In the run up to the implementation of Solvency II EIOPA issued two sets of Guidelines to accompany the respective Implementing Technical Standards (ITS). The first set of Guidelines (Guidelines Set 1) was published on 27 November 2014. These Guidelines primarily addressed areas of the directive relating to approval processes.
Guidelines are addressed to National Competent Authorities (NCAs) to help interpret the rules in a harmonised way. While they are not legally binding, each NCA has to indicate to EIOPA if they will comply with the Guidelines.
The ‘comply or explain’ exercise proved a useful indicator of the state of preparation for Solvency II in the past.
An analysis of the responses to the two sets of Guidelines (starting with Set 1 here) is instructive of the approach of Member States and the general state of preparation for implementing the directive.
Guidelines set 1
Guidelines Set 1 contain 19 separate Guidelines covering areas such as use of internal models, look-through approach and classification of own funds. Each one of these Guidelines contains within it number of Guidelines (the Guidelines on Use of internal models, for example, contains 68 related Guidelines (Guideline 1 – Pre-application, Guideline 50 – External data, etc.).
To avoid confusion, these will be referred to as individual Guidelines. Guidelines Set 1 therefore, contains a total of 432 individual Guidelines. 32 NCAs (31 EEA countries plus Gibraltar) took part in the comply or explain exercise and could respond to each one of these individual Guidelines in one of four ways: ‘comply’, ‘intend to comply’, ‘do not comply’ or ‘not applicable’. In case of non-compliance or intention to comply NCAs were asked to explain their action. However, not all the explanations were published.
Comply, comply, comply
Aggregating the responses to the comply or explain exercise from all 32 NCAs (13,824 responses in total) reveals a number of broad trends across Europe. NCAs said they will ‘comply’ with 24% of all individual Guidelines and ‘intend to comply’ with 75%, a near 100% positive response rate across all individual Guidelines.
Only 13 individual Guidelines received a ‘do not comply’ response and one ‘not applicable’. Of these Germany said it would not comply with 6 Guidelines, Belgium with 3, France with 2, and Sweden and Iceland one each. Details of individual NCA’s responses can be found on the Solvency II interactive implementation map.
Based only on the number of responses to the comply or explain exercise it is clear there is an overwhelmingly positive intention of Member States to take up the Guidelines. However, the qualitative nature of individual responses reveals further nuance.
Final Compliance Percentage score (FCP score)
By assigning a score to each one of the four responses to the comply or explain exercise (‘Comply’ = 3 points, ‘Intend to comply’ = 2 points, ‘Do not comply’ = 1 point, ‘Not applicable’ = 1 point. The last two are equally weighted, as in effect their outcome is identical: non-compliance) it is possible to create a ranking of each NCA’s approach to the Guidelines (see also Europe says ‘yes’ to EIOPA Guidelines, 26/1/2014) and allocate each Member State a Final Compliance Percentage (FCP) score out of 1296 (432 individual Guidelines multiplied by the highest score 3).
Cyprus and Finland are the only two countries that said they would comply with all 432 Guidelines (100% CFP score). They are followed closely by Denmark, Austria, Germany and Luxembourg, all with scores of 98%. The vast majority of Member States scored between 70% and 66%, the latter representing ‘intend to comply’ response to all 432 Guidelines.
Different interpretations, same outcome
As highlighted in the Solvency II Wire analysis of the responses to the comply and explain exercise for the interim Guidelines, there are considerable differences in the way NCAs interpret the meaning of the term ‘comply’ and ‘intend to comply’.
Often ‘intend to comply’, as opposed to ‘comply’, represents a legal limitation or a decision pending. For example, for the Guidelines on the Application of Outwards reinsurance the PRA said it ‘intends to comply’, giving the following reasoning (emphasis added): “As of 1 April 2015, EIOPA’s Board of Supervisors is still considering the nature of a public communication that external audit of standard formula reporting, or aspects thereof, should occur.
The PRA will await the outcome before reaching a final determination on whether any additional steps might be needed to achieve full compliance.” The DNB on the other hand, uses the following reasoning for most ‘intend to comply’ responses (emphasis added): “The legislative proceedings to implement the Solvency II and Omnbus II (sic) directives have not yet been finalised. DNB expects finalisation and implementation in June 2015. As soon as the Solvency II Directive and the Omnibus II Directive have been implemented … DNB will apply the Guidelines.”
In both cases it is clear the NCAs will comply with the Guidelines but have chosen a stricter legal interpretation of the answers. Given that ‘comply’ and ‘intend to comply’ both show an intention to comply in practice we can see that most Member States have been progressing towards implementation and that the lowest CFP score of 66% is in effect the same as the highest.
The 13 do not comply’s
The 13 ‘do not comply’ responses seem insignificant given the volume of positive responses. Of the 5 respective NCAs, only Germany and Iceland gave a reason for non-compliance.
There is also no observable pattern in the areas they address, which range from Classification of own funds (Belgium), Operational functioning of colleges (France), Group solvency (Sweden), Supervisory review process (Iceland), and Contract boundaries (Germany).
In the two instances where there is overlap in the Guidelines – Classification of Own Funds: Belgium and Germany; Group solvency: Germany and Sweden – they refer to different individual guidelines. Germany, which said it would not comply with 6 of the 13 individual Guidelines, noted that 4 individuals Guidelines (on Loss-absorbing capacity of technical provisions, Deferred taxes and Contract boundaries) were in conflict with Germany’s constitutional proportionality principle.
For the remaining two instances (on Classification of Own Funds and Group Solvency), BaFin explained that these Guidelines were too over-arching and contradicted the narrower interpretation in German law.
Industry preparation: some problems understanding the data requirements
While responses from NCAs have been overwhelmingly positive, the messaging from industry is somewhat different. The latest press release from Insurance Europe, for example, (15/12/2015) focuses almost in its entirety on industry claims of “gold plating” by national regulators.
Somewhere in the shopping list of complaints you will find the line: “However, despite all of these challenges, the survey confirmed that the vast majority of Europe’s insurers will be ready to operate under Solvency II from January 2016.”
You can almost sense the author’s reluctance to write these words. This, of course, is all part of laying the ground work for the next attempt of watering-down the rules, which the industry is claiming to be necessary in the name of promoting long-term investment.
The ABI, on the other hand, is sounding decidedly more chipper: “After ten years of preparation and a £3bn investment from the UK industry, insurers and reinsurers are ready to implement the new regime.” Understanding the exact state of preparation of the industry across Europe is near impossible.
A project this vast can only be tested when it goes live. Some insights into the types of challenges the industry is facing in its preparation work can be gleaned by analysing data from the Thomson Reuters Solvency II Diagnostics tool (disclosure: Solvency II Wire and Thomson Reuters have entered a commercial agreement to share anonymised aggregated data from the tool).
The current sample includes about 60 insurance firms based in the EU. 70% of these said their organisation was ready for Solvency II – a slight increase since September. Two thirds said they conducted an ORSA, but only a third had it approved. About two thirds said their Solvency II model was fit for purpose, retaining the same proportion as the sample has grows. The results reveal a slight drop in the confidence level in the understanding of EIOPA’s asset data requirements. The number of all European respondents (insurers, asset managers, custodians, prime brokers and fund administrators) who said they were either ‘somewhat unsure’ or ‘very unsure’ rose from 31% to 36% since September, while the overall level of confidence dropped by 5% to 64% of the sample. The drop in confidence is surprising as it would be reasonable to expect that as firms progress through the work they would gain more clarity. However, it is also possible that as firms finalise their preparation work new questions about the use of the data are arising.
A telling story
There has been an overwhelming positive take up of the first set of Guidelines by NCAs, demonstrating both the quality of EIOPA’s work and the commitment from Member States to implement Solvency II. This commitment will be tested as the directive is rolled out across Europe.