The likelihood that implementation of the EU’s Solvency II legislative regime will again be delayed is growing, says Moody’s Investors Service.
The credit ratings agency (CRA) believes that that the current macro-economic environment has contributed to this delay, the credit implications of which are broadly negative in terms of:
- Delaying the implementation of a stronger, credit-enhancing regulatory regime.
- Allowing companies that would currently struggle to meet Solvency II’s capital adequacy requirements to incur more risk than regulators would allow under the new regime.
- Larger market players losing a potential competitive advantage if less sophisticated competitors (those less advanced with respect to Solvency II) are aided by delayed implementation.
On 12 October, the European Parliament rescheduled the plenary vote of the Omnibus II Directive from 20 November to 11 March 2013 and the final criteria for calculating the Solvency II capital requirements cannot be published until this vote has occurred. Then, on 17 October, the European Insurance and Occupational Authority (EIOPA) chairman, Gabriel Bernardino, interviewed by the Wall Street Journal, said that under the best scenario, Solvency II could start to be implemented in either 2015, or more probably, 2016. As a result, the current official implementation date of 1 January 2014 seems increasingly unlikely.
Moody’s cites two specific areas in which the macro-economic environment has contributed to this likely delay in Solvency II. Firstly, the historically low level of interest rates within Europe has increased spread deficiency risk for life insurers that provide guaranteed rates of return on certain savings policies, including annuities. The running yield on these insurers’ investments is reducing and is now close to, or even below, the average guaranteed rates of return they offer their customers. For treasurers with responsibility for pensions, this could prove a problem.
Implementing Solvency II would require many insurers to hold more capital for this risk. As a result, and to try to address industry concerns, the rate at which insurers should discount such liabilities under Solvency II has been the subject of much debate and remains under political discussion. Concepts including the illiquidity premium, and matching adjustment and countercyclical premium have been suggested at various stages.
With sustained low interest rates, EIOPA will again ask insurers to participate in an evaluation exercise – the long-term guarantee (LTG) assessment, which Moody’s believes to be a likely contributor to the push-back of the Omnibus II vote and the project overall.
Another macro-economic factor depressing performance is the general lack of economic growth in Europe, and the CRA believe policymakers remain concerned over the ability of unintended consequences of regulatory change to hinder such growth. According to a letter from the European Commission (EC) to Gabriel Bernardino, chair of EIOPA, the Commission, further to the European Council’s determination to stimulate growth within Europe, recognises that European insurers are a potentially powerful financing channel for long-term investment in growth- and job-enhancement. Consequently, they have asked EIOPA to examine the calibration and design of capital requirements for investments in certain assets. Again, in Moody’s view, this is a likely contributor to the plenary vote delay, and to the more general impetus to delay the Solvency II project.
Under Solvency II, (re)insurers will be required to take account of all the types of risk to which they are exposed and to manage those risks more effectively. This is in stark contrast with the current Solvency I, in which capital requirements focus solely on insurance risk in a somewhat crude fashion, and where definitions of capital differ between countries. The CRA, therefore, views Solvency II as an improved and tighter regulatory regime compared with Solvency I, and a regime under which the promotion of a strong culture of risk management is credit positive for the industry. Delaying Solvency II compliance, therefore, delays the implementation of a stronger, credit-enhancing regulatory regime.
Furthermore, a further delay to Solvency II could be construed as a form of regulatory forbearance, which Moody’s regards as credit negative. Companies that would currently struggle to meet Solvency II’s solvency capital requirement (SCR) in the current low interest-rate environment are in effect being allowed to take more risk than regulators would allow under the new regime.
Moody’s concludes that the larger, more sophisticated groups already generally conform with Solvency II principles regarding risk management and reporting. These groups also typically hold capital buffers in excess of an economic capital requirement that is normally calibrated to at least the same confidence level as Solvency II. Consequently, for these groups, a potential competitive advantage is removed if less sophisticated competitors, who are less advanced with respect to Solvency II, are aided by delayed implementation.
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