The insurance sector’s roller-coaster relationship with prudential regulation

The EU has a legislative procedure that can be extremely slow and complex. The process involves several different stages and phases that can involve surprising turns.

Unlike Finnish legislation, EU directives contain a mandatory review clause. The review usually takes place some years after the adoption of the directive, allowing amendments to be made to the regulation if necessary. In Finland, too, committee reports and resolutions can entail more or less binding requirements to address certain matters, but less as a rule.

The EU’s legislative process provides an ideal environment for increasing regulation. A review process that does not propose amendments is unheard of. After all, if the three key parties involved in the process – the European Commission, the Council of the European Union and the European Parliament – had nothing to amend, it would be like they admitted to being dispensable. In Finland, there must be a special reason to increase regulation, but in the EU, there must be a very special reason not to increase regulation.

After a lengthy preparation process, the Solvency II Directive came into effect on 1 January 2016, replacing a set of rather rudimentary legislation that failed to take into consideration the risks of the insurance business. The insurance sector supported the Solvency II process and the idea of the brave new directive matching the sector’s best practices in risk management. But the insurance sector considered the new prudential requirements excessive and the burden of the various reporting duties unreasonable, causing a rift in its love affair with Solvency II.

Tensions from outside the insurance sector and not related to regulation caused further bumps in the relationship. These included especially the financial crisis and interest rates that settled at a considerably lower level than had been experienced before. With the financial crisis fresh in mind, the authorities decided that insufficient reporting would not stand in the way of surviving the next financial crisis. The low interest level increased capital requirements especially for life and pension insurance policies that include long-term guarantees.

A few years ago, the Commission, the Council and the Parliament undertook a small-scale review of Solvency II. This review did not touch the directive itself, instead only resulting in relatively small changes to lower-level regulation. More complex matters were transferred to the currently ongoing comprehensive review.

The Commission has now adopted a comprehensive review package and issued a proposal that will be next discussed by the Council and the Parliament. The Commission’s proposal was preceded by a formal request for technical advice from the European Insurance and Occupational Pensions Authority EIOPA. The proposal’s key features include enhancing proportionality, relaxing capital requirements and increasing reporting and supervision.

The Council aims to process the Commission’s proposal on the Solvency II review by June 2022, the Parliament by late 2022. The next step will be the trilogue between the Commission, the Council and the Parliament, which is expected to last at least until mid-2023. This means that the Solvency II amendments could then become effective sometime in late 2024. 

The insurance sector’s key goals for the Solvency II review are to reach more reasonable capital requirements, ease the reporting burden, apply the proportionality principle in a determined fashion and minimise overlapping regulation resulting from different regulatory regimes. The insurance sector does not consider a separate resolution directive necessary: the Solvency II framework should cover this.

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The insurance sector’s key goals
are to reach more reasonable capital requirements
and to minimise overlapping regulation.
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In September 2021, the Commission adopted a proposal for an Insurance Recovery and Resolution Directive (IRRD). This further complicated the insurance sector’s relationship with Solvency II. Because the IRRD proposal is separate from the Solvency II framework, it is uncertain whether it will move forward in the same pace as the Solvency II review.

The objective of the IRRD is understandable. It aims to ensure that if an insurance company becomes insolvent, it can be closed down without insured interests suffering damage or problems being reflected on the society at large, for example through the need to use tax money to protect policyholders.

But the IRRD is a curious directive. It is modelled after the BRRD, an equivalent directive in the banking sector. The problem is that, despite their seeming similarity, the business model in the insurance sector is radically different from the business model in the banking sector. Measures copied from the BRRD will therefore not help solve problems in the insurance sector.

Finnish legislation already has comprehensive regulation governing the winding up and bankruptcy of insurance companies. Its central feature is to prioritise the interests of policyholders and other beneficiaries before those of creditors. The Finnish insurance sector does not rely on national funds to cover an insurer’s crisis. Tax money has never been needed to date, and Solvency II makes it even less likely to be needed in the future because it has increased capital adequacy to a level that is well in line with risk levels.

It seems realistic to expect that the IRRD is here to stay, no matter how badly suited it is to Finnish regulation. It therefore only remains to hope that the IRRD will be developed to better account for the specifics of the insurance business and will not interfere with the functionality of Solvency II unnecessarily.