Solvency II Review: What’s Changing and What to Do Now
The forthcoming review of the Solvency II framework introduces several opportunities for insurance undertakings to reduce their regulatory burden. The proposals include simplifications across all three pillars of the regime, affecting reporting, capital calculations and governance. In practice, insurers will be able to access these simplifications through three main pillars, that focus on quantitative capital requirements (Pillar 1), qualitative governance and risk management (Pillar 2), and transparency through reporting (Pillar 3).
Captive insurers will continue to benefit from simplified requirements. A notable development is that small and non-complex undertakings will now also be eligible for a range of simplifications. In addition, other insurance undertakings may, depending on the nature and scope of their business, apply for certain simplifications. Such applications will require supervisory approval, and some measures may only be granted to a defined market coverage threshold. There may therefore be a clear advantage in preparing early and being ready to apply once the framework takes effect.
Against this backdrop, insurers would be well advised to assess carefully which simplifications may be available in light of their specific business model, risk profile and operational structure.
The review introduces changes across all three pillars of Solvency II:
- Pillar I – Quantitative requirements on financial strength and capital
- Pillar II – Governance and risk management
- Pillar III – Reporting and transparency
Pillar I – Quantitative Requirements on Financial Strength and Capital
The review includes amendments to the capital requirement for interest rate risk, notably changes to the methodology for calculating the risk-free interest rate. At the same time, the stress calibration of the interest rate curve will be adjusted to allow for more severe stresses in low or negative interest rate environments, through the removal of the existing floor.
The overall impact of these changes will depend on the specific cash flow profile of each undertaking. The removal of the floor will affect capital requirement calculations in very low interest rate environments, whereas in a more normalised rate environment the impact is expected to be limited.
The proposals also amend the framework for the volatility adjustment and the matching adjustment. Among other things, liquidity management requirements will need to be more clearly articulated. While the use of these mechanisms has historically been relatively limited in the Swedish market, both can strengthen the capital position. However, their use is accompanied by enhanced governance and risk management requirements.
The review further proposes changes to the symmetric adjustment mechanism for equity risk (the so-called equity dampener). The current cap of 10 percentage points will be increased to 13 percentage points. The intention is to strengthen the mechanism’s ability to mitigate procyclical effects and reduce the risk that insurers are forced to raise additional capital or dispose of assets as a result of adverse market movements. Historically, the equity dampener has rarely reached ±10 percentage points, and the proposed adjustment is therefore not expected to lead to material changes in capital requirements.
With respect to long-term equity investments, a stress factor of 22 per cent is proposed for a specified portion of equity holdings. The application of this treatment will be subject to approval by Finansinspektionen, provided certain conditions are met. These conditions relate, among other things, to the investment time horizon, listing venue, diversification and ownership interest.
Pillar II – Governance and Risk Management
The review extends beyond simplifications. One significant change concerns the definition of an insurance group, which may become a key issue for certain structures. Under the revised definition, for example, two mutual undertakings could constitute a group, depending on the nature of their relationship and the extent of cooperation and coordination between them.
Another important development is the possibility of including subordinated loans in the capital base. This creates scope for a more efficient capital structure. Subordinated debt has been more widely used in other parts of Europe, meaning Swedish insurers may be able to compete on more equal terms going forward. However, the proposal includes a cap on the proportion of the capital base that may consist of subordinated loans. It should be noted that Finansinspektionen, in its consultation response, has expressed reservations about the proposed design and has called for further in-depth analysis.
A new provision in the Directive requires Member States to ensure that insurance undertakings establish and monitor the implementation of specific plans to address financial risks arising in the short, medium and long term as a result of sustainability factors. These plans must include quantifiable targets. The objectives, processes and measures adopted to manage sustainability risks must be proportionate to the nature, scale and complexity of the risks inherent in the undertaking’s business model.
Requirements relating to climate risk management are also being strengthened. Where an undertaking is exposed to climate risks, a thorough climate scenario analysis must now be conducted as part of the Own Risk and Solvency Assessment (ORSA). Importantly, undertakings must also document and substantiate any conclusion that they are not exposed to climate risks. In practice, this means all insurers will need to assess climate risk exposure to demonstrate compliance.
Cyber risk is now explicitly referenced in the Directive, although it is already captured within the broader framework for operational risk management. In addition, insurers remain subject to specific requirements under the Digital Operational Resilience Act (DORA).
The ORSA will also be affected by additional requirements to consider macroeconomic developments and to assess the undertaking’s ability to meet its financial obligations under a range of market conditions.
Liquidity risk management requirements will become more explicit. Certain insurers will be required to submit a liquidity risk management plan to the supervisory authority. This plan must include short-term liquidity analyses that assess cash flows in relation to assets and liabilities. Supervisory authorities may also request medium- and long-term analyses.
Insurance undertakings will be required to implement a diversity and sustainability policy for their administrative, management or supervisory body. Diversity is defined broadly and includes dimensions such as gender, age, background and geographical representation. Clear objectives must be set, and progress towards those objectives must be monitored.
Two new provisions are also introduced in relation to fit and proper requirements for board members. The Directive now makes it explicit that all members must be of good repute and that the board collectively must possess sufficient knowledge, skills and experience to perform its duties effectively. Board members must not have been convicted, during at least the preceding ten years, of serious or repeated offences relating to money laundering, terrorist financing or other crimes that could undermine their good repute.
Finally, the Directive clarifies what the review of the system of governance must encompass.
Pillar III – Reporting and Transparency
Under Pillar III, reporting and disclosure requirements will be updated through amendments to Commission Delegated Regulation (EU) 2015/35 and the related technical standards. The impact on individual undertakings will depend on the robustness of their reporting processes, their internal capability to manage regulatory change and, perhaps most importantly, the maturity of their data governance and data architecture. The technical amendments may require new or revised data to meet reporting obligations.
The Solvency and Financial Condition Report (SFCR) is proposed to be divided into two parts, each tailored to a different audience: one aimed at policyholders and beneficiaries, and the other at financial market professionals.
The section directed at policyholders and beneficiaries must include:
- Business and performance
- Solvency position and risk profile, including sustainability risks
The section directed at financial market professionals must include:
- Business and performance
- System of governance
- Risk profile
- Valuation for solvency purposes
- Capital management
- Material exposure to climate change risks and plans to address financial risks arising from sustainability risks
Changes to supervisory reporting, including the quantitative reporting templates, will require adjustments to reporting processes and, in some cases, the sourcing of additional data.
A further new requirement is that the balance sheet included in the SFCR must be subject to audit. Small and non-complex undertakings and captive insurers will, however, be exempt from this audit requirement.
The review introduces a broad range of changes. Insurance undertakings should now begin their implementation efforts to ensure full compliance by 30 January 2027.
If you would like to discuss how your organisation may be affected, or require support in preparing for the revised framework, please feel free to contact us.
