In preparing for the upcoming 2020 Solvency II review an important area of focus for life insurers and reinsurers should be a reassessment of asset-liability management (ALM) strategies for long-term liabilities both from the perspective of legislative changes that are under consideration as well as shortcomings in practices that have already been highlighted by regulators. Firms should be assessing these issues for day-to-day solvency, the own risk and solvency assessment (ORSA) and overall risk management needs, bearing in mind the consequences for different types of business and the potential influence on business mix into the future.
In this blog post I
highlight some of the key legislative changes currently under consideration regarding
the treatment of long-term liabilities, including those that may affect each of
the following areas which are important in the context of ALM:
- The methodology and
assumptions underlying the extrapolation of the risk-free rate curves for
varying currencies including the last liquid point (LLP), the rate of
convergence to the ultimate forward rate (UFR) and the level of the UFR itself
- The volatility
- The matching adjustment
also summarise public feedback from the European Insurance and Occupational
Pensions Authority (EIOPA) and national regulators regarding ALM best
guarantee measures under Solvency II
As part of the final set
of rules established prior to the commencement of the Solvency II regime in 2016, a set
of measures was introduced regarding the
treatment of ‘long-term guarantees’ or LTGs. These measures, commonly referred
to as the ‘LTG measures,’ comprised the extrapolation of the risk-free rate, the VA, the MA and the transitional
measures for the risk-free rate and technical provisions (TRFR and TTP).
is well underway towards the review of the LTG measures, as originally envisaged to happen by the end of 2020
under the Omnibus II Directive. EIOPA has been charged with overseeing ongoing experience
with regards to the LTG measures,
publishing an annual report for each of 2016, 2017 and 2018. These annual reports
are intended to be a key input informing the wide-ranging review of Solvency II. Indeed EIOPA
is specifically required to submit an opinion on its assessment of the application of the LTG
measures by the end of 2020.
Additional requests from the European Commission (EC) as part of the review process now make it clear that a point of focus regarding the LTG measures will be a reassessment of their appropriateness, particularly taking into account ALM practices of life (re)insurers.
In May 2019, the European Insurance and Occupational Pensions Authority (EIOPA) published its thematic review on the benefits and risks arising from the use of Big Data Analytics (BDA) in health and motor insurance. This briefing note by Milliman’s Matthew McIlvanna, Eamonn Phelan, and Eoin O Baoighill summarises EIOPA’s report. The note explores the types of big data and predictive analytics tools currently being used in the motor and health insurance industry and some of the challenges insurers have faced. While EIOPA’s report focuses solely on motor and health insurance, the findings of its review have much broader relevance to other types of insurance.
The European Insurance and Occupational Pensions Authority (EIOPA) aims to facilitate insurtech innovation in a way that ensures a level playing field and does not lead to deregulation. The agency recently published a report providing an overview of the European Union’s insurtech industry. The report also explores licencing requirements and the principle of proportionality related to insurtech innovation. Milliman consultants Bridget MacDonnell and Dominik Sznajder offer some perspective in this briefing note.
The Solvency II Directive requires that certain areas must be reviewed by the European Commission by the end of 2020. The Commission has now written to the European Insurance and Occupational Pensions Authority (EIOPA) requesting its advice by 30 June 2020 on items that it has identified as deserving a reassessment. In forming its advice, it’s expected that EIOPA will issue a series of industry consultations addressed to various stakeholders over the coming months. Any proposed changes will be high on the agenda of actuarial functions and risk functions and (re)insurers will need to carry out impact assessments in relation to areas affecting them.
In this briefing note, Milliman’s Karl Murray and Eoin King set out the areas covered by the Commission’s latest request for the 2020 review of the whole Solvency II framework. They also cover a separate request that the Commission has issued to EIOPA related to insurers’ asset and liability management, which is also part of the 2020 review process, as well as providing an update on the latest news in relation to the 2018 interim review of the Solvency II Delegated Regulation.
Solvency II came into force on 1 January 2016. The agreed Pillar 1 quantitative requirements set a market-consistent valuation framework for the valuation of assets and liabilities, as well as sufficient holdings of capital to withstand a combination of so-called ‘1-in-200-year’ Standard Formula (SF) stresses. There is no doubt these fundamental principles are set in stone but nonetheless there have been ongoing changes to the detailed rules since their introduction. This was planned from the outset with certain powers given to the European Insurance and Occupational Pensions Authority (EIOPA) to review methodology and assumptions over time, as well as a specific milestone for the European Commission (EC) to review elements of the Standard Formula in 2018, followed by a more holistic review of the entire rulebook by 2021.
Any changes are intended to reflect developments in the insurance sector and the wider environment. These changes could have significant impacts on individual companies and firms may need to reassess their capital management strategies.
This report by Milliman’s Karl Murray, Eamonn Phelan, and Bridget MacDonnell revisits the rules in specifying the risk-free rate term structure, which forms a fundamental part of the calculation of Technical Provisions (TPs). In particular, they analyse changes to the Ultimate Forward Rate (UFR).
EIOPA’s consultation paper on the formal integration of sustainability risks into both Solvency II and the Insurance Distribution Directive (IDD) details a number of proposed changes to regulation which may lead to challenges for insurers. The consultation closed to responses on 30 January 2019 and technical advice to the European Commission is expected by the end of April.
Of particular interest are the following three changes which have been proposed to the Solvency II Delegated Regulation:
1. The risk management function would explicitly be required to have a role in identifying and assessing sustainability risks.
2. The actuarial function opinion on the underwriting policy would need to address sustainability risks.
3. Sustainability risks would be integrated into the requirements governing investments under the ‘prudent person principle.’
This latest consultation is part of the wider package of measures on sustainable finance which the European Commission adopted in May 2018. EIOPA has also issued a call for evidence to collect information from insurers regarding the integration of sustainability risks in the assessment of assets and liabilities. EIOPA will prepare its draft opinion to the European Commission on sustainability within Solvency II for consultation during the second half of 2019.
The Commission’s request for advice from EIOPA includes various wider Solvency II aspects. For example, the opinion should also highlight where the calibration of the standard parameters in the market risk module of the standard formula do not sufficiently account for sustainability factors, with particular regard to the climate risk that insurers are exposed to via their investments and how it should be addressed.
What is meant by sustainability risk?
While there is no universal definition of sustainability risk for insurers, we see this risk as having two key aspects:
1. It is the specific risk (mainly to non-life insurers) of additional claims brought about by increased incidence of environmental events or natural disasters.
2. It is the more general risk associated with having business models and/or investments that fall outside of the definition of ‘sustainable,’ and that are therefore threatened by events, market forces and new regulation that arise as a result of a general shift towards sustainable investments and business models.
Sustainable investments can be defined as investments in an economic activity that contribute to an environmental, social or governance (ESG) objective1. Sustainability risks stem from these ESG factors and could affect both the investments and the liabilities of insurers.