Solvency II News: new Level 2 draft broadly consistent with previous version

The draft of the Solvency II Level 2 text (Delegated Acts) remains largely consistent with the October 2011 version, according to people familiar with the document.

“It appears that the Commission has been able to stick to its plan not to rewrite the entire text following the Omnibus II agreement on the Level 1 text last November,” a person familiar with the current draft and the version published in October 2011, said. A copy of the draft seen by Solvency II Wire, dated 10 January 2014, is 399 pages long. A Commission Official verified that a draft text has been sent to finance ministries in the Member States and circulated to selected stakeholders. The text will be discussed at the Commission’s Expert Group on Banking, Payments and Insurance (EGBIP) on 28 January.

LTG measures

Two people familiar with the drafts confirmed that much of the changes amount to “tidying up” of the text, which in essence remains true to the October 2011 draft. As expected the text includes a number of new sections relating to the Omnibus II agreement on Long-Term Guarantees (LTG). The area raising most concern is the calibration of the Credit Risk Adjustment (CRA), which is a deduction made to the swap rates used to derive the basic risk-free curve. According to one person familiar with the new text, the Commission is proposing to introduce a floor of 10 basis points (bps) to the CRA, while industry is asking for the CRA to be capped at 10bps. The cap is in line with the value used in QIS5, which was later raised to 35bps as at YE2011 in EIOPA’s LTGA report. According to the source, “Without a cap the CRA adjustment would be exposed to significant volatility which would flow through to the risk-free rate, making this hard to manage effectively.” The text also details the composition of the reference portfolio for the Volatility Adjustment, which surprisingly also includes property and equity in addition to government and corporate bonds. Another area that may prove controversial is the interest rate stress. The text removes restrictions on the downward interest rate stress which could potentially result in negative stressed interest rates. Leaving the bulk of the text unchanged would be a welcome relief and raise confidence that the implementation timetable can remain on track. However, it also means that other unresolved issues remain. These include: some of the SCR modules, interest rates and the Ultimate Forward Rates. Contract boundaries have not been aligned with IFRS.

Process

A Commission Official said there were no plans for a public consultation on the text, which will need to be finalised in March or April this year in order to be submitted for translation ahead of adoption later in the summer. The October 2011 draft of the Level 2 text has not been consulted on publicly, although copies have been widely circulated. The current draft will be discussed at the Commission’s Expert Group on Banking, Payments and Insurance (EGBIP), which is a relatively new body. According to the Commission website the EGBIP is, “a consultative entity, composed of experts appointed by the Member States, in order to provide advice and expertise in the preparation of draft delegated acts in the area of banking, payments and insurance to the Commission and its services.” It is similar to the European Insurance and Pensions Committee (EIOPC) but with a different remit. The EIOPC is made up of members of the insurance supervisory and regulatory authorities of EU member states and performs a similar function. In 2013, following the institutional changes introduced by the Treaty of Lisbon (Articles 290 and 291 of the consolidated Treaties, with Declaration 39 on Article 290), the EIOPC, although it still exists, will only deal with draft Implementing Acts of the Commission (Article 291). Draft Delegated Acts of the Commission (Article 290) and all matters related to insurance and occupational pensions legislation, are discussed by the new EGBIP in its insurance formation. The group’s first meeting was held on 1 July 2013. A detailed discussion of the Omnibus II LTG package is available in its published minutes. Further details of the role of EGBIP and changes introduced by the Treaty of Lisbon can be found here. To subscribe to the Solvency II Wire mailing list for free click here.]]>

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5 thoughts on “Solvency II News: new Level 2 draft broadly consistent with previous version

  1. I would certainly agree with the headline.
    But a couple of areas where I would disagree with the commentary:
    “According to the source, “Without a cap the CRA adjustment would be exposed to significant volatility which would flow through to the risk-free rate, making this hard to manage effectively.””
    Actually, there is a specific requirement that the method “ensure the stability of the adjustment”, so that should not be a concern for managing the risk-free rate. In practice I think the CRA will be quasi-fixed, but with some scientific justification of it’s basis – rather like the fundamental spread.
    And on the inclusion of property and equity in the Vol Adjustment portfolio, I think that’s a red herring. Classification is to stick assets in different buckets and given size of holdings you can’t ignore those two. But they don’t attract a vol adjustment – only government and other bonds do – so they aren’t really included – as the formula in Level II suggests.
    Views on both of these – from Solvency II Wire, the “source”, or other readers – very welcome.
    There are a few other areas that do seem to be changes from before eg relaxation of look through for funds, even better treatment of mortgages than before and removal of duration cap on spread tests, but overall doesn’t seem much new.
    Also a few areas where drafting isn’t great so meaning ambiguous (eg how you treat matching adjustment in SCR, where their wording read literally makes no sense) – that’s where the lack of a consultation process is frustrating. The LTGA specs were similar to Level II in content but a lot less ambiguous.

    1. Paul,
      On your reference to the easing of look through on funds, can you elaborate?
      From what I have seen, it looks like firms can use the investment mandate once this does not exceed 20% of assets under management.
      This would not ease the look through for a life insurer who would have a significantly higher percentage.

      1. Well to my point on the sloppy drafting and the silly consultation process, it’s all a bit messy!
        Yes there is a reference to a 20% limit but that applies for “data grouping” but doesn’t seem to apply to the idea of basing your calculation on the target underlying asset allocation – which you could potentially do without grouping.
        And in a wonderful piece of drafting they’ve ended up with a double negative. The condition that “they do not apply to no more than 20 %” – actually says that data grouping is OK as long as it DOES exceed (rather than does NOT exceed) 20%!
        An Omnishambles (or strictly a LevelIIShambles).

        1. Paul
          The double negative is quite frankly hilarious !
          But at the end of the day… Look through is going to be a requirement, not just for solvency II as defined, but for pension funds, risk in retail investors investing in complex instruments they don’t understand…. The list goes on.

    2. The latest text is also rumoured to pick up on the reliance placed on external credit ratings …
      Insurers should be performing their own credit assessments – at least for their large and more complex exposures.
      If the models they use for this purpose haven’t been approved by the supervisor, they won’t be allowed to set aside less capital than they would otherwise be required to hold if they used the external credit rating.

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