Solvency II - Level 2 implementation measures Consultation Response Retirement and “socially useful” products
The European Commission has published its summary of the comments it received in
response to the consultation on the Level 2 implementation measures for Solvency II (1).
This and the accompanying exchange of letters between the insurance industry
representatives group (2) and Commissioner Barnier (3) highlight a potentially serious
problem which could impact the final developments of the Solvency II project. Solvency II
is now reaching its final stages and technical details are being hammered out at so called
Level 2 of the legislative process. This is notionally less political and consigned more to
technical solutions. However, it has become increasingly apparent that a number of major
strategic issues are manifesting at this technical level. In this commentary, the focus is on
the impact on existing long term guarantee products from insurers and whether innovation
for long term savings will have to come from outside the traditional life/pensions sector.
For instance, the rise of unit-linked investment vehicles, ‘pure’ DC (e.g. UK) is basically a
long-term investment sold under the legal structure of an insurance wrapper.
Some respondents suggest that a further consequence would be increased investment by
consumers in unit-linked products or variable annuities as a cheaper alternative to longterm insurance with guarantees. Other critics have argued that there could be an increase
in investment in cheaper unregulated products. These fears may well resonate with the
Commission and EU politicians who are widely concerned to enhance consumer confidence
in financial services in the wake of the financial crisis. It may be that Solvency II becomes
a de facto product regulating measure working against consumer long term interests.
Background
The genesis of the Solvency II project predates the financial crisis and was accepted by all
partners as a necessary transformational event for the insurance industry. It is due to be
implemented at the start of 2013. It is curious that fundamental issues regarding the
availability of what be considered socially useful long term products remain to be resolved.
The strong tone of the correspondence indicates that this is not just the expected lobbying
of a sector which feels it had a “good crisis”, as the Commission does seem to have
recognised the significance of what could happen. Commissioner Barnier in his letter,
firms up comments made in the Commission paper;
“In particular, we take very seriously the issue of the ongoing viability of insurance
products with long-term guarantees. The problem mainly relates to the volatility of own
funds under a market consistent valuation framework and the measurement of the specific
risks that these undertakings are exposed to. A working party is currently analysing these
issues and the necessary measures will be taken in order to ensure that the characteristics
and risks of these products are adequately reflected in the implementing measures.”
(Emphasis added).
The Level 2 consultation followed on from the impact assessment of the Solvency II
Framework Directive. It is hoped that the Commission's proposal for implementing
measures would take into account any additional and/ or incremental effects that the
policy decisions for the level 2 implementing measures may have on the pricing, design
and availability of insurance products and on insurance market (4 ).
The earlier impact study carried out by Deloitte for the Commission hinted at possible
product related problems: “In the short-term, the need to adapt products may lead to
reduced product offerings by undertakings, whose financial requirements are expected to
be higher under Solvency II (for example long-term/ high-severity insurance lines). Over
the long-term coverage is expected to stabilise as new products emerge, prices are
adjusted and insurers make greater use of risk mitigation techniques.” (5).
Many respondents to the consultation suggested that Solvency II would indeed result in
the cost of capital and risks becoming a much greater consideration in product
development than is currently the case under Solvency I. As a result, insurance prices are
predicted to decrease for those products which will incur lower capital costs (for example
simple term assurance) and to increase for those products which may incur higher capital
costs (for example annuities). The Commission identifies the following product areas as
areas of special interest to the respondents.
Long term products
The vast majority of responses noted the potential impact of the level 2 implementing
measures on long-term products with guarantees. The concern is that the Level 2
implementing measures as set out in the technical specifications for the fifth quantitative
impact study (QIS5) will make it commercially unviable for insurers to continue to offer
these types of products.
The Commission summarise the problem as being in large part related to the volatility of
the value of assets and liabilities under a market consistent valuation framework and the
measurement of the specific risks that undertakings offering these products are exposed
to. The policy issues most relevant to this issue are the risk-free interest rate curve for
technical provisions and the Pillar I dampener.
These respondents suggested that requirements leading to higher technical provisions or
higher capital requirements, as a result of high market risk or high underwriting risk
requirements, could increase the cost of offering this type of business. In some cases,
respondents expect that these costs will be passed directly to policy holders and that the
price of these products will increase. In other cases, respondents suggested that these
products may be withdrawn from the market altogether.
It was highlighted that this would primarily affect consumers saving for retirement and
pensions. Respondents stressed the important role of insurers as providers of private
pensions, particularly given the demographic challenge currently faced by many Member
States. It was stressed that if Solvency II results in insurers ceasing to offer long-term
products, there would be increased pressure on social security systems to fill the pensions
gap
Unit-linked products
According to the Commission there were mixed reactions from respondents on the
potential impact of the level 2 measures on unit-linked products. Some responses
suggested that the price and design of unit-linked products will be largely unaffected.
Others indicated that a greater variety of unit-linked products may be developed which
change the way that risk and reward from capital market investments is shared between
insurers and policy holders with a certain minimum performance guarantee.
Other respondents suggested that the definition of contract boundaries, together with the
counterparty risk exposures could have a negative impact on unit-linked business and
result in price increases. One respondent suggested that potentially negative impacts on
unit-linked business could be reduced through the provision of counter guarantees by third
parties such as investment banks.
Some critics suggested that such products expose consumers to greater investment risk
making it difficult for them to save reliably for old age.
Summary
The response by the Commission has indicated that further work will need to be done on
the issues of what social and economic knock-on effects might occur as a result of the
changes to the design, pricing and availability of insurance products brought about by
Solvency II.
As one respondent put it: “The most dangerous effects could be: financial exclusion (due
to higher premium) or lack of insurance products providing long-term guarantees (like:
long-term care or annuities). Low income consumers, and thus riskier for the insurance
firms and in general the most vulnerable parts of the society are expected to be more
severely affected due to the new risk-based assessment orientation. The final social effects
will depend on the social security coverage assured by the state.”
It will not have gone unnoticed in these growth starved times that it was widely suggested
that if new requirements result in insurers ceasing to offer long-term insurance products
they would also cease to invest in long-term assets. If reduced long-term investment by
the insurance sector proves to be a reality, the role of insurers in providing long-term
financing could diminish. This may have wider economic impacts,
On a more entrepreneurial note, the discussions over the final stage of Solvency II should
also be of interest to other financial institutions outside the insurance sector. The work on
PRIPS has already highlighted the overlaps and substitutability of retail products sourced
from different providers and the need to align regulatory requirements at the sales and
marketing stage. Solvency II, through inadvertent product regulation may provide a shift
in the type of products insurers are able to provide commercially.
References
1.
European Commission
Consultation on the Level 2 implementing measures for Directive 2009/138/EC on the
taking-up and pursuit of the business of Insurance and Reinsurance (Solvency 2)
http://ec.europa.eu/internal_market/consultations/2010/solvency-2_en.htm
2.
Joint industry letter (i.e. the Pan European Insurance Forum (PEIF), the Comité
Européen des Assurances (CEA), the CFO Forum and the CRO Forum).
3.
June 2011: Solvency II - Letter from Commissioner Barnier to Insurance Industry
http://ec.europa.eu/internal_market/insurance/docs/solvency/barnier_june_2011_en.pdf
4. Consultation on the Level 2 implementing measures for Directive 2009 /138/EC on the
taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II)
5.
Deloitte Paper. External Study by Deloitte for the Impact Assessment of Solvency
II (Level 2) www.deloitte.com