1.7.1. Improved protection of policyholders and beneficiaries

As we have discussed, the introduction of a market consistent approach has resulted in a regime that provides a more scientific approach of determining capital requirements. In addition, allocating more money to back insurance liabilities and their capital requirements has also enhanced policyholder protection.

During the oral evidence given by Andrew Chamberlain on behalf of the IFoA, the TSC made the point that, because the PRA has no primary responsibility in respect of competition, allocating more money to back insurance liabilities and their capital requirements is an easy way for regulators to improve policyholder protection.

In our working party we believe that the improved consumer protection objectives have been met although there was no prevailing view to that effect at the Life Conference workshop (see Figure 1).

Figure 1 Improved customer protection has been achieved. Conference workshop: Votes 43, average 3.1, SD 0.9.

1.7.2. Effective risk management

The market consistent aspect of Solvency II provides a solid foundation upon which the capital requirements reflect the risks inherent within an insurance company or group.

Insurers are now rewarded for matching liabilities with corresponding assets where this is possible. Market consistency is being questioned in terms of its impact on financial stability and its relevance to long-term guaranteed business. However, it has a huge impact in encouraging effective risk management.

These incentives have been reduced by the extrapolation from a 20-year point to the UFR in respect of euro liabilities. Similarly, under the MA it is possible to improve a life insurer’s capital position by taking on credit risk. To ensure effective risk management it has been necessary to develop strict admissibility and cash flow matching rules.

Our working party’s view is that in general Solvency II has delivered a system that tends to encourage effective risk management. The views of those voting at the Life Conference was less emphatic where there were divergent views on how successful Solvency II has performed in this respect (see Figure 2).

Figure 2 Effective risk management across Europe has been achieved. Conference workshop: Votes 55, average 3.0, SD 0.95.

1.7.3. Harmonisation

The detail of the regulation and the introduction of a common European regulator has resulted in a high degree of harmonisation on the face of it, but in section 6 we take a deeper look to reveal important areas in which harmonisation has not been achieved. Even reserving and capital requirements may differ significantly between insurers.

An insurer writing long-term traditional with-profits business in euro benefits from an extrapolation of the euro swap curve to the UFR from year 20. Whilst a UK insurer writing annuity business may, or may not, take advantage of the MA.

Nor, in this case, is the reporting similar. The impact of the MA is disclosed when reporting whilst the impact of the extrapolation to the UFR is not. Hence an analyst has additional information to form a view on the balance sheet strength of a UK annuity writer but does not necessarily have similar information regarding a continental with-profits office.

An insurer with an internal model might measure more risks than an insurer using the standard formula. Elsewhere aspects such as the volatility adjustment (VA) and the transitional measures are not applied uniformly.

That said, Solvency II has imposed a sophisticated, detailed and revolutionary set of rules across 28-member states and this feat is a major accomplishment.

Despite this, our view and that of our voting audience at the Life Conference was that Solvency II had failed to achieve harmonisation (see Figure 3).

Figure 3 Harmonisation across Europe has been achieved. Conference workshop: Votes 54, average 2.0, SD 0.85.

1.7.4. Financial stability

There is a concern around the pro-cyclical nature of market consistent approaches and questions are being asked about the going concern approach of Solvency II compared to the run-off approach of Solvency I.

Pro-cyclicality and financial stability are areas where we can inform the debate. Market consistency will tend to be pro-cyclical. If markets fall, it makes sense to hold capital against further falls. For insurers without enough spare capital this can result in insurers selling risky assets creating pro-cyclicality with potentially disastrous outcomes for financial institutions. The move to market consistency and the use of a 1-year Value at Risk (VaR) increases the risk of herd behaviour as, in the absence of capital, insurers would be required to de-risk within the same time frame as other institutions.

Markets though can over-react. Many are not deep and liquid. Insurers writing long tail business do not have immediate cash flows to pay. A capital regime that provides time for insurers to formulate a measured response would be desirable.

The symmetric adjustment for equities in the Standard Formula achieves this but its effectiveness is restricted by a maximum 10% reduction in the size of the standard equity stress.

It does, however, give time for markets to find their new level if they have over-reacted and for insurers to formulate their best response if they have not. Variations to this and applying it to other market risks such as spread risk could be one solution. Indeed there is a range of solutions that could be usefully assessed.

The concern around pro-cyclicality is such that our working party is unanimous in its view that Solvency II has fallen short of its goal of aiding financial stability. The Life Conference voting pattern was similarly tight but with a stronger view that Solvency II had not met its objectives (see Figure 4).

Figure 4 Financial markets are more stable. Conference workshop: Votes 56, average 1.4, SD 0.55.

2.1.1. UFR

The risk-free yield curve is based on interest rates swaps observed in deep, liquid and transparent markets; where swaps are not available government bonds are used. However, for long-term liabilities where liquid financial instruments are not available, the curve is extrapolated from a stipulated Last Liquid Point (LLP) to the UFR, which is provided by EIOPA.

For the euro the LLP is year 20 and the extrapolated curve converges to the UFR of 4.2% over a period of 40 years. Anecdotally the 20 year LLP seems to be a political compromise between the European countries. However, in the current low interest rate environment EIOPA has already suggested a lower UFR in just over 1 year into Solvency II. Their suggestion is that, for the euro in 2018, the “calculated UFR” is 3.65% (as opposed to the current 4.2%) and that after applying a maximum year on year change of 15 basis points the “applicable UFR” will be 4.05% (EIOPA, 2017)

With interest rates at unprecedented low levels, many question the suitability of the UFR. There are debates around this area with insurers and regulators alike trying to gauge what the “right” value should be.

The emergence of negative interest rates in countries such as Switzerland and Germany show more acutely the issues surrounding a fixed UFR set before the current low interest rate environment. In general, negative interest rates challenge current economic theory and the calibration of solvency models across a broad spectrum of financial institutions.

Some countries, such as Germany, are more dependent on the value of the UFR than others, due to the nature of the business sold; while other countries, such as the United Kingdom, rely on measures such as the MA. These valuation tools are a part of the LTG package, countries which may object to the UFR but rely on other aspects of the LTG package, are less likely to challenge it.

The UFR is less of an issue in countries where swap markets are deemed to be deep and liquid out to very long maturities.

2.1.2. MA

The MA is a flat addition to the risk-free yield curve, and can be applied to portfolios where the liabilities are fixed cash flows and the assets backing them can be separately identified, organised and managed from the rest of the business activities of the insurer.

MA is based on the portfolio of the insurer, and is essentially a proxy for the illiquidity premium on the assets held to back the liabilities.

As at 1 January 2016, according to data published by EIOPA (2016a), the MA was being used by insurers in Spain (15 insurers) and the UK (23 insurers) with two further national supervisors indicating that it may be used in the future, particularly in respect of new business. The data shows that removing the MA would reduce the SCR ratio by an average of 65% in the United Kingdom and 50% in Spain.

In the United Kingdom it is applied to annuities, however, it might be considered unfair to single out annuities for preferential treatment. That it is restricted to annuities reflects the fact that this was part of the compromise measures agreed as part of Omnibus II.

Basing the value of a fixed cash flow liability on the assets backing it and recognising on day 1 the unearned illiquidity premium is clearly not market consistent. Indeed it is very similar to the Solvency I discount rate used in the United Kingdom but without a prudent margin in the fundamental spread.

This impact can be to reduce the technical provisions at an undertaking level by up to circa 10%, compared to not using the MA, according to data published by EIOPA (2016a).

Investing in this way creates a capital requirement for spread risk although the spread risk has been reduced to capture the fact that the portfolio is exposed to default rather than spread risk. According to data published by EIOPA (2016a), the impact at insurer level can be to reduce the SCR up to a half, although for other insurers it can result in a small increase.

It is possible that this capital requirement can be more than covered by the benefit of the lower BEL coming from the higher discount rate. This appears counter-intuitive as it is the exact opposite of rewarding effective risk management, as it is hard to imagine that the additional yield comes without additional risk other than illiquidity risk.

There are stipulations in the derivation of the fundamental spread on government and non-government exposures; it is also adjusted so that the MA on non-investment grade assets does not exceed that calculated for investment grade assets. Hence additional capital is required when a BBB-rated bond downgrades to BB-rated.

The MA can become negative when spreads are very tight, although it is usually higher than the VA.

The eligibility criteria for the MA are set out in Appendix 5.

In order to use the MA, insurers need to apply for it from their national regulator; however, once approved the insurer cannot choose not to apply it. If the insurer cannot comply with the eligibility criteria or is not able to restore eligibility status, it will be banned from using MA for a period of 2 years. These rules appear to be a deterrent from applying the MA in the first place and also introduce a new risk in respect of the loss of the MA. It is not clear what other benefit this rule serves for the protection of policyholders.

The consequence of a departure from a market consistent framework is the ability to arbitrage rule inconsistencies.

Assets such as equity release mortgages do not meet the rules and can no longer be held directly within MA portfolios. However, many companies have created special legal entities to meet the eligibility criteria. Special purpose vehicles (SPVs) have been used for cash flows from equity release products, commercial real estate mortgages and infrastructure finance (Rule, Reference Rule2017). In these SPVs securitisation techniques such as credit enhancement features and liquidity facilities are used so as to allow them to issue eligible senior tranches.

Liabilities such as Periodic Payment Order (PPO) annuity payments can, at least in theory, be reinsured on a Retail Price Index basis into a MA compliant portfolio as a means to derive some benefit from the MA.

Arbitrage opportunities such as this have created the growth of an “industry” in structuring portfolios to make them eligible. These increase the cost base of insurers, increase operational risk and add to the complexity of an insurer’s balance sheet.

Finally, the SCR is calculated separately for different MA portfolios and cannot be diversified with the rest of the insurer’s business activities, or between MA portfolios. Therefore, the more MA portfolios, the less diversification benefit that can be taken into account. However, MA can be taken into account for the calculation of the SCR for spread risk, and hence can decrease the SCR. It significantly reduces SCR volatility too.

2.1.3. VA

The VA is a constant addition to the liquid part of the risk-free yield curve, therefore the spread is only applied up until the LLP for each currency and thereafter the adjusted yield curve is extrapolated to the UFR should it also be applicable.

It aims to protect insurers with long-term liabilities from short-term volatility in the market. VA is the spread between the interest rate of the assets in the reference portfolio and the corresponding risk-free rate for each currency, minus the fundamental spread – a haircut for default and downgrade on the qualifying assets. If the market spreads are very wide in a specific country, a country spread can be added to the currency spread.

The reference portfolio is determined by EIOPA and includes assets typically held by insurers to cover their liabilities (BEL).

Unlike MA, VA can be used in conjunction with transitional measures on risk-free rates, and if the VA is used MA cannot be applied. However, in the standard formula it does not respond to SCR shocks for spread risk.

The use of VA should be allowed by national supervisors, but some countries may have an approval process.

As at 1 January 2016, according to data published by EIOPA (2016a), VA was being used by 852 undertakings in 23 countries, the largest take-ups are in France with 217 undertakings. The technical provisions of the French undertakings applying the VA represent 18.1% of the total technical provisions in the European Economic Area (EEA); this is followed by Germany at 10.1% and the United Kingdom at 9.2% and are mainly for the life businesses.

The data show that removing the VA would reduce the SCR ratio by an average of 34% at the EEA level, with the biggest impact in Denmark and Germany at 91% and 85%, respectively; as compared to the United Kingdom where it is only 6%, therefore at the EEA level it is fairly significant especially for certain countries such as Germany.

2.1.4. General

MA and VA are utilised by different insurers in different countries. Where approvals need to be obtained, processes may not be equally stringent therefore creating an uneven playing field. This reduces the harmonising effects of Solvency II, which is one of the objectives mentioned in section 1.2.

The various adjustments to the risk-free discount rate raise the question of whether it is too conservative for the insurance industry with long-term liabilities. Where specific adjustments were designed for specific products, such as the MA, there could be a case for unification by establishing a fairer adjustment across the whole yield curve and across all products.

This suggests that there is a case, if not for entity specific discount rates, then a discount rate that reflects a good investment grade entity where insolvency can be entertained – AA or A rated discount curves.

The fact that the standard formula treats sovereign bonds in the domestic currency in all member states as risk-free (as stated in section 3.1.6.6) raises questions as not all countries issue bonds of equal credit quality; spreads in certain countries trade at significant spreads above German government bonds. Further, certain supranational, regional and local authority bonds get a similar treatment, irrespective of financial health although there are requirements they need to meet, e.g., around tax raising powers to provide consistency with sovereigns (Solvency II Wire, 2016a).

Solvency II equivalence for other non-Solvency II countries, e.g.: the United States, Bermuda and Japan also introduce non-market consistent valuation methodologies and reduce the impact of harmonisation for insurers across countries outside of the EU. There is already emergence of evidence which show insurers in Solvency II countries reinsuring longevity risk to regions outside of the EU where solvency requirements are not as stringent (Bulley, Reference Bulley2016).

2.1.5. Findings on market consistency

Our survey at last year’s Life Conference in Edinburgh asked whether aspects of Solvency II that were not market consistent should be removed.

Figure 5 shows that most participants were in favour of the deviations from market consistency, and within the working party we have a difference of opinion on the subject.

Figure 5 The aspects of Solvency II that are not market consistent (e.g. matching adjustment (MA), Ultimate Forward Rate (UFR)) should be removed. Conference workshop: Votes 59, average 1.9, SD 1.25.

There may be flaws in following a market consistent approach but in the working party’s view it is through market consistency that effective risk management is rewarded.

In the United Kingdom, annuity business is the most important long-term guaranteed business written, and it has been recognised that default risk rather than spread risk was key and this was accommodated through a higher discount rate linked to the assets’ owned and lower capital requirements.

The front-ending of the illiquidity premium on the assets held by the insurer is a deviation from market consistency, which means that a significant proportion of the UK’s long-term guaranteed business is still regulated on a basis that is close to the Solvency I regime. To ensure effective risk management for MA business it has been necessary to develop strict admissibility and cash flow matching rules, which comes with issues of its own in terms of creating additional costs and complexity.

Further, the impact of market consistency on financial stability has come into question and the effect on long-term guaranteed business. However, overall, it has made significant improvements in encouraging effective risk management in Europe.

2.2.1. Cost of capital approach

Under Solvency II, the technical provisions are defined as the sum of the BEL and risk margin.

The risk margin is intended to represent the amount another insurer would require to take on the obligations of the insurer. It is calculated using a cost of capital approach; the insurer must project its SCR in respect of non-hedgeable risks, and apply a prescribed cost of capital charge of 6% p.a. This charge is then discounted at the risk-free rate to determine the risk margin.

The risk margin is relatively large for insurers with significant non-hedgeable risks, and particularly for those that have a long duration, such as longevity.

The underlying concept is that the notional transfer of technical provisions to another insurer would enable that insurer to cover the technical provisions (including the risk margin) and that the run-off of risk margin each year would compensate the insurer for providing capital against non-hedgeable risks. This effectively means that the transfer of technical provisions of an insurer in financial difficulties would be sufficient (on best estimate assumptions) to fully capitalise the transferred liabilities in the future.

2.2.2. Choice of approach: risk margin as prudence

The concept of a risk margin was not an entirely new concept unique to Solvency II.

The Market Consistent Embedded Value Principles (CFO Forum, 2016a), which pre-date Solvency II, include Cost of Non-Hedgeable Risks, which is similar in concept to the Solvency II risk margin, and is presented as an equivalent cost of capital.

When Solvency II was under development, two alternative approaches to defining the risk margin were considered (CEIOPS, 2007, page 12). One was the cost of capital approach described above (which is the Swiss Solvency Test (SST) approach), and the other was a recalculation of liabilities replacing best estimate assumptions (which are by definition 50^th percentile) with an alternative point on the probability distribution, e.g., 75^th percentile (which is the Australian approach). One of the main factors which swayed the decision in favour of cost of capital is the difficulty of defining assumptions on the basis of a probability distribution.

It appears from the consideration of two alternative approaches that a key driver for the inclusion of the risk margin in Solvency II was the desire to retain some form of prudent margin to the BEL, rather than a specific conviction that cost of capital must be covered.

2.2.3. Projection of SCR

Although the cost of capital approach was selected on grounds of relative simplicity, it requires an annual projection of SCR for the full run-off period of the liabilities, which is anything but straightforward for many insurers.

To calculate SCR accurately at each future duration requires complex projections within complex projections, and this is impractical for many insurers’ models. This difficulty is recognised within EIOPA guidance, which has set out a number of simplified methods. Unfortunately, these methods do not appear to be sufficiently accurate in many cases.

One robust approach to this problem is to define, for each block of business and for each component of SCR, an appropriate “risk driver” which is output by the model, so that it is assumed that that component of SCR moves proportionately to the driver. For example, for the mass lapse component, the risk driver might be the excess of total surrender values over total BEL in each future year. The projected SCR is then determined in each future year by combining the individual elements in the normal way. This approach requires both analysis and understanding of causes of risks and significant testing.

2.2.4. Cost of capital rate

The cost of capital rate of risk free plus 6% p.a. is defined in the European Commission Delegated Regulation (EU) 2015/35, which is the same rate used for the corresponding calculation in the SST.

It was defined on the basis that the insurer to which liabilities are notionally transferred is itself subject to risks and therefore subject to a relatively high cost of capital. In the development of the SST, it was stated that 6% was deemed to be a reasonable estimate for the stressed cost of capital in BBB-rated companies, which broadly corresponds to the definition of the capital requirement in the SST (Federal Office of Private Insurance, 2006).

It may also be relevant to consider whether discounting at the risk-free rate in determining the risk margin is consistent with adopting a high cost of capital rate reflecting risk.

2.2.5. Problems with the risk margin

In practice, the risk margin has been subject to considerable criticism, primarily on the grounds that it is too sensitive to interest rate movements, but also that it is in any case too large.

To illustrate this, in a speech on 21 February 2017, David Rule (Executive Director, Insurance Supervision, Bank of England) stated that total risk margins for major life insurers in the United Kingdom had increased from £30bn at the start of 2016 to about £44bn in September 2016. He also estimated that a 100 bp reduction in interest rates increase risk margins by around 20%. He went on to refer to the “flawed design” of the risk margin, though he pointed out that for existing business the problems are mitigated by the transitional measure on technical provisions (Rule, Reference Rule2017).

The other issue with the risk margin is that its sensitivity to market risk does not fall within the calculation of the SCR under the standard formula. Consequently hedging the risk margins sensitivity to interest rates results in an increase in the SCR for rates risk.

2.2.6. Potential amendments to the risk margin

An urgent review of the operation of the risk margin is needed.

This could start off by considering two fundamental questions:

• ∙ Is the purpose of the risk margin to provide coverage for the cost of capital, or is it more a means of standardising a measure of prudence in addition to BEL?

• ∙ If the former (or if cost of capital is the preferred approach to the latter), is the requirement to cover full future capitalisation of existing business an appropriate element of Solvency II, or does this represent too high (and therefore too expensive) a level of customer protection?

Answers to these questions could then illuminate a review of risk margin.

The following changes could be considered:

2.3.1. Background and summary

• Transitional measures are set out in Articles 308b-308e of the Solvency II Directive. These include:

• ∙ Transitional measure on risk-free interest rates (Article 308c).

• ∙ Transitional measure on technical provisions (Article 308d).

• ∙ Equity stress in standard formula (Article 308b, paragraph 13).

• ∙ Grandfathering of Tier 1 and 2 Own Funds (Article 308b, paragraphs 9 and 10).

• ∙ Concentration and spread risk for government exposures not denominated in the domestic currency (Article 308b, paragraph 12).

• ∙ Extension of period for initial compliance with SCR (Article 308b, paragraph 14).

These transitional measures are presented as providing an orderly transition to Solvency II.

They are a package of measures negotiated as a political response to issues which were hindering final agreement to implement Solvency II. It would not have been politically acceptable to introduce Solvency II in many countries, including the United Kingdom, if that had meant that many insurers suddenly could not meet the Solvency II requirements.

The most significant issue was the cost of LTG in a low interest environment, and the measures sit alongside the other changes introduced in response to this issue. However, other issues are also covered by the transitional measures.

2.3.2. Transitional measures on risk-free interest rates and technical provisions

These two measures are alternatives – an insurer can use one or the other, but not both together.

Both measures apply only to business in force at end-2015.

Both measures require regulatory approval. The Bank of England has indicated that UK insurers wishing to use transitional measures will be given the freedom to do so (Woods, Reference Woods2015). In contrast, the regulator in the Netherlands has stated that approval will not normally be given, on the grounds that it would be a backwards step from the existing solvency regime there (McCaughey, Reference McCaughey2016).

The results ignoring the measures must still be produced and published. It is therefore possible that rating agencies and other commentators will place more weight on the results ignoring the transitional measure, which better reflect a level playing field. However, in the United Kingdom, analysts appear to be concentrating on results including the transitional measure, as use of transitional measures does not restrict payment of dividends.

The Directive requires that an insurer that would be insolvent without the transitional measure must report annually to the regulator on progress to restore solvency by the end of the transitional period.

2.3.3. Comments on selected other transitional measures

3.1.1. Summary of general structure of standard formula

The standard formula requires a separate capital requirement to be determined for each individual risk type (up to 17 for life insurers).

The capital requirement for each risk is defined in the Delegated Regulation, and for life insurers it is equal to the impact on Own Funds (ignoring the risk margin) of specified scenarios or other calculations of the following types:

• ∙ For interest rate risks, the more onerous of two yield curve scenarios (up and down).

• ∙ For other market risks, scenarios with changes in the market value of each type of exposure.

• ∙ For life and health insurance risks, scenarios that are defined as either:

  • ∙ a change in future assumptions; or

  • ∙ a fixed stress independent of assumptions.

• ∙ For counterparty default risk, a calculation for each exposure depending on type of exposure, probability of default, variance of loss distribution and amount of collateral.

• ∙ For operational risk, a calculation based on the size of the business defined by various metrics (premiums, reserves, expenses).

Each individual capital requirement is required to be defined so that it is calibrated as a 99.5% VaR over a 1-year period – a “1 in 200 year event”.

Simplified methods can be used where the full requirement is disproportionate to the particular risk. Certain simplifications are specified, but insurers can use other simplifications where these can be justified.

The base SCR (excluding operational risk) is determined from the impact of the capital requirements for individual risks, aggregated using a series of correlation matrices. These use correlation factors between each pair of risks at each level. These factors are specified in the Solvency II Directive or the Delegated Regulation, depending on level.

This process is intended to ensure that the overall result remains consistent with 99.5% VaR over a 1-year period, allowing for the effect of diversification between risks on stressed assumptions.

The base SCR is first calculated without allowing for any change in the value of discretionary benefits or that of deferred taxes, as determined in the technical provisions.

The adjustment for the impact on discretionary benefits is then allowed for by repeating the entire calculation using appropriate revised assumptions for these benefits under each risk scenario and taking the difference from the original SCR calculation; the adjustment is subject to a maximum equal to the total value of discretionary benefits in the calculation of technical provisions.

The impact of deferred taxes is determined by assuming an instantaneous loss equal to the SCR, irrespective of the actual taxation regime.

The SCR for operational risk is then added to the result.

EIOPA (2014) has published a useful document setting out the assumptions made in defining the standard formula parameters.

3.1.2. Comments on general structure

The standard formula is required to be suitable for a broad range of mainly smaller and medium-sized insurers across all EU countries.

It should therefore cover the major risks relevant to these insurers, whilst being sufficiently simple and clear to operate, albeit with the option of using simplified methods where appropriate.

It has proved difficult to gain political approval for aspects of the standard formula, e.g., treatment of securitisation, and there are inevitably compromises between simplicity and universal appropriateness.

The appropriateness of the standard formula, both for general use and where considered in the case of a specific insurer, depends to a significant extent on:

• ∙ the comprehensiveness of the risks covered;

• ∙ the appropriateness and accuracy of the diversification methodology and correlation factors for combining risks; and

• ∙ the accuracy of the calibration of the capital requirements for individual risks.

3.1.3. Risks covered

The following are examples of significant risks relevant to certain life insurers, which are not covered by the standard formula:

Further information relating to some of these risks is given in EIOPA (2014).

3.1.4. Correlation and diversification

The methodology used in the standard formula, which determines the capital required for each risk separately, at the same level (99.5% VaR/1 year) as the overall capital requirement, and then uses correlation matrices to allow for diversification between risks, has the advantage of conceptual, operational and mathematical simplicity. The impact of diversification on the SCR can be highly material, particularly where there is no single dominant risk. For example, Aviva (2017, page 30) reported total diversification benefit at end-2016 of £5.2bn (about 30% of pre-diversification SCR). Although this relates to an internal model rather than the standard formula, it illustrates the significance of diversification to Solvency II results.

However, it is subject to a number of valid criticisms:

• ∙ The methodology makes no allowance for the combined impacts of risks. This can operate either to increase or decrease overall capital required: e.g., the combined impact of a mass lapse stress with most other stresses would result in an overall reduction in required capital compared with both considered separately; on the other hand, for an insurer subject to guaranteed annuity options, the combined impact of an interest rate down stress and a longevity stress is likely to be higher than with both considered separately.

• ∙ There are alternative methodologies which allow for the combination of risks, but these significantly increase the complexity of the modelling required to determine the results.

• ∙ The capital requirement is based on extreme downside risks, and as a result the diversification approach should consider correlations between risks in extreme downside circumstances (“tail dependency” and “asymmetry”), which might be expected to differ from correlations observed in normal circumstances. This makes it very difficult to evaluate the correlation factors, as available data might not be considered relevant to the circumstances. A significant degree of judgement was therefore used in defining the factors. This has resulted in a broad approach, with simply determined factors; e.g., each specified correlation factor used in the standard formula is one of 1, 0.75, 0.5, 0.25, 0 or −0.25.

Nevertheless, the methodology used appears to result in a reduction for diversification which subjectively appears to be reasonable in many cases. It may therefore be considered that the advantage of standardising on a relatively simple method outweighs these criticisms.

3.1.5. Assessment of the appropriateness of the standard formula in the ORSA

Insurers using the standard formula are required to carry out an assessment of whether the assumptions used in the standard formula are appropriate, allowing for the specific risk profile of the insurer.

This must consider risks not covered by the standard formula as well as risks where the standard formula assumptions and parameters are not appropriate for the insurer’s risk profile.

In the event of there being significant deviations between the risk profile and the standard formula, insurers are expected to consider how this situation can be addressed. EIOPA guidance suggests developing a partial or full internal model, de-risking and aligning the risk profile with the standard formula as solutions to this. These solutions do not appear to recognise that they may be impractical where the problem lies primarily in the definition of the standard formula rather than with the insurer’s risk profile. For example, an insurer which is subject to higher longevity risk than covered by the standard formula, due to having a long liability profile, cannot readily de-risk or re-align its liabilities.

The regulator is permitted to require a capital add-on where the risk profile is significantly different, though this is intended to be temporary until the situation has been addressed. It is not clear what would happen if none of the above solutions work on a permanent basis.

Where elements of the standard formula understate the risk for an insurer, it is possible that other elements overstate the risk, and in these circumstances the insurer may wish to offset decreases in capital against increases. The Delegated Regulation relating to capital add-ons imposes strict conditions on data and methodology used to justify the reduction when applying such offsetting. Furthermore, at least one regulator has indicated that these conditions should also be applied in the case of the assessment within the ORSA.

Unless all elements of the standard formula are demonstrably appropriate for the insurer, this assessment appears to impose either additional capital requirements or a significant additional analytical burden on small and medium insurers, for whom internal models may not be appropriate.

3.1.6. Comments on the definition and calibration of individual stresses

This section includes commentary on the definitions of selected individual stresses used in the standard formula. For stresses where no comments are made, no implication is intended that the definition is considered to be fully appropriate.

3.2.1. Original aims

Recital 68 of the Solvency II Directive states:

The recital implies that a feature of a risk-oriented approach to regulation is to allow insurers to use a risk based internal model to determine its regulatory capital requirements, subject to supervisory approval.

The working party’s interpretation is that one of the aims of the internal model framework under Solvency II was to encourage insurers to develop their own capital models which provide a better assessment of the insurer’s own risk profile, and enable insurers to use those models to determine their regulatory capital.

Internal models as part of a regulatory capital framework were not a completely new innovation that came with Solvency II. Both the SST insurance regime and the Basel II banking regime included internal model frameworks. Furthermore, in the United Kingdom, internal models were effectively being used for Pillar 2 risk management under the “ICAS” regime. In designing Solvency II, policymakers would have taken insights from the experience of these regulatory developments which pre-dated Solvency II.

3.2.2. Overview of EU regulatory framework

The Solvency II Directive sets out the main overarching requirements for Internal Models in Articles 120–126, which include the “6 tests” that an insurer’s internal model must satisfy in order for it to be approved for use in determining Pillar 1 capital requirements.

The key features of the Directive requirements are summarised below:

• ∙ Scope: Solo entities and/or groups can apply for a “Full” or “Partial” internal model if their risk profile deviates significantly from the assumptions of the standard formula. This can be at the initiation of the insurer, but the national regulator also has the powers to request that an insurer uses an internal model.

• ∙ Approval process: Firms submit a formal application to their supervisor according to a prescribed list of contents. Upon receipt of the application, the supervisor must review the application against the Directive requirements and respond with the approval decision within 6 months of the application date. However, national supervisors were also permitted to have in place an extended “pre-approval” process ahead of the Directive going live, which in practice provides additional time for supervisory review. The internal model can be approved with or without conditions or declined.

• ∙ Groups: In the case of multinational group applications, a college of supervisors from different jurisdictions may be involved in the review of the application.

• ∙ Criteria for approval: The key criteria are set out in the “6 tests” of the Directive, namely: use test, statistical quality, calibration, documentation, data, and use of external models. These high-level requirements are then supplemented with much more detailed requirements set out in the delegated acts, EIOPA guidance and requirements of the national supervisor.

• ∙ Ongoing change control: After an internal model is formally approved, the insurer must follow a regulatory process for making changes to the internal model. This change control process is intended to be principles based, with insurers developing their own model change policies (which must be approved by the supervisor) and making formal application for supervisory approval of any changes which the insurer deems to be a “major change”.

• ∙ Disclosures: There are certain disclosures (e.g. specific Quantitative Reporting Templates (QRTs)) which relate specifically to internal models.

In the opinion of the working party, while there is a large amount of prescriptive regulation around internal models, the subject matter is inherently subjective and therefore there is considerable scope for discretion to be exercised by the national supervisors.

3.2.3. Local UK regulatory requirements

The working party’s opinion is that in the United Kingdom, the PRA was supportive of the development of internal models and therefore educated insurers and encouraged the preparatory work. The PRA initiated a “pre-application” process which allowed both the supervisor and insurers a significant period of time in advance of Solvency II go-live to prepare for the formal application process.

The PRA also introduced the concept of “quantitative indicators” which are tools used by the supervisor to benchmark and challenge insurers’ internal model calibrations. The use of these quantitative indicators (most notably for credit and longevity risk) gained a mixed reception amongst insurers involved in the IMAP.

The PRA also provided overriding guidance in certain areas, e.g., the requirement to hold capital against gilt-swap spread risk and the prohibition of a dynamic VA. Arguably, these are contrary to the logic of an “internal” model and weaken the logic of the “use test” if the insurer had a different opinion on these issues.

The PRA certainly appears to have been an enthusiastic adopter of the internal models (evidenced by the number of models approved in United Kingdom) and indeed provided a lot of additional guidance and local regulation to UK insurers on top of the EU regulatory instruments. However, the working party could not find clear evidence that any of this “national overlay” by the PRA amounted to anything contrary to or against the spirit of the Directive requirements. If anything, this “national overlay” appears to have provided additional guidance and support to insurers who wanted to get their internal models approved.

3.2.4. Benchmarking

Table 1 in section 3.1 provides a breakdown of the number of full and partial internal models across the EEA market. The evidence suggests that internal models are not a majority practice.

In December 2015, the PRA announced that it had approved the use of full or partial internal models for 19 firms, effective from 1 January 2016 (PRA, 2015d). As the firms listed mostly comprised insurance groups including several insurers, it is clear that the number of UK insurers using full or partial internal models is a significant proportion of the EEA totals of 86 insurers using full internal models and 83 insurers using partial internal models given in Table 1.

3.2.5. Critique of internal models

The working party was generally of the opinion that the use of internal models in Solvency II is a positive aspect of the framework, with several advantages. It enables firms to more accurately model its risk profile compared to a one size fits all standard formula.

The more accurate modelling of the risk profile should provide greater protection to policyholders.

Firms can use the internal model as a tool which is integrated into the management of their businesses and used for decision-making purposes.

It encourages firms to take more ownership and responsibility for managing their risks.

It removes some of the incentives for gaming that might otherwise result from firms attempting to manage their business to the standard formula.

As part of its field work, the working party debated (both internally and with stakeholders) the effectiveness of the Solvency II framework for internal models in achieving the original aims. A wide range of views were expressed on this subject. Below we have listed some opinions which were expressed and some working party observations.

• ∙ Burdensome documentation requirements: Some stakeholders held the view that the extensive documentation requirements for achieving internal model approval were extremely burdensome and costly, with application packs containing enormous libraries of detailed documents. It is unclear whether the extent of the documentation was disproportionate to the aim of meeting the Article 125 requirements.

• ∙ Herding: The use of benchmarking calibrations by supervisors arguably encourages herding. To maximise the chances of internal model approval, a possible strategy would be to select a calibration which is in line with the average of other insurers’ (assuming that data are somehow available), as opposed to selecting the calibration which the insurer’s experts believe to be most appropriate.

• ∙ Supervisory overlay to calibrations: Anecdotal evidence on the approvals process included accounts of the supervisors exerting influence over the level of calibrations and/or methodology. This could in theory create challenging questions over expert judgement for the actuaries signing off such calibrations.

• ∙ Burdensome governance requirements: In order to obtain approval, the internal model must have a governance framework around it which also evidences the use of the model in the system of governance. Anecdotal evidence suggests some insurers have had to develop complex and burdensome governance processes around the model in order to meet the expectations of supervisors, therefore leading to additional cost.

• ∙ Non-level playing field versus standard formula: The standard formula is far less costly to implement than an internal model, putting standard formula insurers at a competitive advantage in terms of cost. Furthermore, the treatment of certain risks is inconsistent and could lead to lower capital requirements for standard formula insurers. Examples where this could arise include:

  1. a) application of a transitional reduction in the equity risk SCR in the standard formula;

  2. b) no risk capital required for implied volatility in the standard formula;

  3. c) no risk capital required for sovereign risk in the standard formula.

• ∙ Complexity of models: There was a view expressed by some stakeholders that internal models had become extremely complicated as a result of Solvency II and it was unclear whether the additional complexity was adding value proportionate with the cost.

Within our working party we question whether internal models are too complex and too detailed for the purposes that they serve. The votes cast at the Life Conference suggested a broader range of views than those of our working party (see Figure 6).

Figure 6 Internal models are too complex. Conference workshop: Votes 51, average 3.8, SD 1.3.

3.3.1. Economic capital models outside Solvency II

In recent years, many insurers have developed economic capital models, with a variety of uses, e.g.:

• ∙ Determination of embedded value

• ∙ Measurement of use of capital

• ∙ Planning and forecasting

• ∙ Risk management

• ∙ In the United Kingdom, the ICA required by the regulator under Solvency I

Many insurers have used the results from economic capital models in public disclosures, in particular embedded value.

In most cases, the methodology and assumptions used in such models has reflected the insurer’s own views, with limited external prescription. Although parts of the ICA were prescribed by the regulator, there was significant freedom over many assumptions.

3.3.2. Comparison with Solvency II economic capital model

Pillar 1 of Solvency II is based on the output of an economic capital model, details of which are prescribed by regulation.

Although Solvency II permits an insurer to use an approved internal model, this only permits the use of own methodology and assumptions in determining the capital requirement. Solvency II is prescriptive in relation to the calculation of Own Funds (including the valuation of assets and Technical Provisions) and in many other areas. Furthermore, the calculation of capital requirements in the internal model may also diverge from the insurer’s own view where the regulator has taken a different view in the approval process, e.g., due to industry benchmarking.

This prescription is likely to have resulted in a number of differences between the Solvency II economic capital model and the model previously in use, or any model reflecting the insurer’s own “view of the world”. The PRA has added to this by publishing national guidance on certain aspects, such as the supervisory statement SS30/15 on the treatment of gilt-swap spread risk (PRA, 2015c).

Examples of such potential differences are:

3.3.3. Practical use of alternative economic capital models

In practice, there may be advantages for an insurer with an established economic capital model and/or a different view of methodology or assumptions from those required by Solvency II to use an alternative model alongside its Solvency II model, in order to maintain continuity and a consistent internal view.

A disadvantage is added complexity, although where the differences between models relate to exclusion of specific items or to changes in assumptions within the same modelling framework, the technical challenges of using two models alongside each other may not be significant.

A further disadvantage is the potential for confusion in reporting and using results. This can potentially be overcome by combining the results of the models, so that any reduction in Own Funds required by Solvency II compared with the insurer’s own view could be described as “economic capital excluded from regulatory Own Funds” and any increase in capital required as “additional regulatory capital requirement”.

A condition of approval of an internal model under Solvency II is that the internal model should be used as part of the system of governance. It would therefore be necessary for an insurer using an alternative economic capital model to ensure compliance with this requirement.

As the insurer must in any event comply with the Solvency II requirements for determination of Own Funds and capital required, many insurers and groups may take the view that use of an alternative economic capital model (demonstrating the existence of more capital held or lower capital requirements than under Solvency II) is of little practical value.

As an indication of this, a number of insurers have ceased reporting embedded value following the introduction of Solvency II.

Furthermore, as a consequence of Solvency II, the European Insurance CFO Forum has amended both their MCEV and EEV Principles and Guidance to permit, but not require, the use of projection methods and assumptions applied for market consistent solvency regimes (CFO Forum, 2016a, 2016b). This is likely to result in further convergence in economic capital modelling.

3.3.4. Use of alternative economic capital models by rating agencies

Although rating agencies are expected to use Solvency II results in assessing insurers in the EU, they are expected to continue to place more weight on internally developed economic capital models, which they continue to regard as being appropriate for purpose.

For example, the Fitch rating agency has stated (Fitch Ratings, 2017):

4.1.1. Situation under Solvency I

Asset allocation for insurance companies is influenced or even driven by the regulatory regime the insurer is working in.

For many years, the United Kingdom has operated a realistic balance sheet approach to with-profits funds and an ICA alongside the Solvency I framework. Outside of the United Kingdom, many of the Scandinavian countries and the Netherlands had also moved to regimes that recognised a market consistent approach to capital management. For these countries Solvency II has been evolutionary rather than revolutionary.

By contrast for those European member states whose regulatory regime has been based around historic book prices/amortised value of bonds and technical provisions discounted at a prescribed discount rate, Solvency II has proved a sea change for many of its insurance companies. The impact on ALM practices for many of the insurers in these member states is correspondingly greater.

4.1.2. With-profits funds

In the United Kingdom, these funds are now deconstructed into their constituent parts of asset share, cost of guarantees, smoothing account, free assets, etc. Many are now run on the basis of duration matching of maturity guarantees, hedging the interest rate risk of guaranteed annuity options (where these exist) and delta hedging, or hedging with options, the equity risk associated with maturity guarantees.

Solvency II has motivated little more than a refinement in the way that with-profits funds are run. The main ALM change as a result of Solvency II has been a move to a swaps-based discount rate. For those insurers that had been running their funds assuming a gilt discount rate it has been necessary for them to review their ALM practices. This might have given rise to a change in asset allocation or hedging, through the use of spread locks, of the basis risk between gilt and swap rates.

The Danish pension companies reacted to the risk of falling interest rates on their with-profits contracts by buying swaps, swaptions and constant maturity swap (CMS) floors as a means to hedge the cost of guaranteed minimum growth rates (Ladekarl et al., Reference Ladekarl, Ladekarl, Andersen and Vittas2007).

By contrast German insurers have, as a generality, not hedged themselves in this way. German accounting standards and the way in which bonuses are determined by reference to revenue account profits have acted as a constraint to hedging the Solvency II position. In addition, increasing duration in the current low interest rate environment removes the prospect of reinvesting at a higher rate and there has been a reluctance to effectively lock in long-term interest rates at current low levels.

The need to hedge has been reduced in part by the construction of the risk free curve which is extrapolated from the 20-year point and which reduces the interest rate volatility of very long-term liabilities. Some German insurers, however, have seen the need for or benefit of extending the duration of their assets by buying “forward bonds”, from investment banks. These are agreements to buy government bonds at a fixed price on a fixed point in time in the future, e.g., 5 years, so as to reduce the duration mismatch with their liabilities.

4.1.3. MA

Within UK non-profit funds, and for annuity business in particular, there has long been a recognition of duration risk with a punitive reinvestment rate applying under Solvency I to investment portfolios that had a shorter duration than the corresponding liabilities. The MA, however, has had a huge impact on ALM behaviour.

In order to accommodate the MA in an otherwise market consistent framework, it has been necessary to define eligibility rules to ring-fence the assets backing these liabilities from the rest of the balance sheet’s assets.

The rules as set out in Omnibus II suggest that active approaches to trading bonds are not permissible, presumably to give time for the illiquidity premium to emerge. Hence it is not possible to allow an insurer to actively substitute one bond for a similar, but cheaper bond.

It would be preferable if the regulations were to allow such trading as the insurer could, if need be, choose to hold the bond to maturity and so meet its payment obligations. It would also allow cash flow matching to be refined at the short end as annuity portfolios run off.

Allowing low-risk profit taking in this way increases the profitability of annuity business and ought to result in added competition for the benefit of consumers. It would also contribute to the efficiency of bond markets.

The impact of this change has driven the demand for high-quality illiquid assets and introduces an incentive to bias annuity portfolios towards such assets and away from more traditional allocations to corporate and government bonds (Non-traditional Investments Working Party, 2015). In part, this has also been driven by the search for yield as a result of low rates and falling credit spreads.

Currently illiquid assets back 25% of annuities but the PRA has received indications to say that this could increase to as much as 40%. These trends are welcomed both by the PRA and politically as they may have wider economic benefits (Rule, Reference Rule2017); e.g., greater investment in public infrastructure and social housing.

These rules have given rise to other behavioural changes. On the positive side, the risks and characteristics of callable bonds are properly recognised and these do not qualify for MA treatment. Less positive are the costs and resources that have been invested into the construction of SPVs that invest in MA ineligible assets such as equity release mortgages, where the SPV issues fixed interest bonds that do qualify for MA eligibility (Robertson & Mee, Reference Robertson and Mee2016).

The rules have been accompanied by strict parameters within which annuity liability cash flows must be matched. These rules add to the burden of efficiently running an annuity portfolio (PRA, 2015a).

These rules also require that MA portfolios retain within them sufficient liquidity for margin calls for any derivatives held. This liquidity requirement results in retaining cash or government bonds (that can be repo’d to provide cash) with a consequent reduction in the portfolio’s discount rate. It is not clear why this requirement is necessary when there may be the ability to provide collateral from elsewhere on the balance sheet. It is another factor that reduces the ability to lower the price of annuities.

4.1.4. Unit-linked

There is no requirement within Solvency II for unit-linked liabilities to match the face value of the unit liability with the underlying assets (although other rules within member states may require this).

Commonly unit-linked policies have management charges that are linked to the value of units. The BEL recognises these charges including any profit element as a deduction to the unit liability.

Under Solvency II, following the Solvency I approach of close matching of the unit liability results in an insurer holding more unit related assets than the BEL. The net balance represents an addition to market risk attracting a SCR.

To mitigate this risk insurers can look to hold less than the total face value of units. There are practical considerations (Turnbull & Burger, Reference Turnbull and Burger2015). These may dissuade the wide scale adoption of this approach and as there may be some unease at an insurer investing in less than the full face value (or at least the surrender value) of its unit liability from a public perception point of view. The approach has variously been called actuarial funding, unit shorting and unit matching. However, it is entirely logical and could slowly become more widely adopted.

4.1.5. Own funds

The face value of units in excess of the best estimate liabilities form part of Own Funds and unit shorting represents the de-risking of risk within Own Funds.

Where long-term guaranteed business is written, market risk represents a large proportion of an “insurer’s total SCR”. Consequently there is an awareness of the need to invest in those assets that provide the greatest expected return on an assets relative to their SCR for market risk.

If investment strategy is allowed to drive asset allocation this can lead to a less diversified asset allocation than one where asset allocation is capital aware. A capital aware investment strategy will still be driven by economic considerations but with some adjustment that tilts the asset allocation away from capital inefficient assets to capital efficient assets. This adjustment would be constrained to the extent that the portfolio manager would consider it acceptable.

SCRs constrain the way that asset managers build strategic asset allocation models. An asset manager may look at a range of scenarios and derive a strategy that best fits rather than one based on expected returns and risk measured by reference to market volatilities and correlations. A Solvency II optimisation based on tail risks and tail risk correlations will produce a portfolio that relies less on diversification benefits between asset classes (Blamont & Rae, Reference Blamont and Rae2016).

4.1.6. Staff pension funds

The staff pension fund of an insurer has an impact on the SCR (PRA, 2016a).

The defined benefit fund liabilities of, typically older, traditional insurers, can be significant. These schemes can contain significant, long dated, inflation and interest rate risk as well as market risk associated with their growth assets, e.g., equity and property risk. The capital benefits of hedging these risks does encourage insurance companies that sponsor these defined benefit pension schemes to negotiate risk reducing investment strategies. Hedging these risks outside the scheme tends not to be viable. Hedging in this way can give rise to the need for an insurer to post collateral under the hedging instrument whilst the increase in the value of the hedged asset sits inside the pension scheme.

4.2.1. Capital drivers of pro-cyclicality

For all the benefits of a market consistent framework, Solvency II has received some criticism for its pro-cyclicality in respect of its treatment of market risk. Solvency II represents a shift from the Solvency I approach of reserving through what are hoped to be prudent margins.

The 1-year VaR approach of Solvency II requires insurers to find additional capital if their best estimates prove wrong, or to take actions within a short time period to reduce risk on the balance sheet. If markets fall then insurers can become sellers of assets; potentially driving prices down further.

Ultimately, if many insurers become forced sellers, this could create a solvency crisis for the insurance industry and the financial services industry as a whole. Implicit within the VaR approach is the assumption that market volatility is a good measure of risk when this is not always the case (Haldane et al., Reference Haldane2014).

Through a tighter, more harmonised regulation, Solvency II has imposed a standardised framework across the entire EU insurance industry that manages around EUR10 trillion of assets, increasing the risk that insurers will act in tandem (IFoA, 2016).

One of the strengths of Solvency II though is that it does reward sound management of market risk if options and guarantees are matched with appropriate assets. The trend across Europe is to manage market risk in this way although the very low interest rate environment encourages insurers that have not already hedged themselves to do so at what could be an expensive point in time.

4.2.2. Pro-cyclicality within UK with-profits funds

In the United Kingdom, with-profits funds have been run on an economic basis since 2003 when the realistic balance sheet was introduced. These funds have since mostly moved to one where interest rate risk is managed through the matching of assets and liabilities and where equity risk is managed, at least in part, through management actions such as delta hedging or the purchase of equity put options.

Delta hedging by with-profits funds, or the investment banks that have written their equity puts, is in itself pro-cyclical. As equity markets fall so delta hedging involves selling equities and moving into cash. An asset manager’s approach might be to buy assets that appear cheap in a falling market.

Certainly there is plenty of academic evidence of market momentum (Carhart Reference Carhart1997) that demonstrates the ability of equity markets to over-react to changes in market conditions. However, increasing risk positions in this way should require additional capital to allow for the possibility that the markets could continue to fall.

The concept of buying all the way down a market fall requires considerable capital, as evidenced by the fall in equities during 2000, 2001 and 2002. Hence the requirement for additional capital is entirely logical.

The debate therefore around the pro-cyclical nature of the regulatory regime is not that regulation should not be pro-cyclical but more the degree to which it is pro-cyclical or the extent to which it buffers short-term market fluctuations.

4.2.3. Management of pro-cyclicality

Consequently it is necessary to look for those areas where pro-cyclicality can be better managed. The VaR measure for capital requirements is used by both banks and insurers. As both work off of a 1-year VaR measure it potentially requires both to find extra capital and to reduce risk at the same time.

This logic is sound where a liability is due in the near future as with most banking and non-life liabilities. For long-term liabilities, short-term volatility is less important than the volatility of long-term returns. For assets backing long-tail liabilities the concept of giving time to allow the orderly sale of risky assets rather than a rapid fire sale would mitigate pro-cyclicality within the market.

The equity dampener introduces a contra-cyclical capital requirement. Its effect is to temporarily reduce the capital requirement (to mitigate the reduction in actual capital held) for falls of up to 20%, although it offers no further relief during the periods of the worst crashes when the risk of pro-cyclical behaviour is at its greatest.

The dampener provides breathing space for insurers to manage the timing of any asset disposals and may reduce the need to sell if the markets recover in the interim. Certainly there are many instances where markets recover sharply after a shock fall given their tendency to build momentum.

There is an argument that this type of relief could be extended to all market risks.

For credit risk the 1-year VaR measure results in capital being allocated to spread risk rather than default risk. This is perhaps the clearest example of where it is long-term returns rather than short-term asset values that are relevant to honouring long-term obligations.

This argument was finally accepted in Omnibus II in the restricted form of the MA where, for annuity business, assets are typically held for their cash flow matching characteristics rather than for making short-term trading gains.

This adjustment results in a BEL that more closely matches the value of the bonds backing it, and the capital requirement is commensurately less to reflect the reduced volatility of the Solvency II balance sheet. The capital requirement would be better if based on the increased risk of default, unless the lower SCR calculated for spread risk on MA portfolios represents a good approximation to this.

4.2.4. Interest rate risk for non-MA fixed interest portfolios

Outside of the MA the risk-free rate is based on a swap rate, making the matching risk-free asset a swap together with cash on deposit (with a default free deposit taker) earning a LIBOR-based deposit rate. The cash both matches the payment obligations under the floating rate leg under the swap and is available to post as collateral to a central clearer.

However, common risk-free assets favoured by insurers are government bonds. For UK insurers it is not unreasonable to consider these risk-free as the UK’s government is ultimately free to print money to meet its debt obligations (with any resultant inflation eroding policyholders’ benefits in real terms).

As stated in section 3.1.5.6, the standard formula pragmatically does not penalise insurers for holding EU government debt in the domestic currency; however, internal models have been required to recognise the basis risk between swaps and gilts.

Were the basis between gilts and swaps to become more volatile, then insurers may look to reduce their holdings of government bonds. From a forced sale perspective this would represent a “right way risk” as during times of market volatility it can be expected that gilt prices would be high as the trend would be a flight to quality as investors sell risky assets to buy gilts.

There is an additional protection as there is scope to apply to the regulator to use the VA that will give some regard to the assets typically held by insurers. The risk of pro-cyclicality would appear low, although any switching out of gilts and into cash plus swaps would increase the insurance industry’s exposure to the banking sector. A prudent person may prefer to hold gilts.

4.2.5. Spread risk for non-MA fixed interest portfolios

For liabilities that do not meet the strict definition of the MA (and where the VA could apply) there is a greater exposure to spread risk and, with it, pro-cyclicality. The corporate bond markets are far from liquid and much of the price movement during periods of illiquidity can be ascribed to the credit markets becoming illiquid.

A dampener for credit spread risk could also be seen not only as beneficial for insurers but also as desirable for regulators if limiting pro-cyclicality were a key concern. The same argument as for the MA can be applied, namely that spread risk is irrelevant for longer dated cash flows. It is actual defaults that matter.

4.2.6. The overall issues with discounting

The MA, VA and 20-year point from which the euro swap rate is extrapolated represent a number of compromises to the discount rates and capital requirements that make the overall regulatory regime acceptable to a number of EU member states.

These measures amend the, otherwise, market consistent framework and were a pragmatic response to the need to weaken the Solvency II regime for long-term guaranteed business. Harmonising as many of these concessions into a more homogeneous approach could result in a regime that has fewer discontinuities and a reduced number of fixes.

One such approach might be to recognise that an insurer’s liabilities are also bond like and to discount these at a uniform bond rate for all insurers, e.g., at an investment grade bond rate, e.g., commensurate with a 1 in 200 year solvency standard or a higher level such as AA rated bond. It might also avoid the need for eligibility requirements. It might also remove the need for the MA and VA.

Other suggestions exist. One is a “minimum cost” liability valuation based on the higher of gilts or swaps (Foroughi, Reference Foroughi2010). Such alternative frameworks as those above are of course open to criticism. An insurer that chooses to hold safer and lower yielding assets than the risk discount rate would not be able to meet its cash flow liabilities. An additional reserve to cover this shortfall would be necessary but would benefit from a reduced capital requirement.

4.2.7. Dealing with short-term volatility

In respect of the capital requirements, it seems entirely reasonable to recognise that short-term market volatility does not necessarily imply that additional capital is required by an insurer to meet its long-term liabilities.

However, there is a balance to be had between a capital regime that buffers sharp market corrections and insurers being required to hold capital against further falls. A dampener for all market risks could be an answer that allows an insurer to de-risk or recapitalise and avoid over-reacting to market shocks. It would also avoid asset disposals at a time when banks and insurers with short tail business are selling assets to reduce risk.

The symmetric adjustment for equities described in section 3.1.6.5 is a good example. The formula implicitly recognises that half of the fall might be due to short-term market volatility. Its ability to reduce pro-cyclicality is limited to a maximum reduction in the stress of 10%. Possibly there is potential to provide short term relief in excess of 10% in the event of a sharp market fall.

Extending the use of counter-cyclical capital requirements would take risk out of the financial system during short, severe, market downturns. The benefits of lower capital requirements could result in an acceptable trade-off between lower charges for consumers and risk where the increased chance of policyholders’ obligations not being met takes this type of market behaviour into account. It is reasonable that symmetry applies as the symmetrical adjustment for equity risk suggests. In this way insurers will hold additional capital when markets are strong. Indeed, in banking, counter-cyclical buffers means building up extra buffers in good times for release in the bad times.

In our workshop at the Life Conference there was agreement that a capital regime that provides time for insurers to formulate a measured response would be desirable (see Figure 7).

Figure 7 The capital requirements should be adapted to allow insurers to introduce management actions or allow for markets to find new levels. Conference workshop: Votes 43, average 3.5, SD 0.95.

4.2.8. Risk appetite and target coverage ratio

Insurers’ and groups’ risk appetites include a target for the solvency coverage ratio. The target is normally defined as a percentage of the SCR or a range of percentages. As reported by Honour (Reference Honour2016) and summarised in Appendix 3, a few groups have published target ranges, e.g., Aviva’s range is between 150% and 180% of SCR.

The target aims to ensure that the SCR will continue to be covered following an adverse event. This event may be defined in terms of VaR over a 1-year period, e.g., 90% or 95% VaR would correspond to a one in 10 or one in 20 year event, respectively.

Although the Solvency II regime allows for a recovery period to restore SCR, which may in certain circumstances be extended as described in section 4.2.9, it seems unlikely that commercially insurers would wish to be in breach of their SCR at all, let alone for a significant period. The size of the target coverage ratio will depend on the extent of the insurer’s risk aversion to breach of SCR, balanced against the desire to minimise capital.

EIOPA has expressed concern about analysts’ and investors’ lack of understanding of SCR, and insurers having too high targets.

In a conference in September 2015 Gabriel Bernardino, chairman of EIOPA (Risk.net, 2015), stated:

Bernardino also said that firms were contributing to the market’s overly cautious view by targeting a solvency level far in excess of the SCR.

Ludovic Antony, Director, Financial Institutions Advisory at Societe Generale Corporate & Investment Banking stated (Solvency II Wire, 2012):

However, Tom Wilson, Chief Risk Officer, Allianz, stated (Solvency II Wire, 2012):

The Dutch supervisor, De Nederlandsche Bank (DNB), has stated that it expects insurers’ target solvency ratios to be closer to 100% than under Solvency I, since Solvency II is a better measure of an insurer’s risk profile. It notes that insurers are setting internal standards over 100% to ensure continuous compliance following adverse events (DNB, 2016).

There are indications that some supervisors have too high expectations for solvency ratios, though they are not shared by EIOPA. Karel Van Hulle, chair of the Insurance and Reinsurance Stakeholder Group at EIOPA, stated (Risk.net, 2015):

It seems to be standard that insurers’ risk appetites define target solvency ratios by reference to SCR. However, if it became more accepted that breach of SCR was to be expected from time to time, it may be seen as more logical to define targets with reference to MCR. This may also have the benefit of reducing volatility, at least for insurers where the MCR is not subject to the minimum or maximum proportion of SCR.

4.2.9. Extension of recovery period

Under stressed market conditions, regulators are allowed to extend the recovery period by a maximum of 7 years, if an exceptional situation is declared by EIOPA. This is characterised by one or more of the following:

• ∙ a fall in markets which is unforeseen, sharp and steep

• ∙ a persistent low interest environment

• ∙ a high impact catastrophic event

Under normal market conditions the recovery period is 6 months. This extension aims to reduce pro-cyclicality as insurers are not forced to sell assets at the same time during adverse market conditions.

However, as indicated in section 4.2.8, insurers are likely to be averse to an extended period in recovery, and therefore their behaviour could still be to sell their risky assets.

Under the current low interest rate environment, one wonders how low and how long interest rates need to remain for an exceptional market condition to be declared.

This flexibility, however, does not extend to breaches in the MCR, where the limit is 3 months.

4.2.10. Use of regulatory flexibility

In the past, during periods of stressed market conditions, Solvency I allowed regulators a degree of flexibility not available in Solvency II (Haldane et al., Reference Haldane2014). Such measures allowed for relaxation of rules for valuation of liabilities and capital requirements and the duration of any proposed plans to restore solvency.

Table 2 (Haldane et al., Reference Haldane2014) illustrates when such flexibility has been used in the past as a means to address pro-cyclicality in the market. These measures have been applied to prevent the technical insolvency of insurers. Avoiding technical insolvency has probably assisted consumer confidence. Whilst such flexibility has been advantageous, it is also criticised for penalising insurers that take management actions before the regulatory regime is relaxed.

Table 2 Summary of Use of Regulatory Flexibility for Insurers in Various Countries

Solvency II pays regard to this and some recognition to flexibility as, in the event of exceptional falls in financial markets, the regulator has the ability to extend the period by which insurers must have restored solvency in the event of a breach of the SCR. The impact of such a breach may have an impact on consumers and their actions.

Past practice in the United Kingdom has been that regulatory forbearance has prevented life insurers from publicly becoming technically insolvent. This has served policyholders well whilst longer-term solutions for troubled insurers have been found; often by merger or acquisition. Under Solvency II it looks as though insurers will go technically insolvent before any forbearance is possible.

The market reaction and the effect on policyholder actions in such an event are hard to imagine. In the United Kingdom the unprecedented consequences of such an event makes the outcome for policyholders hard to predict.

4.3.1. Focus on capital

The preparation for and introduction of Solvency II would be expected to have an impact on product design, pricing and strategy as a consequence of its increased focus on risk capital, use of capital and capital steering via the use test. This increased focus provides strong incentives for insurers to price and manage risks appropriately. As a result some risks become uneconomic to run, e.g., unrewarded ALM risk. In this particular case we do see that many insurance companies have made efforts to more closely match assets to liabilities for their traditional businesses.

4.3.2. New business margin (NBM) and capital intensity

Current NBM does not allow fully for costs of holding risk capital to cover product risks obligations. The European CFO Forum NBM methodology only allows for frictional tax and expense costs of holding risk capital with an ad hoc charge for non-financial risks on top (CFO Forum, 2016a). In order to allow for the full costs of holding risk capital we have to consider the capital intensity for each product over its full term, i.e., the present value of risk capital. Considering a profitability measure based on the value of new business in relation to the capital intensity provides a measure of how efficient capital is employed per unit of new business profitability. Clearly the lower the capital intensity for a given profitability, the better. Such a measure (profitability over capital intensity) should correlate over time to a company’s return on equity, and should also correlate to share price and company performance.

4.3.3. Improving profitability

So, how can insurers improve profitability over capital intensity?

• ∙ By redesigning products to accelerate the emergence of profits over time. Early profitability is less “at risk” to shocks compared with later-emerging profitability, so move to front-end-loaded products compared with back-end-loaded products, where allowed by regulation and supported by market practice.

• ∙ By reducing capital intensity of the business by moving from traditional savings to hybrid and unit-linked products, and within traditional savings by lowering and shortening guarantees and thus reducing interest rate exposure and duration. For example, move to rolling guarantees or guarantees that only vest on maturity (non-cliquet) rather than every year. Some markets have even moved from guaranteed returns or payouts towards softer guarantees or aspirations, where the payout is often described as “protected” rather than “guaranteed”.

• ∙ Introduce weaker guarantees overall on all guaranteed products, e.g., out-of-the-money guarantees. Introduce ratchets on hybrid products to provide some positive performance to customers from rising markets. In some markets such as the UK, LTG have all but disappeared, and the hot product idea of the 2000s, the variable annuity, is becoming less viable.

• ∙ Further flexibility can be introduced by increasing the possibility for management action or other levers that allow management to alter product parameters as conditions change. This improves capital efficiency. For example, move away from guaranteed surrender values unless required by regulation and introduce market value adjustors where possible.

• ∙ By promoting protection business. Selling protection is often more capital efficient compared with savings products, as it brings diversification benefits, which reduce capital intensity. There is arguably negative diversification within protection business, e.g., between longevity and mortality, and little correlation between protection business (biometric risks) and the dominating market and credit risks (which highly correlate with market risk).

• ∙ Protection business can also be strengthened by adding riders to base savings-type products.

• ∙ Increase interest in health insurance to further boost protection presence. Strong preference for annually renewable/annually reviewable premiums over long-term guaranteed rates as this results in lower capital intensity under Solvency II.

• ∙ Increase presence in corporate/group business, especially protection. This will further diversify business lines away from savings and longer-term retail business.

4.3.4. Impact on products

All of this is happening in practice: we see this shift in product strategy for many large European insurers. Despite all of this strategic movement on the product side, there are other important considerations that need to be balanced against a slavish devotion to capital efficiency, including regulation and the customer value proposition.

For example, front-end loaded unit-linked products are some of the most capital efficient products but they offer poor customer outcomes for the many policyholders that surrender their policies early. Consequently they have been effectively banned by many regulators, such as in the United Kingdom.

Furthermore, non-market consistent UFRs introduce a distortion into pricing in certain markets, such as in Germany, which favour long-dated policies over others, and there is some uncertainty over whether investment management can perform in practice at this level.

Finally the introduction of Solvency II contract boundary rules has had a significant negative impact on NBMs for products with future reviewable premiums, and margins are in fact pushed to future periods. Some companies have considered reducing this premium reviewability in order to recognise the future profits embedded in these products (Risk.net, 2014).

It is important to note that Solvency II is not solely responsible for these changes. Solvency II has increased focus on capital management and aligned pricing, risk management and capital management compared with the risk-insensitive Solvency I. However, the move away from LTG is in large a consequence of the current very low interest rates in Europe in particular, although again, Solvency II may have increased and brought forward focus on this.

There have been a lot of new regulatory initiatives from the European Union that aim to improve consumer protection in the insurance sector and harmonise the national rules. Some of these include the Insurance Distribution Directive and the Packaged Retail and Insurance-Based Investment Products regulation (PRIIPS).

PRIIPS mandates that insurance companies selling typical savings and investment products will have to provide Key Information Documents to customers before sale, which include information on the riskiness of the product, potential future performance and the costs and charges within the product (including disclosing the Reduction in Yield).

This increases pressure on companies to take a more customer focussed view, and ideally one would hope that the introduction of these regulations would have a material positive impact on conduct risk and help reduce reputational risk and future mis-selling. It remains to be seen how insurance companies will factor all of this into the Solvency II calculation of risk capital.

5.2.1. Summary of requirements

The Solvency II Directive states that every insurer should conduct an ORSA which should include at least the following:

1. a) the overall solvency needs taking into account the specific risk profile, approved risk tolerance limits and the business strategy of the insurer;

2. b) the compliance, on a continuous basis, with the SCRs, and with the requirements regarding technical provisions;

3. c) the significance with which the risk profile of the undertaking concerned deviates from the assumptions underlying the SCR, calculated with the standard formula.

The Directive also states that the ORSA should be an integral part of the business strategy and should be taken into account in the ongoing strategic decisions of the insurer.

EIOPA has published a set of guidelines setting out further detail in relation to the ORSA. These state that the ORSA should be performed at least annually. The Board should take an active part in the ORSA, including steering how the assessment is to be performed and challenging the results.

The EIOPA guidelines also state that insurers should have the following ORSA documentation in place:

1. a) the policy for the ORSA;

2. b) a record of each ORSA;

3. c) an internal report on each ORSA;

4. d) a supervisory report of the ORSA.

The insurer should take into account the results of the ORSA and the insights gained during the process of this assessment in at least:

1. a) its capital management;

2. b) its business planning;

3. c) its product development and design.

5.2.2. Public disclosure

The contents of the public Solvency and Financial Condition Report (SFCR) are set out in detail in Articles 290–303 of the Delegated Regulation. This includes the following information on the ORSA:

1. a) a description of the process undertaken by the undertaking to fulfil its obligation to conduct an ORSA as part of its risk management system including how the ORSA is integrated into the organisational structure and decision making processes of the undertaking;

2. b) a statement detailing how often the ORSA is reviewed and approved by the undertaking’s administrative, management or supervisory body;

3. c) a statement explaining how the undertaking has determined its own solvency needs given its risk profile and how its capital management activities and its risk management system interact with each other.

This suggests that the results of the ORSA process do not need to be made public.

Other contents of the SFCR include:

• ∙ qualitative and quantitative information regarding the risk profile of the undertaking for each category of risk,

• ∙ a description of the material risks, the material risk concentrations and the techniques for mitigating risks,

• ∙ a description of the methods used, the assumptions made and the outcome of stress testing and sensitivity analysis for material risks and events.

It remains to be seen how much detail companies will publicly disclose in relation to results of the ORSA process. Of the four first publicly available SFCRs (Solvency II Wire, 2017), three of the four just discuss the ORSA process that is followed. One of the four gave some information on the stresses conducted and which were the most significant (without quoting any figures). It seems unlikely that ORSA results will be made public.

5.2.3. ORSA review

In the United Kingdom, the ICA process was already in place prior to the implementation of Solvency II, however the ORSA is broader than the ICA, with consideration of qualitative risks rather than just the risk of failing to meet capital requirements. Another key difference between the ICA and the ORSA is the role of the Board. It is clear that the Board has a significant role in the ORSA process, which may be a cultural change for many companies.

In June 2015 the PRA published feedback on the ORSA (PRA, 2015b) stating that in general reports were of a reasonable quality but it noted some weaknesses. In November 2016 the PRA set out a supervisory statement of its expectations of the ORSA (PRA, 2016b).

Many other European supervisors have produced feedback on the ORSA produced during the Solvency II preparatory phase (referred to as the Forward Looking Assessment of Own Risks “FLAOR”) or have commented on their expectations in relation to the future ORSA supervisory reports.

In general, good progress seems to have been made in implementing the ORSA process and embedding this risk management tool into organisations. There is still some work to be done to fully meet the expectations of supervisors.

In June 2015, Gabriel Bernardino (chairman of EIOPA), in a speech to the European Insurance Conference (Bernardino, Reference Bernardino2015c) stated that “I always say that the Own Risk and Solvency Assessment (ORSA) is the heart of the Solvency II regime”.

In general, the ORSA, although an onerous process, is seen as a useful risk management tool and a best practice approach to embedding a strong risk culture.

5.4.1. Requirements

Solvency II sets out the qualitative and quantitative information to be provided to supervisors and the qualitative and quantitative information to be made public.

The quantitative information is published in QRTs. There are potentially 112 annual QRTs to be completed, although several templates will not be applicable for all insurers. There are templates for solo undertakings and group undertakings and for third country branches. For a solo undertaking with no ring-fenced funds there are 68 potential annual QRTs. In total, 13 QRTs are required quarterly. Some QRTs are publicly available (see below). Larger companies and groups are also required to complete “financial stability” versions of the QRTs (where total assets exceed €12 billion). Some supervisors, including the PRA, also require additional National Specific Templates (NSTs) to be completed.

A summary of the 68 QRTs required for solo undertakings with no ring-fenced funds is shown in Table 3.

Table 3 Number of Quantitative Reporting Templates (QRTs) Required

SCR, solvency capital requirement; MCR, minimum capital requirement.

The qualitative information required is contained in the public SFCR and the private Regular Supervisory Report (RSR). Where an undertaking owns a website it is required to publish the SFCR annually on the website. The full RSR should be submitted to the supervisor at least every three years and a summary is required annually. The content required for these reports is set out in detail. The RSR follows the same structure as the SFCR but more detail is required. Both reports contain the relevant QRTs.

As reported in Solvency II Wire (2016b), EIOPA has also stated that external audit of the Solvency II balance sheet can be a “powerful tool”. It also reports that countries planning to apply external audit include the United Kingdom, Ireland, Austria, Belgium, Cyprus, Germany, Hungary, the Netherlands, Poland, Portugal, Slovenia and Spain. Countries that will not be applying external audit to the Solvency II balance sheet include: Croatia, Czech Republic, Denmark, Estonia, Finland, France, Greece, Lithuania, Latvia, Norway, Sweden and Slovakia. Internal models are not generally included in the scope of external audits.

5.4.2. Issues

There are several common issues identified in relation to Pillar 3 disclosures. The following changes could be considered for the UK post-Brexit:

• ∙ Granularity of reporting, e.g., asset data reporting.

• ∙ The extent that the current volumes of data are necessary for the PRA to fulfil its role as regulator.

• ∙ Frequency of reporting, e.g., under Solvency I, quarterly reporting was not generally required in the United Kingdom. Even if quarterly reporting is retained, there could be an increase in insurers who are waived from quarterly requirements.

• ∙ Speed of reporting, e.g., extending the 5 week deadline for solo reporting.

• ∙ An increase in the number of QRTs that are publicly disclosed.

5.4.3. Public disclosures

Public disclosure is an important aspect of Solvency II. It is a key aspect of enabling the public to scrutinise an insurer’s financial strength and risk profile.

Informed persons (investment analysts, financial intermediaries and other interested parties) have the ability to analyse, compare and inform the broader public of an insurer’s strength. This provides market discipline in respect of solvency and risk management.

Prior to Solvency II, local regulators set reporting standards. The United Kingdom has benefitted from high levels of public disclosure whilst in other regimes the public disclosure has been more limited.

As such Solvency II scores highly in respect of harmonising a common reporting standard across Europe. Another huge step forward is the solvency reporting both at national level and at insurer level.

A principle of Solvency I disclosure in the United Kingdom was that the disclosures would be enough to allow a third party to approximately replicate the calculation of the technical provisions. The disclosures under Solvency II are much more “black box”. They are a statement of results produced by a calculation engine. The scope of audit under Solvency II varies by country. In the United Kingdom, the publicly disclosed QRTs are subject to external audit. However, this is not the case in many European countries.

Much of the disclosure is similar to that already enjoyed in the United Kingdom. Table 4 compares required disclosure under Solvency II with the Solvency I regime in the United Kingdom.

Table 4 Disclosure Comparison Between Solvency II and Solvency I

It could be said that the publicly disclosed data represents the bare minimum.

The public disclosures show the impact of the LTG and transitional measures. These measures had the effect of moving Solvency II further away from a market consistent framework and this disclosure enables the public to see the capital benefit that the company or group has received as a result. It also enables the financial strength of the insurer to be assessed without these benefits. If these adjustments are significant then there would be a question mark over the quality of the capital that these reliefs provide.

The public disclosures however do not go far enough in enabling the public to determine the market consistent framework of Solvency II prior to the LTG package as there is no disclosure of the impact of the UFR on the technical provisions. Analysts are well aware of this, and it is interesting to note that the capital markets are looking for insurers to disclose voluntarily the impact of a change in the UFR to the balance sheet.

A summary of voluntary Solvency II disclosures as at 31 December 2015 is given in Appendix 3.

EIOPA also carried out a stress testing exercise as at 1 January 2016, and a high-level summary of the results is given in Appendix 4.

6.3.1. Internal model approvals

MEPs raised concerns over the consistency of Solvency II across Europe at the meeting of the Economic and Monetary Affairs committee in September 2015. At the meeting Gabriel Bernardino, chairman of EIOPA, said:

It is not clear how EIOPA could address different interpretations by supervisors if rules are being communicated privately as part of the model approval process.

The publicly available data (and also private anecdotal evidence from practitioners that the working party spoke to as part of its field work), suggests that the national implementation of internal models varies quite widely across EU member states.

In the United Kingdom, originally around 100 insurers were initially encouraged to participate in the “pre-application” process prior to Solvency II going live. During this extended pre-application process (which arguably ran for 5 years due to the delays in the Solvency II go-live date) several UK insurers dropped out of the process due to the requirements being too onerous. In December 2015, PRA announced that internal models were approved for a total of 19 undertakings.

The number of approved internal models outside of United Kingdom varies widely between member states, depending on local market practice and the attitudes of the national supervisor. For example, the use of internal models appears to be far less common in France and Germany.

Data on the use of internal models across EU is given in Table 1 in section 3.1. The table illustrates that use of an internal model is not a widespread practice and is reserved for a handful of insurers that have the resources to meet the requirements.

The working party struggled to find conclusive data on whether the approval process in the United Kingdom was more difficult to pass than approvals processes conducted by EU regulators. This question is a highly subjective one which is difficult to assess based on any data.

6.3.2. ORSA

Some supervisors have set out templates or deadlines for the submission of ORSA reports. For example, the Italian supervisor, IVASS, has required insurers to submit the ORSA by 31 May 2016 and has specified a format for the ORSA report. In addition, some supervisors have set out their expectations as to what should be included in the ORSA report. For example, the French supervisor, Autorité de Contrôle Prudentiel et de Résolution (ACPR), set out some specific scenarios to consider in the 2015 FLAOR and its findings from this exercise suggest that it expects insurers to continue considering these scenarios in the ORSA (in particular a prolonged period of low interest rates or a rapid increase in rates). In addition, the Dutch supervisor, DNB, has stated that it expects insurers to consider the impact of the UFR in its ORSA.

6.3.3. Required solvency ratios

EIOPA has expressed concerns that supervisors have different expectations regarding solvency ratios. See section 4.2.8.