The amendments aim to maintain the directive's relevance by incentivising insurers to support sustainable, long-term economic financing, which will improve risk sensitivity, reduce short-term volatility in solvency positions, and enhance the quality and consistency of insurance supervision across the EU. Additionally, the amendments seek to bolster policyholder protection and address systemic risks that have emerged due to changes in the economic environment and insurance market dynamics since the incorporation of Omnibus II in the Solvency II Directive (2014). These changes include volatility in interest rates, spikes in credit spreads, ongoing market consolidation in the insurance market, shifts towards more illiquid asset mixes, and updated exposure data.
The Solvency II regulatory framework is built on a three-pillar structure:
- Pillar I sets the quantitative requirements, i.e. the assets and liabilities valuation and capital requirements.
- Pillar II sets the qualitative requirements, including governance and risk management of the undertakings and the own risk and solvency assessment (ORSA).
- Pillar III sets the supervisory reporting and public disclosure requirements.
The three-pillar structure makes it easier to understand and to manage risks across the sector. In the following section we will explain the main changes per pillar as a result of the Solvency II 2020 review.
Approved amendments of the Solvency II 2020 review
Key amendments to Pillar 1
The Solvency II 2020 review has introduced significant amendments to Pillar 1, which focuses on quantitative requirements, i.e. the assets and liabilities valuation and capital requirements.
Risk margin (RM)
The cost of capital (CoC) and risk margin have been reduced, yet they continue to uphold the necessary prudence for safeguarding policyholder interests. The revised risk margin calculation now incorporates the time dependency of risks, effectively lowering the margin for long-term liabilities and reducing its sensitivity to interest rate fluctuations. Additionally, the CoC rate will decrease from 6% to 4.75% and remains risk based.
Solvency capital requirement (SCR) – interest rate risk
Recent market conditions have highlighted the necessity to adjust insurance supervision to accurately represent extremely low and negative interest rates. This adjustment should involve recalibrating the interest rate risk sub-module to account for negative yields. The methodology used must avoid excessively large drops in the more liquid parts of the curve, which can be managed by setting an explicit lower limit or floor on negative interest rates. Importantly, this floor should vary with the term of the interest rates, rather than being a flat rate, to ensure it aligns with the actual market data and supports a solid, risk-based calibration that reflects term dependencies. This recalibration will be implemented gradually over a five-year transitional period.
Solvency capital requirement (SCR) – symmetric adjustment
The increase of the symmetric adjustment's corridor from 10 to 13 percentage points around the standard equity capital charge allows for a broader symmetric shock adjustment. This change is particularly significant as it responds to extreme market conditions, such as those observed during the initial outbreak of COVID-19.
Long-term guarantee (LTG) – interest rate risk
The revised LTG measures introduce a new methodology for extrapolating risk-free interest rates. This begins from the first smoothing point (FSP), where bond markets are no longer deemed deep, liquid, or transparent. The extrapolation method smooths the transition of forward rates from the FSP to an ultimate forward rate (UFR). For the euro, the FSP is set at a 20-year maturity, with the UFR's influence increasing significantly after 40 years. This method utilises a weighted average of the UFR and a liquid forward rate, incorporating data from multiple financial instruments to ensure accuracy and relevance.
LTG – volatility adjustment
The volatility adjustment (VA) framework has recently undergone significant revisions, now requiring supervisory approval in all countries prior to its application. The general application ratio of the VA framework has been increased from 65% to 85%. Additionally, a macroeconomic VA has replaced the country-specific component for euro countries, and a new credit spread sensitivity ratio has been introduced to better address mismatches in volume and duration.
Insurance and reinsurance undertakings are now able to apply an additional adjustment on the risk-corrected spread of the currency, subject to supervisory approval. It is important to note that the weights used to weigh spreads for government bonds and non-government bonds must sum up to 100%. The VA also extends to the last liquid forward rate in the extrapolation of risk-free interest rates.
The detailed parameters, formulae, and definitions associated with these changes will be outlined in the upcoming Delegated Acts and guidelines. This redesign is strategically aimed at reducing overall spread mismatches and mitigating the risk of VA overshooting during periods of high market stress, such as those experienced at the onset of the COVID-19 pandemic.
Proportionality measures
For smaller and less complex insurance undertakings, the European Insurance and Occupational Pensions Authority (EIOPA) proposes new proportionality measures. These measures are designed to reduce administrative burdens while ensuring compliance. Specific criteria have been set for life and non-life undertakings, including limits on annual gross written premium and the size of certain risk modules and capital requirements.
Digital Operational Resilience Act (DORA)
The European Insurance and Occupational Pensions Authority (EIOPA) has released an Opinion on the consequences of increased size thresholds for exclusion from the Solvency II framework as per the Solvency II Review, particularly affecting insurance undertakings covered by the Digital Operational Resilience Act (DORA). With the revised Solvency II Directive elevating the size thresholds, more insurance and reinsurance undertakings might be exempt from Solvency II, yet they are required to comply with DORA starting 17 January 2025. EIOPA considers that this temporary enforcement of DORA on small entities is disproportionate, leading to significant costs and administrative burdens without substantially contributing to DORA's main objectives. Consequently, EIOPA invokes Article 9a of the EIOPA Regulation and is calling on the European Commission to amend Union Law accordingly. The Opinion also outlines EIOPA's expectation that national competent authorities should not prioritise DORA supervisory actions for these small insurance undertakings.
Key amendments to Pillar 2
Pillar 2 focuses on the qualitative requirements, including governance and risk management of the undertakings and the Own Risk and Solvency Assessment (ORSA).
Governance and organisational structure
Insurance undertakings are mandated to foster diversity within their board and segregate key functions such as risk management and actuarial services to prevent conflicts of interest. They are also required to implement a remuneration policy and fulfill criteria concerning the requirements of key personnel.
Cybersecurity and sustainability risk management
One of the key changes introduced is the explicit inclusion of cybersecurity as part of the operational risk management requirements. Additionally, insurance companies need to establish a liquidity risk management plan and devise strategies to mitigate financial risks associated with sustainability factors.
Macroprudential oversight
The ORSA should incorporate an analysis of the macroeconomic landscape and macroprudential issues. It must evaluate the firm's financial responsibilities under stressed conditions and integrate macroeconomic and financial market developments into investment strategy decisions.
Climate change impact
Insurance companies are required to evaluate their vulnerability to climate-related risks. They must outline detailed scenarios for long-term climate change impacts, including one scenario where the global temperature rise stays below 2 degrees Celsius and another where it significantly exceeds this threshold.
Key amendments to Pillar 3
Pillar 3 sets the regulatory framework and the supervisory reporting and public disclosures.
Adjusted deadlines due to new audit requirements
The amendments introduce updated requirements for disclosure and reporting that are essential for maintaining transparency in the insurance sector. The deadlines for annual reporting have been extended because of the new audit requirements. Specifically, the annual quantitative reporting templates (QRTs) deadline has been extended from 14 weeks to 16 weeks. Similarly, the regular supervisory report (RSR) and the solvency and financial condition report (SFCR) will have a submission deadline of 18 weeks, up from 14 weeks, with the group SFCR deadline moving from 20 weeks to 22 weeks. Notably, the quarterly reporting deadlines remain unchanged.
Solvency and financial condition report (SFCR)
The SFCR is now distinctly divided into two parts. The first part addresses policyholders and beneficiaries, and contains key information about the company’s business performance, capital management, and risk profile. The second part is tailored for market professionals, providing data that are crucial for specialised analysis, such as detailed governance information, specific information on technical provisions and other liabilities, and solvency positions.
For the Netherlands, where the audit of the QRTs was implemented, the primary change is the adjustment in reporting deadlines and changes to the SFCR. Dutch insurers will need to ensure they can meet these revised timelines and are capable of providing any additional information that is required in the second part of the SFCR. For insurance and reinsurance undertakings other than small and non-complex undertakings and for captive insurance undertakings and captive reinsurance undertakings, the balance sheet disclosed as part of the solvency and financial condition report in accordance with Article 51(1) or the balance sheet disclosed as part of the single solvency and financial condition report in accordance with Article 256(2), point (b), shall be subject to an audit.
Conclusion
In light of the recent amendments to the Solvency II Directive, insurance undertakings must take proactive steps to ensure compliance and optimise their operations. The amendments, which span across the three pillars of Solvency II, introduce significant changes that aim to enhance risk sensitivity, reduce volatility, and improve the overall quality of insurance supervision.
For Pillar I, the amendments focus on quantitative requirements, including adjustments to the risk margin, solvency capital requirements, and long-term guarantee measures.
Pillar II amendments emphasise qualitative requirements, such as governance, risk management, and organisational structure. Companies must enhance their cybersecurity measures, incorporate sustainability risk management, and ensure diversity within their boards. Additionally, the Own Risk and Solvency Assessment (ORSA) must now include macroprudential oversight and climate change impact assessments.
Pillar III focuses on supervisory reporting and public disclosure requirements. The updated deadlines and new audit requirements necessitate adjustments to your reporting processes to ensure timely and accurate submissions. The SFCR has been divided into two parts, requiring companies to provide detailed information tailored to both policyholders and market professionals.
To effectively navigate these changes, it is crucial to conduct comprehensive impact assessments, adjust internal controls, and align your business strategies with the new regulatory requirements. Proactive planning and preparation, timely involvement of various departments such as the actuarial department, risk and compliance, internal audit and financial reporting, will help mitigate risks and leverage opportunities, ensuring your organisation remains compliant and well-positioned for future success.
