Explanatory Memorandum by HM Treasury
DIRECTIVE OF THE EUROPEAN PARLIAMENT AND
OF THE COUNCIL ON THE TAKING-UP AND PERSUIT OF THE BUSINESS OF
INSURANCE AND REINSURANCE (SOLVENCY II) ("THE DIRECTIVE")
The proposed Solvency II Directive (COM (2007)
361), published by the European Commission on 19 July, is a wide-ranging
revision of the prudential regulation of insurance and reinsurance
companies operating in the EU. The project has four main objectives:
Deepen the single market for insurance
Enhance policyholder protection;
Improve the international competitiveness
of EU insurers and reinsurers; and
Improve insurance and reinsurance
regulation to further the European Commission's Better Regulation
The Directive is based on a 3-pillar approach
similar to that used in the Basel II banking accord:
Pillar 1 covers principles for the
valuation of insurers' assets and liabilities, in particular the
liabilities to their policyholders. It also sets capital requirements
and defines what kinds of capital are eligible to meet those requirements.
Pillar 1 provides for a harmonised standard formula for insurers
and reinsurers to use in calculating their capital requirements,
and subject to supervisory approval, allows the use of insurers'
own internal models to calculate the main capital requirement
which Solvency II will impose.
Pillar 2 defines qualitative requirements
that insurers and reinsurers will be required to meet as part
of the process of supervisory review of their business by regulators.
All firms regulated by the Directive will be required to undertake
an assessment of the risks to their business, the adequacy of
their capital resources and to determine the appropriateness of
their internal governance.
Pillar 3 sets out requirements on
disclosure of information that firms will have to release both
to regulators and publicly. Insurers and reinsurers will be required
to produce annually a public report which will include information
on capital and risk management.
The Directive specifies the above requirements
for insurance and reinsurance companies, and also includes provisions
for the supervision of insurance and reinsurance groups.
The Chancellor of the Exchequer has responsibility
for United Kingdom policy on financial services. The field of
financial services is a reserved matter.
(i) Legal basis
The legal base of the Directive is Articles
47(2) and 55 of the EC Treaty. Article 47(2) concerns freedom
of establishment, in particular, by making it easier for persons
to take up and pursue activities by issuing directives for the
coordination of laws, regulations and administrative actions in
Member States. Article 55 applies the same provision in relation
to the freedom to provide cross-border services (ie where the
undertaking does not have a permanent physical presence in the
Member State into which it is providing services).
The Directive incorporates and amends the 13
existing EU Insurance Directives which relate to prudential supervision
(including in particular the key Non-life and Life Insurance Directives,
the Insurers Reorganisation and Winding up directive,
the Reinsurance Directive
and the Insurance Groups Directive).
The Directive utilises the Lamfalussy arrangements
for developing EU-wide legislation for the financial services
sector. The Commission's proposal, published on 19 July, is the
Level 1 framework Directive and as such sets out high-level principles
and the requirements that constitute the core of the new prudential
framework. The Directive gives the Commission the power to develop
Level 2 implementing measures (ie Commission Regulations or Directives)
which will specify the technical detail of the framework.
(ii) European Parliament procedure
The articles referred to above which provide
the legal basis of the Directive require the co-decision procedure
to be followed in Article 251 of the EC Treaty.
(iii) Voting procedure
The voting procedure in the Council on this
directive with be qualified majority voting.
(iv) Impact on United Kingdom Law
The Directive will need to be implemented in
UK law. The present directives are implemented in the Financial
Services and Markets Act 2000 (FSMA), which applies throughout
the UK, and in the rules of the Financial Services Authority,
which are made under the provisions of FSMA. The Directive will
require changes to be made to the regulation of insurers and reinsurers
in the UK. Most of the rules concerning the prudential requirements
on insurers and reinsurers are in the FSA's Handbook, which will
need to be amended accordingly. Aspects of the Directive might
also require amendments to be made to FSMA and to its secondary
legislation; we would expect such changes to be made predominantly
by regulations made under section 2(2) of the European Communities
(v) Application to Gibraltar
The Directive concerns free movement of services
and therefore will apply in Gibraltar.
The present directives which are to be re-cast
apply to the European Economic Area (EEA) and the Directive is
a text relevant to the EEA.
The Government takes the view that the Directive
overall complies with the principle of subsidiarity. In particular,
the implementation of the single passport for insurers and reinsurers
and of a single set of rules for the prudential supervision of
insurers and reinsurers throughout the European Union can only
be achieved through legislation at the European level.
The Government supports the Solvency II project.
The current EU Directives on prudential supervision of insurance
are widely perceived to be out of date and in need of fundamental
revision. For life and non-life insurance these Directives date
back to the 1970s and since then there have been fundamental changes
in the insurance sector, financial markets, the approach to accounting
for financial institutions, risk management techniques and best
practice in the conduct of prudential supervision.
These changes have been reflected in the prudential
requirements for UK insurers and reinsurers that were introduced
by the FSA in 2004. These standards are imposed alongside the
existing EU Directives and typically are more demanding both in
terms of the quantity of regulatory capital insurers and reinsurers
are required to hold and in terms of the level of sophistication
with which they are expected to assess their risk profile.
The framework for prudential supervision adopted
in Solvency II is broadly consistent with the FSA's approach and
this should help to limit the burden on the UK industry from the
transition to Solvency II. In addition the implementation of Solvency
II will lead to significantly more harmonised prudential standards
across the EU, materially reducing the risk that insurers and
reinsurers in the UK face a competitive disadvantage through higher
domestic regulatory requirements.
The Government views the Commission's proposed
Directive as enabling a step change in the quality of the EU's
supervisory framework for insurers and reinsurers and that its
core principles are the right ones for the Solvency II project.
Five key areas in the Directive are:
The Directive requires that insurers
value their assets and liabilities on a market consistent basis,
including liabilities to policyholders, and that the value of
options and guarantees are taken into account.
Capital requirements are risk-sensitive
and reflect diversification between risks leading to a more efficient
use of capital by insurers and reinsurers across the EU.
The requirements on firms to assess
their own risks and ensure they achieve high standards of internal
governance should improve the quality of risk management across
the industry as a whole.
Subject to supervisory approval firms
are allowed to use an internal model to calculate their main capital
requirement, which can therefore be tailored more closely to the
specific risks of the insurer's business.
The Commission's proposal includes
an innovative approach to the supervision of insurance and reinsurance
groups which is broadly consistent with the position advocated
jointly by HM Treasury and the FSA in a discussion paper published
in November 2006.
The Government considers that the broad thrust
of the Commission's proposal for the Solvency II framework Directive
is appropriate. There are some areas of detail within the Directive
where the Government intends to propose amendments. Further, substantial
negotiations in Council are anticipated, in particular on two
major issues: the supervision of insurance and reinsurance groups
and the Minimum Capital Requirement.
The supervision of insurance and reinsurance
groups is a sensitive issue because the Directive will determine
the balance of responsibilities between the group supervisor of
the parent company and the supervisor of a subsidiary company
including where the companies are located in different Member
States. The Commission's proposal is for a significant step towards
consolidating supervision in the hands of the group supervisor
and focussing on capital requirements at the group level. The
Government supports this approach but it is likely that this will
be a controversial issue for some Member States.
Solvency II imposes capital requirements at
two levels, and the structure and calibration of the lower capital
requirement (the Minimum Capital Requirement) has not been precisely
determined in the Commission's proposal. The Minimum Capital Requirement
is a key element of the framework an insurer whose capital resources
fall below this level will be liable to have its authorisation
withdrawn. The Commission's proposals in this area are yet to
be finalised and are dependent on the results of the third Quantitative
Impact Study (an EU wide study to assess the impact of Solvency
The European Commission has conducted an Impact
Assessment on the Solvency proposal, including a description of
the benefits and an analysis of the administrative costs for the
EU insurance industry. A key constraint on this analysis is the
fact that the directive only outlines the principles and core
elements of the Solvency II regime. The actual costs that are
imposed on the insurance sector will be influenced strongly by
the detail of the Level 2 implementing measures. The Commission
plans to conducting Impact Assessments on the key Level 2 implementing
The central estimate presented by the Commission
for the implementation costs of Solvency II for the whole EU insurance
sector is £1.3-2.0 billion and £0.2-0.3 billion for
on-going costs on an annual basis.
The Commission's Impact Assessment does not provide an estimate
of what share of these costs would be incurred by insurers and
reinsurers in the different Member States. If those shares were
proportionate to the relative size of Member States' markets in
life and non-life insurance, the UK insurance industry would incur
just under one quarter of the overall EU costs.
It will only be possible to assess the costs
for the UK insurance sector more fully once data from the third
Quantitative Impact Study is available. This will provide information
both on administrative costs for companies and on the costs they
incur in holding sufficient capital to meet the regulatory requirements.
Publication of a Regulatory Impact Assessment based on this data
is scheduled for later this year.
The UK has already implemented a prudential
regime for the insurance sector which is broadly similar to Solvency
II. Therefore some of the costs of implementing Solvency II may
have already been incurred. However Solvency II will certainly
differ from the current arrangements in the UK and it would be
incorrect to assume that adapting to the new EU-wide framework
will not entail substantial costs for UK insurers.
The likely benefits of Solvency II for the UK
insurance sector are likely to be:
A more harmonised approach to prudential
supervision of insurers and reinsurers across the EU, reducing
the risk that UK companies face a higher regulatory burden than
insurers and reinsurers located in other Member States
A system of supervision based on
one set of principles and rules replacing the current dual application
of the existing EU Directives and the FSA's domestic requirements
For UK insurance groups operating
in other Member States, a streamlined approach to group supervision,
reducing administrative costs for groups and allowing them to
use their capital more efficiently
For the EU as a whole additional main benefits
are likely to flow from:
A more robust insurance sector, providing
stronger policyholder protection combined with more efficient
use of capital;
Improved returns on insurers' asset
portfolios flowing from the removal of quantitative restrictions
on asset allocation;
Stronger risk management and a more
realistic valuation of insurance liabilities by firms;
Improved international competitiveness
of the insurance and reinsurance industry;
Improved product design and, in some
areas, lower costs for some types of insurance products; and
Increased transparency of firms'
performance to customers and the markets.
The FSA will incur transitional and on-going
administrative costs relating to the implementation and operation
of the Solvency II regime in the UK.
While it is not possible to give a robust estimate
of these costs yet, it is reasonable to expect that they will
lie in the range of costs incurred by the FSA to implement its
own prudential regime for the insurance sector and the costs incurred
in its implementation of the Capital Requirements Directive for
the banking sector. On this basis the FSA's one-off costs of implementation
would be in the range £1.8 million to £12.5 million,
with ongoing costs between £400,000 and £1.9 million
Direct costs for HM Treasury are likely not
to be material.
HM Treasury has consulted extensively on the
Solvency II project with the UK insurance industry, in particular
the Association of British Insurers (ABI). HM Treasury and the
FSA have published two joint discussion papers on Solvency II.
A further consultation document is planned for later this year
which will include an analysis of the costs and benefits for the
UK insurance sector.
The Council negotiations on the Solvency II
Directive are due to commence in September under the Portuguese
Presidency. The Economic and Monetary Committee of the European
Parliament will also begin its deliberations on the Commission's
proposal at this time. It is expected that the Council and Parliament
should reach political agreement on the Solvency II framework
Directive before the end of 2008.
The Commission's proposal envisages an implementation
date for Solvency II of 31 October 2012. This is intended to permit
time for the Level 2 implementing measures to be developed and
agreed and a period for the industry to adapt to the new framework's
Kitty Ussher MP
7 August 2007
1 Directives 73/239/EEC, 88/357/EEC, 92/49/EEC and
Directive 2001/17/EC. Back
Directive 2005/68/EC. Back
Directive 98/78/EC. Back
"Supervising insurance groups under Solvency II", HM
Treasury and Financial Services Authority, November 2006. Back
The figures presented by the Commission are 2.0-3.0bn and
0.3-0.5bn for transitional and on-going costs respectively;
an exchange rate for £/ of 0.67 is assumed. Back
The estimate is based on 2005 data provided in "European
Insurance in Figures", Comité Européen des
Assurances, June 2006. Back
These estimates are based on the information provided in the following
Financial Services Authority publications: "Enhanced capital
requirements and individual capital assessments for non-life insurers".
July 2003; "Enhanced capital requirements and individual
capital assessments for life insurers", August 2003 and "Strengthening
Capital Standards 2", February 2006. Back
"Solvency II: a new framework for prudential regulation of
insurance in the EU" and "Supervising insurance groups
under Solvency II", HM Treasury and Financial Services Authority,
February 2006 and November 2006 respectively. Back