplier for catastrophe bond issuance increased.

Profitability and solvency risks remain at medium level but show an increasing trend. This is mainly due to newly available data on the return on investments for life solo undertakings, which was considerably lower in 2018 than in the preceding year. SCR ratios are above 100% for the majority of insurers in the sample even when excluding the impact of the transitional measures on technical provisions and interest rates. The proportion of Tier 1 capital in total own funds remains high across the whole distribution and the share of expected profit in future premiums in eligible own funds is below 15% for most undertakings in the sample.

Interlinkages and imbalances risks remained at medium level in Q1-2019. A minor increase is observed for exposures to banks, while the opposite is true for exposures to other financial institutions. An increase has been reported in the share of premiums ceded to reinsurers.

Insurance risks remained constant at a medium level. Median premium growth of life and non-life business remains positive and a reduction has been reported in insurance groups’ loss ratios and cat loss ratios.

Market perceptions remained constant at medium level. Insurance groups stocks’ performance was broadly in line with the overall market. Median insurers’ CDS spreads have increased, while external ratings have remained unchanged.

RD 719 2

Click here to access EIOPA’s Risk Dashboard July 2019

EIOPA : Sound Regulation in an Evolving Landscape

Regulation is only effective for as long as it remains relevant. While EIOPA is evolving into a supervisory-focused organisation, it pays close attention to how regulation is applied and how effective it remains, with a view to reinforcing cross-sectoral consistency and improving fairness and transparency and with a focus on better and smart regulation.

INSURANCE

  • SOLVENCY II REVIEW

Since the successful implementation of Solvency II Directive in 2016, EIOPA played an important role in monitoring its consistent implementation and during 2018 was able to provide valuable input into preparations for its review.

EIOPA provided advice to the European Commission on the review of the Solvency Capital Requirement based on an in-depth analysis of 29 different elements of the Standard Formula. The advice focused on increasing proportionality, removing unjustified constraints to financing the economy and removing technical inconsistencies.

EIOPA proposed further simplifications and reduced the burden to insurers by:

  • Further simplifying calculations for a number of sub-modules of the Solvency Capital Requirement (SCR) such as natural, man-made and health catastrophes, in particular fire risk and mass accident;
  • Simplifying the use of external credit ratings in the calculation of the SCR (an issue especially relevant for small insurers);
  • Reducing the burden of the treatment of lookthrough to underlying investments;
  • Developing simplifications in the assessment of lapse and counterparty default risks;
  • Recommending the use of undertaking specific parameters for reinsurance stop-loss treaties.

Furthermore, one of the major technical inconsistencies found related to the calculation of interest rate risk, which did not capture very low or even negative interest rates. EIOPA recommended to adjust the methodology using a method already adopted by internal model users and, given the material impact on capital requirements, suggested to implement it gradually over three years.

EIOPA also carried out an analysis of the loss-absorbing capacity of deferred taxes practices. In face of the evidence of wide diversity, especially concerning the projection of future profits, EIOPA proposed a set of key principles that will ensure greater convergence and level playing field, while maintaining a certain degree of flexibility.

Finally, EIOPA analysed the treatment and the evidence available on unrated debt and unlisted equity and proposed criteria for a more granular treatment, namely with the use of financial ratios.

In some areas, the analysis of recent developments did not provide for sufficient reasons to change. This is, for example, the case of mortality and longevity risks and the cost of capital in the calculation of the risk margin. The evolution of financial markets does not justify a change in the cost of capital: the decrease in interest rates has not lead to a decrease in the cost of raising equity.

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  • REPORTING ON THE IMPLEMENTATION OF SOLVENCY II

In 2018, EIOPA published a number of reports related to different aspects of Solvency II.

  • Report on group supervision and capital management

In response to a European Commission’s request for information, EIOPA submitted its Report on Group Supervision and Capital Management of (Re)Insurance Undertakings and specific topics related to Freedom to Provide Services (FoS) and Freedom of Establishment (FoE) under the Solvency II Directive. The report concluded that overall the Solvency II Group supervision regime was operating satisfactorily. The tools developed by EIOPA to further strengthen group supervision and supervision of cross-border issues contributed to further convergence of practices of NCAs’ supervisory practices.

The report also highlighted a number of gaps in the regulatory framework, including issues related to the application of Solvency II requirements for determining scope of insurance groups subject to Solvency II group supervision, the application of certain of these provisions governing the calculation of group solvency in particular where several methods are used, the definition and supervision of intra-group transactions, or the application of governance requirements at group level.

Further, EIOPA’s report emphasised that effective supervision of insurance groups will benefit from a harmonised approach on a number of areas, for example, early intervention, recovery and resolution and the assessment of group own funds.

  • Second annual report on the use of capital addons under Solvency II

In December 2018, EIOPA published its second annual report on the use of capital add-ons by NCAs according to Article 52 of Solvency II. The objective was to contribute to a higher degree of supervisory convergence in the use of capital add-ons between supervisory authorities and to highlight any concerns regarding the capital add-ons framework. In general, the capital add-on appears to be a good and positive measure to adjust the Solvency Capital Requirement to the risks of the undertaking, when the application of other measures, for example the development of an internal model, is not adequate.

  • Third annual report on the use of limitations and exemptions from reporting under Solvency II

This report, published in December 2018, addresses the proportionality principle on the reporting requirements, from which the limitations and exemptions on reporting – as foreseen in Article 35 of the Solvency II Directive – are just one of the existing proportionality tools. Reporting requirements also reflect a natural embedded proportionality and in addition, risk-based thresholds were included in the reporting Implementing Technical Standard (ITS).

  • Third annual report on the use and impact of long-term guarantee measures and measures on equity risk

This is a regular report published in accordance with Article 77f(1) of the Solvency II Directive. This year’s report also included an analysis on risk management aspects in view of the specific requirements for LTG measures set out in Article 44 and 45 of the Directive as well as an analysis of detailed features and types of guarantees of products with long-term guarantees.

This report shows that – as in previous years – most of the measures, in particular the volatility adjustment and the transitional measures on technical provisions are widely used. The average Solvency Capital Requirement (SCR) ratio of undertakings using the voluntary measures is 231 % and would drop to 172 % if the measures were not applied. This confirms the importance of the measures for the financial position of (re)insurance undertakings.

  • INVESTIGATING ILLIQUID LIABILITIES

The treatment of long-term insurance business remains a hotly debated issue. In particular, it has been discussed whether the risks of long-term insurance business and the associated investments backing those long-term insurance business are adequately reflected. The illiquidity characteristics of liabilities may contribute to the ability of insurers to mitigate short-term volatility by holding assets throughout the duration of the commitments, even in times of market stress.

To explore any new evidence on the features of liabilities, especially concerning their illiquidity characteristics, a dedicated EIOPA Project Group on illiquid liabilities was set up with the following main goals:

  1. To identify criteria of liquidity characteristics for the liabilities and measures for insurers’ ability to invest over the long term;
  2. To explore the link between the characteristics of liabilities and the management of insurers’ assets;
  3. To analyse whether the current treatment in the regulatory regime appropriately addresses the risks associated with the long-term nature of the insurance business.

Following a request for information from the European Commission on asset and liability management, EIOPA launched a request for feedback on illiquid liabilities in autumn and held a roundtable with interested stakeholders in December to discuss the submitted responses on illiquidity measurements and asset liability management practices.

  • ANALYSIS OF THE INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) 17 INSURANCE CONTRACTS

Following the publication of International Financial Reporting Standards (IFRS) 17 Insurance Contracts by the International Accounting Standards Board (IASB), EIOPA assessed its potential effects on financial stability and the European public good, on product design, supply and demand of insurance contracts, and the practical implementation in light of the applicable inputs and processes for Solvency II.

EIOPA concluded that the introduction of IFRS 17 can be described as positive paradigm shift compared to its predecessor IFRS 4 Insurance Contracts, bringing increased transparency, comparability and additional insights on insures’ business models. EIOPA, however, noted a few reservations regarding concepts that may affect comparability and relevance of IFRS 17 financial statements.

PENSIONS

EIOPA promotes greater transparency in the European pensions sector. In support of this aim, EIOPA is working to enhance the information available to consumers and supporting pension providers by making clear the expectations, justifications and decisions linked with the information they provide, in particular to prospective members, members and beneficiaries as laid out in Articles 38 – 44 of the EU Directive on the activities and supervision of institutions for occupational retirement provision (IORP II).

  • REPORT ON THE PENSION BENEFIT STATEMENT: GUIDANCE AND PRINCIPLESBASED PRACTICES IMPLEMENTING IORP II

The report presents the outcomes of NCA exchanges of views and assessments of current practices for the implementation of the IORP II Pensions Benefit Statement (PBS) requirement. Based on this investigation, several principles have been identified that will facilitate clear understanding and comparability of statements.

Two proposals are now in further development: a basic PBS and an advanced PBS (containing more detailed information) to meet the PBS goals. These proposals will, as far as possible, take account of the behavioral approach principle be subject to further consumer testing.

  • DECISION ON THE CROSS-BORDER COLLABORATION OF NCAS WITH RESPECT TO IORP II DIRECTIVE

This Decision, published in November 2018, replaces the former Budapest Protocol which had to be revised as a result of the new IORP II Directive. The Decision introduces new rules to improve the way occupational pension funds are governed, to enhance information transparency to pension savers and to clarify the procedures for carrying out cross-border transfers and activities.

The Decision also describes different situations and possibilities for NCAs to exchange information about cross-border activities in relation to the ‘fit and proper’ assessment and the outsourcing of key functions, both new provisions of the IORP II Directive in addition to the cross-border transfer.

PRESERVING FINANCIAL STABILITY

As part of EIOPA’s mandate to safeguard financial stability, EIOPA works to identify trends, potential risks and vulnerabilities that could have a negative effect on the pension and insurance sectors across Europe.

  • 2018 INSURANCE STRESS TEST

EIOPA published the results of its stress test of the European insurance sector in December 2018. This exercise assessed the participating insurers’ resilience to the three severe but plausible scenarios: a yield curve up shock combined with lapse and provisions deficiency shocks; a yield curve down shock combined with longevity stress; and a series of natural catastrophes.

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In total, 42 European (re)insurance groups participated representing a market coverage of around 75 % based on total consolidate assets. EIOPA published for the first time the post-stress estimation of the capital position (Solvency Capital Requirement ratio) of major EU (re)insurance groups.

Overall, the stress test confirmed the significant sensitivity to market shocks combined with specific shocks relevant for the European insurance sector. On aggregate, the sector is adequately capitalised to absorb the prescribed shocks. Participating groups demonstrated a high resilience to the series of natural catastrophes tested, showing the importance of the risk transfer mechanisms, namely reinsurance, in place.

An additional objective of this exercise, stemming from recommendations from the European Court of Auditors, was to increase transparency in order to reinforce market discipline by requesting the voluntary disclosure of a list of individual stress test indicators by the participating groups. Since EIOPA does not have the power to impose the disclosure of individual results, participating groups were asked for their voluntary consent to the publication of a list of individual stress test indicators. Only four of the 42 participating groups provided such consent.

  • RISK DASHBOARD

EIOPA publishes a risk dashboard on a quarterly basis and a financial stability report twice a year. In the December 2018 report, EIOPA concluded:

  1. the persistent low yield environment remains challenging for insurers and pension funds;
  2. the risk of a sudden reassessment of risk premia has become more pronounced over recent months amid rising political and policy uncertainty;
  3. interconnectedness with banks and domestic sovereigns remains high for European insurers, making them susceptible to potential spillovers;
  4. some European insurers are significantly exposed in their investment portfolios to climate-related risks and real estate.
  • FINANCIAL STABILITY REPORT

EIOPA published two reports on the financial stability of the insurance and occupational pensions sector in 2018.

In general the persistent low yield environment remains challenging for both the insurance and pension fund sector, which continues to put pressure on profitability and solvency. However, towards the end of the year, as noted in the December report, the risk of a sudden reassessment of risk premia became more pronounced. This is largely due to rising political uncertainty and trade tensions, concerns over debt sustainability and the gradual normalisation of monetary policy. In the short run a sudden increase in yields driven by rising risk premia could significantly affect the financial and solvency position of insurers and pension funds as the investment portfolios could suffer large losses only partly offset by lower liabilities. In this regard, the high degree of interconnectedness with banks and domestic sovereigns of insurers could lead to potential spillovers in case a sudden reassessment of risk premia materialise.

While overall the insurance sector remains adequately capitalised, profitability is under increased pressure in the current low yield environment. The Solvency Capital Requirement ratio for the median company is 225 % for life and 206 % for non-life insurance sector, although significant disparities remain across undertakings and countries.

In the European occupational pension fund sector, total assets increased for the euro area and cover ratios slightly improved. However, the current macroeconomic environment and ongoing low interest rates continue to pose significant challenges to the sector, with the weighted return on assets considerably down in 2017.

  • ENHANCED INFORMATION AND STATISTICS

EIOPA continuously works to improve the availability and quality of available information and statistics on insurance and pensions.

  • Solvency II information

For the insurance sector, EIOPA publishes high-quality insurance statistics at both solo and group level. The statistics are based on Solvency II information from regulatory reporting and their regular publication demonstrates EIOPA’s commitment to transparency. Over the past year, through the increased availability of Solvency II data EIOPA has been able to increase the coverage of its statistics. In June 2018, for the first time, the Authority published further insight into the assets of solo (re)insurance undertakings at country level.

  • Decision on EIOPA’s regular information requests towards NCAs regarding provision of occupational pensions information

In April 2018, the Authority published its decision regarding the submission of occupational pension information. The decision defined a single framework for the reporting of occupational pension information that facilitates reporting processes. As a result, EIOPA will receive the information required to carry out appropriate monitoring and assessment of market developments, as well as in-depth economic analyses of the occupational pension market. The requirements were developed in close cooperation with the European Central Bank in order to minimise the burden on the industry and will apply as of 2019.

  • Pensions information taxonomy

In November 2018, EIOPA published the eXtensible Business Reporting Language (XBRL) Taxonomy applicable for reporting of information on IORPs. It provides NCAs with the technical means for the submission to EIOPA of harmonised information of all pension funds in the European Economic Area. Developed in close collaboration with the European Central Bank (ECB), it allows for integrated technical templates and means to report via a single submission both the information required by EIOPA and the ECB.

CRISIS PREVENTION

In addition to regular financial stability tools, EIOPA undertooka number of additional activities in 2018 related to crisis prevention.

  • Development of a macroprudential framework for insurance

With the aim of contributing to the overall debate on systemic risk and macroprudential policy, over the last year, EIOPA has published a series of reports that extend the debate to the insurance sector and, more specifically, the characteristics of that sector. These reports cover the following:

  1. Systemic risk and macroprudential policy in insurance;
  2. Solvency II tools with macroprudential impact; and
  3. Other potential macroprudential tools and measures to enhance the current framework.

As a next step, EIOPA will consult on concrete proposals to include macroprudential elements in the upcoming review of Solvency II.

  • Analysis of the causes and early identification of failures and near misses in insurance

In July 2018, EIOPA published ‘Failures and near misses in insurance: Overview of the causes and early identification’ as the first in a series aimed at enhancing supervisory knowledge of the prevention and management of insurance failures. The report’s findings are based on information contained in EIOPA’s database of failures and near misses, covering the period from 1999 to 2016, including sample data of 180 affected insurance undertakings in 31 European countries.

The report focuses on an examination of the causes of failure in insurance, as well as the assessment of the reported early identification signals. It also examines the underlying concepts ‘failure’ and ‘near miss’ as well as providing further information on EIOPA’s database, established in 2014.

Click here to access EIOPA’s 2018 Annual Report

EIOPA reviews the use of Big Data Analytics in motor and health insurance

Data processing has historically been at the very core of the business of insurance undertakings, which is rooted strongly in data-led statistical analysis. Data has always been collected and processed to

  • inform underwriting decisions,
  • price policies,
  • settle claims
  • and prevent fraud.

There has long been a pursuit of more granular data-sets and predictive models, such that the relevance of Big Data Analytics (BDA) for the sector is no surprise.

In view of this, and as a follow-up of the Joint Committee of the European Supervisory Authorities (ESAs) cross-sectorial report on the use of Big Data by financial institutions,1 the European Insurance and Occupational Pensions Authority (EIOPA) decided to launch a thematic review on the use of BDA specifically by insurance firms. The aim is to gather further empirical evidence on the benefits and risks arising from BDA. To keep the exercise proportionate, the focus was limited to motor and health insurance lines of business. The thematic review was officially launched during the summer of 2018.

A total of 222 insurance undertakings and intermediaries from 28 jurisdictions have participated in the thematic review. The input collected from insurance undertakings represents approximately 60% of the total gross written premiums (GWP) of the motor and health insurance lines of business in the respective national markets, and it includes input from both incumbents and start-ups. In addition, EIOPA has collected input from its Members and Observers, i.e. national competent authorities (NCAs) from the European Economic Area, and from two consumers associations.

The thematic review has revealed a strong trend towards increasingly data-driven business models throughout the insurance value chain in motor and health insurance:

  • Traditional data sources such as demographic data or exposure data are increasingly combined (not replaced) with new sources like online media data or telematics data, providing greater granularity and frequency of information about consumer’s characteristics, behaviour and lifestyles. This enables the development of increasingly tailored products and services and more accurate risk assessments.

EIOPA BDA 1

  • The use of data outsourced from third-party data vendors and their corresponding algorithms used to calculate credit scores, driving scores, claims scores, etc. is relatively extended and this information can be used in technical models.

EIOPA BDA 2

  • BDA enables the development of new rating factors, leading to smaller risk pools and a larger number of them. Most rating factors have a causal link while others are perceived as being a proxy for other risk factors or wealth / price elasticity of demand.
  • BDA tools such as such as artificial intelligence (AI) or machine learning (ML) are already actively used by 31% of firms, and another 24% are at a proof of concept stage. Models based on these tools are often cor-relational and not causative, and they are primarily used on pricing and underwriting and claims management.

EIOPA BDA 3

  • Cloud computing services, which reportedly represent a key enabler of agility and data analytics, are already used by 33% of insurance firms, with a further 32% saying they will be moving to the cloud over the next 3 years. Data security and consumer protection are key concerns of this outsourcing activity.
  • Up take of usage-based insurance products will gradually continue in the following years, influenced by developments such as increasingly connected cars, health wearable devices or the introduction of 5G mobile technology. Roboadvisors and specially chatbots are also gaining momentum within consumer product and service journeys.

EIOPA BDA 4

EIOPA BDA 5

  • There is no evidence as yet that an increasing granularity of risk assessments is causing exclusion issues for high-risk consumers, although firms expect the impact of BDA to increase in the years to come.

In view of the evidence gathered from the different stake-holders, EIOPA considers that there are many opportunities arising from BDA, both for the insurance industry as well as for consumers. However, and although insurance firms generally already have in place or are developing sound data governance arrangements, there are also risks arising from BDA that need to be further addressed in practice. Some of these risks are not new, but their significance is amplified in the context of BDA. This is particularly the case regarding ethical issues with the fairness of the use of BDA, as well as regarding the

  • accuracy,
  • transparency,
  • auditability,
  • and explainability

of certain BDA tools such as AI and ML.

Going forward, in 2019 EIOPA’s InsurTech Task Force will conduct further work in these two key areas in collaboration with the industry, academia, consumer associations and other relevant stakeholders. The work being developed by the Joint Committee of the ESAs on AI as well as in other international fora will also be taken into account. EIOPA will also explore third-party data vendor issues, including transparency in the use of rating factors in the context of the EU-US insurance dialogue. Furthermore, EIOPA will develop guidelines on the use of cloud computing by insurance firms and will start a new workstream assessing new business models and ecosystems arising from InsurTech. EIOPA will also continue its on-going work in the area of cyber insurance and cyber security risks.

Click here to access EIOPA’s detailed Big Data Report

EIOPA’s Insurance Stress Test 2018 Recommendations

Introduction

During the course of 2018, EIOPA carried out a European-wide stress test (ST) in accordance with Articles 21(2)(b) and 32 of Regulation (EU) 1094/2010 of 24 November 2010 of the European Parliament and of the Council (hereafter the ‘Regulation’).

The Recommendations contained in this document are issued in accordance with Article 21(2)(b) of the Regulation in order to address issues identified in the stress test.

EIOPA will support National Competent Authorities (NCAs) and undertakings through guidance and other measures if needed.

The 2018 Stress Test results showed that on aggregate the insurance sector is sufficiently capitalised to absorb the combination of shocks prescribed in the three scenarios. However, it also confirms the significant sensitivity to market shocks for the European insurance sector with Groups being vulnerable

  • not only to low yields and longevity risk,
  • but also to a sudden and abrupt reversal of risk premia, combined with an instantaneous shock to lapse rates and claims inflation.

The exercise further reveals potential transmission channels of the tested shocks to insurers’ balance sheets. For instance, in the YCU scenario the assumed claim inflation shock leads to a net increase in the liabilities of those Groups more exposed to non-life business through claims inflation. Finally, both the YCD and YCU scenario have similar negative impact on post-stress SCR ratios.

As outlined in the Executive Summary of the 2018 Insurance Stress Test Report, further analyses of the results are required by EIOPA and the NCAs to obtain a deeper understanding of the risks and vulnerabilities of the sector.

In order to follow-up on the main vulnerabilities, EIOPA is issuing the present Recommendations related to the 2018 stress test exercise.

Recommendation 1
NCAs should strengthen the supervision of the Groups identified as facing greater exposure to Yield Curve Up and/or Yield Curve Down scenarios. This affects, in particular, those Groups where transitional measures have a greater impact.

Recommendation 2
NCAs should carefully review and, where necessary, challenge the capital and risk management strategies of the affected Groups. In particular:

  • NCAs should require Groups to clarify the impact of the stress test in terms of capital and risk management.
  • For the affected Groups, stress test scenarios similar to YCU and YCD should be properly considered in the risk management framework, including the ORSAs.
  • Review the risk appetite framework for the affected Groups.

Recommendation 3
NCAs should evaluate the potential management actions to be implemented by the affected Groups. In particular:

  • NCAs should require Groups to indicate the range of actions based on the results of the stress testing.
  • NCAs should assess if the actions identified are realistic in such stress scenarios.
  • NCAs should consider any eventual second-round effects.

Recommendation 4
NCAs should further contribute to enhance the stress test process.

Recommendation 5
NCAs should enhance cooperation and information exchange with other relevant Authorities, such as the ECB/SSM or other national authorities, concerning the stress test results of the affected insurers which form part of a financial conglomerate.

EIOPA ST

Click here to access EIOPA’s Recommendations

EIOPA’s Supervisory Statement Solvency II: Application of the proportionality principle in the supervision of the Solvency Capital Requirement

EIOPA identified potential divergences in the supervisory practices concerning the supervision of the SCR calculation of immaterial sub-modules.

EIOPA agrees that in case of immaterial SCR sub-modules the principle of proportionality applies regarding the supervisory review process, but considers it is important to guarantee supervisory convergence as divergent approaches could lead to supervisory arbitrage.

EIOPA is of the view that the consistent implementation of the proportionality principle is a key element to ensure supervisory convergence for the supervision of the SCR. For this purpose the following key areas should be considered:

Proportionate approach

Supervisory authorities may allow undertakings, when calculating the SCR at the individual undertaking level, to adopt a proportionate approach towards immaterial SCR sub-modules, provided that the undertaking concerned is able to demonstrate to the satisfaction of the supervisory authorities that:

  1. the amount of the SCR sub-module is immaterial when compared with the total basic SCR (BSCR);
  2. applying a proportionate approach is justifiable taking into account the nature and complexity of the risk;
  3. the pattern of the SCR sub-module is stable over the last three years;
  4. such amount/pattern is consistent with the business model and the business strategy for the following years; and
  5. undertakings have in place a risk management system and processes to monitor any evolution of the risk, either triggered by internal sources or by an external source that could affect the materiality of a certain submodule.

This approach should not be used when calculating SCR at group level.

An SCR sub-module should be considered immaterial for the purposes of the SCR calculation when its amount is not relevant for the decision-making process or the judgement of the undertaking itself or the supervisory authorities. Following this principle, even if materiality needs to be assessed on a case-by-case basis, EIOPA recommends that materiality is assessed considering the weight of the sub-modules in the total BSCR and

  • that each sub-module subject to this approach should not represent more than 5% of the BSCR
  • or all sub-modules should not represent more than 10% of the BSCR.

For immaterial SCR sub-modules supervisory authorities may allow undertakings not to perform a full recalculation of such a sub-module on a yearly basis taking into consideration the complexity and burden that such a calculation would represent when compared to the result of the calculation.

Prudent calculation

For the sub-modules identified as immaterial, a calculation of the SCR submodule using inputs prudently estimated and leading to prudent outcomes should be performed at the time of the decision to adopt a proportionate approach. Such calculation should be subject to the consent of the supervisory authority.

The result of such a calculation may then be used in principle for the next three years, after which a full calculation using inputs prudently estimated is required so that the immateriality of the sub-module and the risk-based and proportionate approach is re-assessed.

During the three-year period the key function holder of the actuarial function should express an opinion to the administrative, management or supervisory body of the undertaking on the outcome of immaterial sub-module used for calculating SCR.

Risk management system and ORSA

Such a system should be proportionate to the risks at stake while ensuring a proper monitoring of any evolution of the risk, either triggered by internal sources such as a change in the business model or business strategy or by an external source such as an exceptional event that could affect the materiality of a certain sub-module.

Such a monitoring should include the setting of qualitative and quantitative early warning indicators (EWI), to be defined by the undertaking and embedded in the ORSA processes.

Supervisory reporting and public disclosure

Undertakings should include information on the risk management system in the ORSA Report. Undertakings should include structured information on the sub-modules for which a proportionate approach is applied in the Regular Supervisory Reporting and in the Solvency and Financial Condition Report (SFCR), under the section “E.2 Capital Management – Solvency Capital Requirement and Minimum Capital Requirement”.

Supervisory review process

The approach should be implemented in the context of on-going supervisory dialogue, meaning that the supervisory authority should be satisfied and agree with the approach taken and be kept informed in case of any material change. Supervisory authorities should inform the undertakings in case there is any concern with the approach. In case the supervisory authority has any concern the approach should not be implemented or might be implemented with additional safeguards as agreed between the supervisory authority and the undertaking.

In some situations supervisory authorities may require a full calculation following the requirements of the Delegated Regulation and using inputs prudently estimated.

Example : Supervisory reporting and public disclosure

Undertakings should include information on the risk management system referred to in the previous paragraphs in the ORSA Report.

Undertakings should include structured information on the sub-modules for which a proportionate approach is applied in the Regular Supervisory Reporting, under the section “E.2 Capital Management – Solvency Capital Requirement and Minimum Capital Requirement” (RSR), including at least the following information:

  1. identification of the sub-module(s) for which a proportionate approach was applied;
  2. amount of the SCR for such a sub-module in the last three years before the application of proportionate approach, including the current year;
  3. the date of the last calculation performed following the requirements of the Delegated Regulation using inputs prudently estimated; and
  4. early warning indicators identified and triggers for a calculation following the requirements of the Delegated Regulation and using inputs prudently estimated.

Undertakings should also include structured information on the sub-modules for which a proportionate approach is applied in the Solvency and Financial Condition Report, under the section “E.2 Capital Management – Solvency Capital Requirement and Minimum Capital Requirement” (SFCR), including at least the identification of the submodule(s) for which a proportionate calculation was applied.

An example of structured information to be included in the regular supervisory report in line with Article 311(6) of the Delegated Regulation is as follows:

Proportionality EIOPA

This proportionate approach should also be reflected in the quantitative reporting templates to be submitted. In this case the templates would reflect the amounts used for the last full calculation performed.

Click here to access EIOPA’s Supervisory Statement