The most recent proposals to revise Europe's Solvency II insurance capital regime appear less onerous overall for insurers than the previous set, but the effect may vary from company to company, according to analysts.

For example, analysts had considered Dutch and German life insurers' capital ratios would be hardest hit under previous proposals, but certain companies in Norway and France could come off worse in the new proposals.

On Dec. 17, 2020, the European Insurance and Occupational Pensions Authority, or EIOPA, submitted its latest opinion on Solvency II to the European Commission as part of a review of the capital regime. The EC is expected to give its proposal on the review in the third quarter of this year. Implementation is projected to take place in 2024 at the earliest.

The review looks to revise key elements of how insurers' Solvency II capital requirements are calculated, including the risk margin — a capital buffer insurers must hold in excess of the best estimate of their liabilities — the interest rate curves insurers use for discounting liabilities and how low and negative interest rates are factored into the capital requirements for users of the standard formula.

The standard formula is a one-size-fits-all method for calculating Solvency II capital requirements used by companies that do not have internal capital models.

Better than expected

There were concerns that EIOPA's previous proposals would result in big hits to life insurers' solvency coverage ratios, which show how much capital insurers hold relative to the regime's solvency capital requirement.

Analysts at Berenberg in a note to clients said the latest proposal is "probably about half as risky as initially feared." EIOPA's latest impact assessment shows that, factoring all proposals, the average coverage ratios of the life insurers in its sample would fall 31 percentage points to 229% from 260%. Composite insurers' ratios would fall 11 percentage points to 227% from 238% including all proposals.

Dutch and German insurers were expected to be most negatively affected under the old proposals, largely because of the LLP change. EIOPA had proposed moving the LLP — the point when insurers switch to using extrapolation rather than market data for calculating risk-free interest rates — to either 30 or 50 years from the current 20-year position for euro rates, as well as alternative extrapolation method.

The new advice opted for the alternative method, which has a far less severe impact on solvency coverage ratios. Benjamin Serra, a senior vice president at Moody's, said in an interview that EIOPA's most recent impact assessments do not show as much of an impact on Dutch and German insurers.

NN Group NV in mid-December 2020 said it expected an approximately 5-percentage-point hit to its Solvency II ratio at the implementation date. Fellow Dutch composite insurer ASR Nederland NV said its ratio would drop 10 percentage points, excluding phase-in measures.

Perhaps the bigger victory for the overall insurance industry is the risk margin, which has been criticized for being too onerous and over-sensitive to interest rates. After initially saying it was not going to change the margin, EIOPA's latest opinion introduces a proposal for changing its calculation to reduce the size of the margin and its volatility, particularly for long-term liabilities. The impact assessment shows that the new method would reduce the risk margin, on average, by about 15%.

Nick Ford, head of transactions at consultancy Hymans Robertson's U.K. insurance and financial services practice, said in an interview that while the changes "could have gone a lot further," he did view the risk margin proposal as "positive news." Willem Loots, senior director in Fitch Ratings' EMEA insurance group, said the proposed risk margin change may be "particularly beneficial" for Dutch life companies.

Not for everyone

Somewhat offsetting the positives is the calibration for low and negative interest rates for standard model users. Were the proposal for low and negative interest rates excluded from the overall package of measures, life insurers' solvency ratios would only fall 5 percentage points to 255% and composite insurers' would increase by 7 percentage points to 245%.

Loots said that although companies with internal models face a smaller hit to coverage ratios under the new proposals, the interest rate calibration might cause "substantial movement" for those using the standard formula, and that some shifts may be more severe than expected, although that would be in "a minority of situations."

While German and Dutch insurers may no longer be considered most affected by the changes, others have taken their place. The EIOPA impact assessment said that for some markets, particularly Norway and France, there was a "more pronounced impact" of the combined package of changes on coverage ratios, which is not apparent when the interest rate risk calibration is excluded.

Still, the shifts are unlikely to plunge solvency ratios into danger areas. Serra noted that if companies' capital levels fall close to 100% of Solvency II's solvency capital requirement, they can face regulatory pressure. But while the new measures will have an impact, "ratios remain quite significantly above 100%," so regulators are unlikely to take action.

While the long lead time before implementation means there could be further changes, some see additional revisions as unlikely. Ford said introducing changes in the governance process leading up to implementation "will be quite challenging," while Kenneth McIvor, a director at Willis Towers Watson PLC, said the doors will be "mostly closed until the next review."