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INSURANCE| 04.01.2024

A new framework for the insurance industry: the revision of Solvency II

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Insurance companies in the European Union operate under a series of regulations grouped under the Solvency II Directive, which measures the risks companies face and the financial resources that must be at their disposal to be viable. European authorities recently reached an agreement to update this legal framework, which reinforces the role of insurers as institutional investors and may direct financing toward the ecological transition.

The current Solvency II legal framework entered into force in 2016. It was a significant regulatory shift for European insurance companies, setting solvency requirements for companies to be able to handle complex economic situations. Since then, extraordinary situations like the pandemic have occurred, and in the financial markets, we’ve seen how interest rates experienced the largest increase in ECB history.

This situation has evidently impacted insurance companies. However, according to Ramón Carrasco, chief risk officer (CRO) at MAPFRE, “their management capacity has enabled these companies to maintain adequate solvency levels and their commitment to insured parties.”

Evolution, not revolution

Over the last few years, Solvency II has worked and overcome events like COVID-19, as, in spite of operational challenges, no significant interruptions occurred. According to Carlos Rami, group head of EU and International Affairs at MAPFRE, “the sector was well capitalized with an average solvency ratio of 200% at the end of 2020.” Since 2019, Rami has also been the vice chairman of the Solvency II working group for Insurance Europe, the European insurance and reinsurance federation.

Why, then, did Solvency II come about? Due to its complexity, the articles of the directive consider the need to review its applicability in a period of five years. Although this was done with a slight delay, the provisional agreement to update the text, between the European Council and the European Parliament, finally saw the light on December 14.

Major improvements

The proposal’s main objective is to improve the Solvency II regime. This revision lays the foundation to:

  • Encourage insurance companies to use their resources to invest in long-term projects.
  • Drive sustainability requirements, compelling all companies to create specific transition plans with quantifiable objectives and analyze the financial impacts arising from these factors.
  • Encourage better integration into the single market with more coordinated oversight.

These improvements also include greater flexibility in the requirements because they will be more adapted to each company’s actual situation. “In no case was it considered necessary to make capital requirements more stringent, given the solid situation of the European insurance industry,” explained Carlos Rami.

A crucial step toward sustainability

The agreement strengthens the role of private insurance as an institutional investor. With trillions in assets under management, the industry is a pillar of the European financial sector. Due to the nature of their liabilities, insurance companies can provide long-term capital financing to companies.

A step beyond the revision of the directive also drives sustainability and includes improvements to insurance companies’ management policies to actively contribute to decarbonization, promoting more sustainable practices.

This aspect was included with two viewpoints in mind, according to Ricardo González, director of Analysis, Sectorial Research, and Regulation of MAPFRE Economics. “On the one hand, companies should develop climate change scenarios in their risk and solvency assessments and prepare transition plans to monitor sustainability risks. On the other, when long-term investments are better structured, it becomes possible to make investments that aid this transition, including investments into the infrastructure necessary to reduce energy dependency on fossil fuels.”

Better customer protection

While Solvency II was being revised, a proposed new Insurance Recovery and Resolution Directive (IRRD) was also drafted. The document strengthens oversight of transnational operations within the single market, with the purpose of improving coordination between national supervisors and guaranteeing better protection for insured parties.

According to Carrasco, risk manager at MAPFRE, the fact is “that the number of insurance companies entering liquidation is paltry. In any event, any regulation that helps insured parties remain protected is welcome.” Without a doubt, added Ricardo González, “this is an aspect that is quite developed in many EU countries, particularly in Spain, so the objective is rather to standardize structuring. These mechanisms were already there, but any improvement helping to add more security to the system is always positive.”

Next steps

In short, the revision of Solvency II cements the role of insurance companies as institutional investors, contributes actively to building the ecological transition, and provides more effective oversight on insurance activity in Europe.

Its practical implementation, however, may be delayed until mid or late 2026, as the proposal includes the need to prepare additional supplementary regulations, in addition to the transposition period for member states once the definitive text is published.

 

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