European Commission proposes Solvency II reform package
The European Commission has set out a Solvency II reform package that couples targeted capital changes with a new recovery and resolution regime for EU insurers, in the first comprehensive review of the framework since its 2016 introduction. The package, adopted on 22 September 2021, comprises a directive amending the Solvency II framework and a separate Insurance Recovery and Resolution Directive, both aimed at keeping insurers allocating balance sheet to long‑term assets while supporting wider EU policy goals.
### Key changes include:
• Volatility adjustment calibration: EIOPA advised raising the general application ratio in the volatility adjustment from 65% to 85%, increasing the share of credit spreads recognised in solvency calculations and dampening the impact of spread shocks on capital positions.
• Equity risk and symmetric adjustment: EIOPA recommended widening the symmetric adjustment corridor for equity risk from +/-10% to +/-17% and introducing a 22% floor for the equity capital charge, altering how far equity stresses can move away from the standard charge in stressed markets.
• Long-term equity eligibility: The Commission will revise the eligibility criteria for the existing long-term equity asset class so more holdings can qualify for the preferential capital treatment when used to provide long-term funding, rather than attracting the higher standard equity stresses.
• Risk-free curve extrapolation: EIOPA advised setting the convergence parameter in the extrapolation of the risk-free interest rate term structure at 10%, with transitional mechanics including a 20% starting value that phases down to 10% by 2032 and a 40% parameter for the Swedish krona.
• Climate and macro risk integration: The Commission proposes new requirements for insurers to identify material climate risk exposures, assess long-term climate scenarios, and integrate macroeconomic developments into investment strategies and the Own Risk and Solvency Assessment.
• Proportionality and small undertakings: Changes to the Solvency II Directive text will allow more small insurers to be exempted from the regime and introduce a more suitable framework for undertakings identified as having a low-risk profile, adjusting reporting and supervisory expectations.
• Group supervision powers: Extensive amendments would apply Solvency II requirements directly to insurance holding and mixed financial holding companies and empower group supervisors to require restructuring where they identify weaknesses in group structures.
• Recovery and resolution framework: A new Insurance Recovery and Resolution Directive would establish a harmonised EU framework for handling failing insurers and reinsurers, addressing cross‑border failures and perceived gaps in the current supervisory toolkit.
### Capital treatment and market-sensitive measures
The Commission is seeking to recalibrate Solvency II rather than replace it, after concluding that the regime has generally worked as intended since it came into force. The proposals build on technical advice requested from EIOPA in 2019 and set out in the authority’s 2020 opinion on the review.
On spread risk, the Commission plans to amend legislation so that short-term market moves have a more limited impact on reported solvency ratios, including through changes to the volatility adjustment. EIOPA’s advice to increase the volatility adjustment’s general application ratio to 85% would allow a larger portion of risk‑adjusted spreads to be recognised in own funds, reducing balance‑sheet volatility from temporary spread widening.
For equity risk, widening the symmetric adjustment corridor to +/-17% and introducing a 22% floor for the equity capital charge would change how far the effective equity stress can deviate from the standard level in boom and bust conditions. Under this calibration, equity exposures would retain at least a 22% capital charge even when the symmetric adjustment is strongly negative.
### Risk-free curve and extrapolation
EIOPA’s opinion sets out a revised approach to extrapolating the risk‑free interest rate term structure beyond the last liquid point, based on a smoothly converging forward rate. The authority advises using a convergence parameter of 10% in the extrapolation formula, with a higher initial value of 20% that would decline linearly to 10% by 2032 to smooth the transition from the current method.
For currencies where the first smoothing point is less than 15 years, EIOPA recommends a 14% starting value for the relevant parameter, while maintaining a 40% convergence parameter for the Swedish krona as a special case. The first smoothing point itself would be determined using a bond availability threshold of 6% of residual volume, which for the euro corresponded to 20 years at the end of 2019.
EIOPA also proposes that undertakings with long-term liabilities disclose sensitivity analyses showing the impact of changing the convergence parameter to 5%, with mandatory reporting limited to firms where cash-flows beyond the first smoothing point or first smoothing point threshold exceed 10% of total cash-flows. This would focus additional disclosure on balance sheets most exposed to very long‑dated discount rates.
### Climate, macro-prudential and sustainability measures
The Commission proposes that insurers must identify any material exposure to climate risks and assess the impact of long-term climate change scenarios on their business, embedding these analyses into their risk management frameworks. In parallel, undertakings would be required to assess macroeconomic circumstances and integrate macroeconomic developments into both their investment strategies and their Own Risk and Solvency Assessment.
These measures are presented as part of a broader effort to keep insurers providing long-term funding while supporting EU priorities including post‑Covid‑19 recovery, completion of the Capital Markets Union and financing the European Green Deal.
### Proportionality and smaller undertakings
The legislative proposal would widen the scope for small insurers to be exempted from Solvency II, reflecting concerns that the current framework can be disproportionate for very small or low‑risk entities. Alongside outright exemptions, the review seeks to create a more suitable framework for undertakings identified as having a low‑risk profile, including simplified requirements and reduced reporting where justified.
The Commission’s amending directive also covers changes to reporting and long-term guarantee measures in the Solvency II Delegated Act, though detailed calibrations for these elements are to be set in secondary legislation.
### Group supervision
On group supervision, the package proposes extensive changes that would apply Solvency II requirements directly to insurance holding companies and mixed financial holding companies, rather than relying solely on supervision at operating entity level. Group supervisors would gain explicit powers to require restructuring of group structures where they identify material weaknesses or barriers to effective supervision.
These changes respond to recent failures of insurers operating across borders, which the Commission said exposed shortcomings in supervision and inconsistent policyholder protection when firms fail.
### Recovery and resolution framework
The second legislative pillar is a new Insurance Recovery and Resolution Directive, which would establish a harmonised EU framework for the recovery and resolution of insurance and reinsurance undertakings. The directive is meant to complement the prudential reforms by providing common tools for dealing with distressed firms, including those with cross‑border operations.
### Legislative process
The Solvency II amending directive is proceeding through the European Parliament and Council as procedural file 2021/0295(COD), with the European Economic and Social Committee having issued its opinion on the review on 23 February 2022. The Insurance Recovery and Resolution Directive is advancing separately as file 2021/0296(COD).
--- Sources: https://ec.europa.eu/ https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52021PC0581 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52021PC0582 https://finance.ec.europa.eu/publications/insurance-rules-review-encouraging-solid-and-reliable-insurers-invest-europes-recovery_en https://www.eiopa.europa.eu/system/files/2020-12/eiopa-bos-20-749-opinion-2020-review-solvency-ii.pdf
