Letter to MEPs on the Solvency II review

Solvency II review

February 2, 2022

Ladies and Gentlemen of the European Parliament, dear Mr Ferber, dear Mrs Yon-Courtin, dear Mrs Lalucq, dear Mr Zanni, dear Mr Van Overtveldt,

I am writing to you in reference to the European Commission's proposal on the Solvency II review.1 Thanks to the work of EU co-legislators and the European Insurance and Occupational Pensions Authority (EIOPA), the market-based regulatory regime for insurers, introduced in 2016, has succeeded in making individual insurers safer. To extend this success beyond individual insurers to the system-wide level, the European Systemic Risk Board (ESRB) has identified ways to improve Solvency II to better address systemic risks. If not taken into account, these risks could limit the contribution of the insurance sector to sustainable growth in the European Union.

The ESRB expressed its views in its response to the consultation organized by the European Commission on the Solvency II review.2 In its response, the ESRB identified the following topics as the most relevant in terms of their systemic relevance: the need (i) to better reflect macroprudential considerations in Solvency II; (ii) establish a harmonized recovery and resolution framework across the European Union; and

continue to ensure that risks are properly taken into account in the Solvency II framework. He also highlighted new information on events related to the coronavirus (Covid19 pandemic. It should be noted that the macroprudential considerations of the ESRB and EIOPA are broadly aligned, as shown by their respective responses to the
consultation of the Commission.

The European Commission's proposal following this consultation is a good starting point, as it reflects many - but not all - of the elements that the ESRB has identified to address risks to financial stability. He is

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It is important that these elements are not watered down in the legislative review since the proposal is seen as a minimum of what is needed to help prevent or mitigate risks to financial stability. I would also like to highlight where the EU co-legislators could take the opportunity to strengthen and improve the proposal.

Opportunities to Strengthen the Proposal to Completely Address Significant Solvency II Shortcomings

I would like to draw your attention to two important elements pointed out by the ESRB in its previous response and addressed to some extent by the European Commission in its proposal. The following elements need further strengthening.

• Solvency risks resulting from low interest rates and financial market volatility. If these risks are not taken into account, solvency ratios will be overestimated, which will lead to fragile insurers at a higher risk of default. The application of a more market-based method to calculate risk-free discount rates for insurers, which sets the last liquid point of the euro at 30 years and extends the convergence period between the last liquid point and the ultimate term rate of 40 to 100 years is an important tool to deal with this risk.
• Distribution risks, such as dividends or share buybacks, can lead to capital depletion and insurers might try to keep capital elsewhere by reducing risk. These de-risking strategies can amplify exceptional market-wide shocks. As distributions are also used as a strength signal for the market, they could undermine the relative position of more cautious insurers, which could be stigmatized. Accordingly, supervisors should have the authority to restrict market-wide distributions in exceptional circumstances.3

Opportunities to improve the proposal to address other gaps that are currently unaddressed

The European Commission's proposal does not address some of the shortcomings highlighted in the ESRB's response. The following deviations are particularly relevant in the context of low interest rates and sector shocks.

• Mortgage risks are closely linked to property risks and insurers in some European countries invest up to 14% of their total assets in mortgage loans.4 Despite lingering concerns about rising house prices in the European Union5, insurers in many countries can engage in mortgage lending with lower capital requirements than banks. I therefore welcome the intention of the European Commission to better align the prudential treatment of mortgage loans in Solvency II with the credit risk framework for the banking sector.6 However, provisions for borrower-centric measures for mortgage loans that apply independently of the part of the financial sector granting a loan are lacking. These measures are important to deal with the risks of residential real estate bubbles and the increase in foreclosures when the bubbles burst.
• Risks associated with procyclical investment behavior can arise when insurers are forced to sell commonly held or correlated assets in times of stress. During the market turmoil of March 2020, insurance supervisors

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in some countries resorted to existing transitional measures to smooth the impact of sharp declines in asset prices. These measures, however, were not designed for this purpose, which is problematic as they will continue to provide capital relief for the next ten years. It is therefore important to improve the existing mechanisms in Solvency II, including making the countercyclical mechanism more symmetrical.

Attached to this letter, you will find a summary table which summarizes the elements set out in the ESRB's response to the European Commission's consultation on the Solvency II review which have been largely integrated into the Commission's proposal and those which are not. have not been or only partially.

My colleagues and I are at your disposal to discuss the macroprudential elements of the Solvency II review.

Finally, please note that the same letter has been sent to the chair of the Council working group responsible for this legislative file, and this letter will be published on our website.

Cordially,

Francesco Mazzaferro

Head of the ESRB Secretariat

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Annex: Mapping of macroprudential measures for insurance recommended by the ESRB against the European Commission's proposal

Note: a check mark [cross] in the column entitled "COM" indicates that a measure recommended by the ESRB has largely [not] reflected in the European Commission's proposal. A tilde indicates that only parts of a measure recommended by the ESRB have been included in the European Commission's proposal and/or that their implementation should be strengthened.

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ESRB - European Systemic Risk Board published this content on February 02, 2022 and is solely responsible for the information contained therein. Distributed by Public, unedited and unmodified, on February 04, 2022 09:25:06 UTC.

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