There is
Non-Compliance with the Solvency Capital
Requirement. So what?
Welcome to the April 2010 edition of the Solvency ii
Association newsletter
Dear Members,
Today
we will discuss one
of the most interesting articles of the Solvency ii Directive.
This is Article 138: Non-Compliance with the Solvency Capital
Requirement. According to this article, insurance and
reinsurance undertakings shall immediately
inform the supervisory authority as soon as they observe that
the Solvency Capital Requirement is no longer complied with, or
where there is a risk of non-compliance in the following three
months.
Within two months from the observation of
non-compliance with the Solvency Capital Requirement the
insurance or reinsurance undertaking concerned
shall submit a realistic recovery plan
for approval by the supervisory authority.
The
supervisory authority shall require the
insurance or reinsurance undertaking concerned to take the
necessary measures to achieve, within six months from the
observation of non-compliance with the Solvency Capital
Requirement, the re-establishment of the level of
eligible own funds covering the Solvency Capital Requirement or
the reduction of its risk profile to ensure compliance with the
Solvency Capital Requirement.
The supervisory authority
may, if appropriate, extend that period by
three months.
In the event
of an exceptional fall in financial markets, the supervisory
authority may extend the above period by "an appropriate period of time"
taking into account all relevant factors.
This
"an appropriate period of time" is the most
interesting part of Article 138, that could lead to inconsistency and
regulatory arbitrage.
CEIOPS Advice for Level 2 Implementing Measures on Solvency II:
Extension of the Recovery Period
The recent financial crisis has shown that
a major slump in financial markets is not an unrealistic
scenario.
Undertakings and supervisory
authorities alike must be able to respond effectively to such
circumstances, ensuring policyholder protection is maintained
whilst avoiding short term actions that may exacerbate the
market downturn and endanger wider market stability which
ultimately would be detrimental to policyholders’ interests as
well.
Recognising this a provision was introduced into
the Level 1 text in Article 138 that
allows supervisory authorities, in the event of an exceptional
fall in financial markets, to extend the normal period of time
of six or nine months at most that undertakings have to remedy a
breach of the Solvency Capital Requirement (SCR).
The purpose of this Advice is to provide advice on the Level
2 implementing measures in connection with Article 138(4) that
shall be adopted under Article 143 of the level 1 text.
Specifically, this refers to factors to be taken into account
when supervisors consider extending the period in which an
undertaking can restore its SCR following a breach during an
exceptional fall in financial markets.
It also includes
CEIOPS’ proposal for the maximum period of time, expressed in
total number of months, which supervisors should be able to
allow under Article 138, for an undertaking to re-comply with
the SCR.
Extract from the Level 1 text
The supervisory power to extend the normal period of time
that undertakings are granted according to the Level 1 text
follows from Article 138 which states:
Article 138:
Non-Compliance with the Solvency Capital Requirement
1.
Insurance and reinsurance undertakings shall immediately inform
the supervisory authority as soon as they observe that the
Solvency Capital Requirement is no longer complied with, or
where there is a risk of non-compliance in the following three
months.
2. Within two months from the observation of
non-compliance with the Solvency Capital Requirement the
insurance or reinsurance undertaking concerned shall submit a
realistic recovery plan for approval by the supervisory
authority.
3. The supervisory authority shall
require the insurance or reinsurance undertaking concerned to
take the necessary measures to achieve, within six months from
the observation of non-compliance with the Solvency Capital
Requirement, the re-establishment of the level of
eligible own funds covering the Solvency Capital Requirement or
the reduction of its risk profile to ensure compliance with the
Solvency Capital Requirement.
The supervisory authority
may, if appropriate, extend that period by three months.
4. In the event of an exceptional fall in
financial markets, the supervisory authority may extend the
period set out in the second sub-paragraph of paragraph 3 by an
appropriate period of time taking into account all relevant
factors.
The insurance or reinsurance undertaking
concerned shall, every three months, submit a progress report to
its supervisory authority setting out the measures taken and the
progress made to re-establish the level of eligible own funds
covering the Solvency Capital Requirement or to reduce the risk
profile to ensure compliance with the Solvency Capital
Requirement.
The extension referred to in the first
subparagraph shall be withdrawn where that progress report
shows that there was no significant progress in achieving the
re-establishment of the level of eligible own funds covering the
Solvency Capital Requirement or the reduction of the risk
profile to ensure compliance with the Solvency Capital
Requirement between the date of the observation of
non-compliance of the Solvency Capital Requirement and the date
of the submission of the progress report.
5. In
exceptional circumstances, where the supervisory authority is of
the opinion that the financial situation of the undertaking
concerned will deteriorate further, it may also restrict or
prohibit the free disposal of the assets of that undertaking.
That supervisory authority shall inform the supervisory
authorities of the host Member States of any measures it has
taken.
Those authorities shall, at the request of the
supervisory authority of the home Member State, take the same
measures.
The supervisory authority of the home Member
State shall designate the assets to be covered by such measures
The scope of the Level 2
implementing measures on Article 138(4) is determined by Article
143 which states:
Article 143: Implementing measures
The Commission shall adopt implementing measures specifying the
factors to be taken into account for the purpose of the
application of Article 138(4) including the maximum appropriate
period of time, expressed in total number of months, which shall
be the same for all insurance and reinsurance undertakings as
referred to in the first sub-paragraph of Article 138(4).
Where it is necessary to enhance convergence, the Commission
may adopt implementing measures laying down further
specifications with respect to the recovery plan referred to in
Article 138(2) and the finance scheme referred to in Articles
139(2) and with respect to Article 141,
taking due care to avoid pro-cyclical effects.
Those measures, designed to amend non-essential elements of this
Directive by supplementing it, shall be adopted in accordance
with the regulatory procedure with scrutiny referred to in
Article 301 (3).
Recital 61 gives
the background for Article 138(5):
In order to
mitigate undue potential pro-cyclical effects of the financial
system and avoid a situation in which insurance and reinsurance
undertakings are unduly forced to raise additional capital or
sell their investments as a result of unsustained adverse
movements in financial markets, the market risk module of the
standard formula for the Solvency Capital Requirement should
include a symmetric adjustment mechanism with respect to changes
in the level of equity prices.
In addition, in
the event of exceptional falls in financial markets, and where
that symmetric adjustment mechanism is not sufficient to enable
insurance and reinsurance undertakings to fulfil their Solvency
Capital Requirement, provision should be made to allow
supervisory authorities to extend the time period within which
insurance and reinsurance undertakings are required to
re-establish the level of eligible own funds covering the
Solvency Capital Requirement.
3.
Advice
3.1. Non-compliance with the SCR during periods of
exceptional falls in financial markets
Explanatory text
3.1. The term
“exceptional fall” as referred to in Article 138(4) is not
defined in the Level 1 text.
It has to be
interpreted in view of the whole purpose of the provision which
is to provide supervisory authorities with
flexibility in difficult financial market situations so that
they do not have to take supervisory measures that could have a
procyclical effect.
Procyclicality in this context refers to the effect on the
economic, financial or insurance cycle as a consequence of the
actions of regulation.
It specifically describes
a situation where the overall impact of actions caused by
regulation increases the severity of these cycles.
In the
light of this, an exceptional fall in financial markets has to
be distinguished from smaller, common market falls which
characterise the fluctuations of normal market activity and
which is not a situation where Article 138(4) applies.
Undertakings should be prepared and have properly designed plans
that ensure they do not breach the SCR when the economic cycle
is in a downturn:
According to Article 45(2) of the
Level 1 text an undertaking is required to have in place
processes which enable it to properly identify and measure the
risks it faces in the short and the long term. This includes
identifying possible events or future changes in economic
conditions that could have unfavourable effects on the
undertaking’s overall financial standing.
In order to be
considered “exceptional” the fall in
financial markets would have to be unforeseen, sharp and steep.
Ordinary downturns
(downturns that occur at more or less regular intervals as part
of the economic cycle), even if they are somewhat more severe
and longer lasting than usual, would not suffice to trigger the
supervisory power of granting extended recovery periods.
The term “financial markets” used in
the Level 1 text is also not defined.
It can be
divided into different subcategories such as capital markets
(i.e. stock and bond markets), commodity markets, derivatives
markets, insurance and money markets and foreign exchange
markets.
The Level 1 text could be read to refer to
“any part of the financial markets” or “financial markets in
general” or to “the financial markets” i.e. the global financial
market situation.
In view of the aim of Article
138(4) to provide sufficient flexibility in order to avoid
procyclical effects, CEIOPS holds that the term “financial
markets” does not necessarily refer to the global financial
markets but could apply to subcategories of financial markets if
a major unforeseen, sharp and steep fall seriously affects the
financial situation of a number of undertakings.
Exceptional falls in financial markets
will, by their nature, arise in unpredictable ways and with
unpredictable consequences.
While CEIOPS
recognises that to maintain a level playing field it is
important to achieve a degree of convergence in the application
of extended recovery periods and in particular in the assessment
of the preconditions for granting an extension, it would defeat
the aim of Article 138(4) if an exceptional fall in financial
markets were too narrowly defined, forcing supervisors to
require short-term recovery plans even if this resulted in
procyclical effects.
CEIOPS therefore does not consider
it appropriate to prescribe in detail what would constitute a
trigger event or to introduce thresholds for “exceptional” falls
in financial markets.
CEIOPS rather proposes to establish a process through which it
is consulted before a supervisory authority decides on any
application of Article 138(4) and where supervisory authorities
rapidly arrive at a common understanding whether an “exceptional
fall in financial markets” has occurred and when it is over.
Once it has been determined that an
“exceptional fall in financial markets” is taking place,
national supervisors will have the possibility to grant
extensions to the period for re-establishing compliance with the
SCR within the maximum limit set out below.
There should
be continuous monitoring of whether the “exceptional fall in
financial markets” is still taking place or not.
An
exceptional fall in financial markets would be over if the
markets recovered to what is considered an ordinary downturn in
the financial markets cycle.
Once this is the case, no
further extensions may be granted.
Maximum extension permissible
Explanatory text
The Level 1
text requires that the maximum extension is measured in total
number of months and specified by Level 2 implementing measures.
Choosing a long maximum recovery period does not mean that
this is the time undertakings will be given as a rule.
The maximum should not be the norm but may be necessary in
individual circumstances.
The maximum extension is
an upper limit and does not
preclude the supervisor from requiring an undertaking to restore
a sound financial position within a shorter timeframe if the
potential effects on market stability and the specific situation
of the undertaking do not suggest that a longer period should be
granted.
In circumstances where it is possible for an
undertaking to achieve rapid re-compliance with the SCR without
concerns about adverse market effects, the maximum extension is
unlikely to be appropriate.
The issue of the extension of
the recovery period in the event of an exceptional fall in
financial markets is subject to an Impact Assessment, as
required by the EC.
Four options were set for
CEIOPS to consider as regards the maximum time period allowed.
These are:
Option 1
15 months – i.e. 6+3
(in normal market circumstances) + another 6 months (in the
event of exceptional market falls)
Option 2
Between 15 and 24 months – i.e. 6+3 (in
normal market circumstances) + up to another 6 to 15 months (in
the event of exceptional market falls)
Option 3
Between 24 and 36
months – i.e. 6+3 (in normal market circumstances) + up to
another 15 to 27 months (in the event of exceptional market
falls)
Option 4
Between
36 and 60 months – i.e. 6+3 months (in normal market
circumstances) + up to another 27 to 51 months (in the event of
exceptional market falls)
CEIOPS has considered the
arguments for and against a short and a
long maximum extension period and assessed them with a
view to their impact on stakeholders and their suitability in
meeting the objectives specified by the European Commission.
During exceptional market falls a
short extension may place too hard a requirement on undertakings
and be harmful in that it may result in further de-stabilising
effects on financial markets (pro-cyclicality).
If
many undertakings are forced to take similar actions in a short
timeframe this may negatively impact the interests of
policyholders.
In this regard, foreseeable management
actions to the need to re-comply with the SCR over an
insufficient timeframe may be contrary to the interests of
policyholders, and could include actions to de-risk such as:
a) a number of undertakings selling
assets at the same time in order to minimise applicable capital
charges and reduce the SCR, increasing financial market falls;
b) a number of undertakings being forced to raise capital at
the same time from sources already under stress, which results
in expensive debt raising with high interest payments over a
long period which is unlikely to be in the best interests of
policyholders; and
c) a number of undertakings purchasing
reinsurance cover in an ‘expensive’ market, as reinsurance
undertakings are also likely to be adversely affected, and
expensive short-term cover is unlikely to be in the best
interests of policyholders.
Mandating
re-compliance with the SCR in a short timeframe may therefore
lead to adverse pro-cyclical effects and market instability and
may not be realistic.
It is worth noting that if short
terms action exacerbates market problems and continued steep
falls occur this puts greater pressure on all insurance
undertakings’ solvency and thus indirectly impacts
policyholders.
Also the current financial crisis shows
that recovery from a plunge in financial markets may take some
time.
The longer the crisis the more undertakings are
potentially affected.
A short
maximum extension period could thus still require a major
number of undertakings to take actions in a situation where
economic conditions are severely stressed.
A longer maximum extension would
provide supervisors with the flexibility to avoid responding to
non-compliance with the SCR in a way which results in adverse
impacts and undermines market stability.
Undertakings
selling assets into a low and/or falling market is not a
desirable outcome for policyholders.
From this it might
be thought that the longer the possible maximum extension the
better, since a longer timeframe also means more flexibility for
the supervisor.
However, this should not mean that the
timeframe for recovery should be extended to the point in time
where financial markets have rebounded after an exceptional
fall.
Undertakings are not supposed to wait for an
improvement of the market situation, but are required to
demonstrate significant progress in their efforts to
re-establish compliance with the SCR.
Further,
a very long maximum recovery period could
be seen as “devaluing” the SCR, as under certain exceptional
circumstances a long lasting breach of regulatory requirements
is permitted – although the undertaking is required to prove
suitable effort and success in remedying the situation.
The impression that the SCR is only relevant under
“normal circumstances” whereas in difficult financial conditions
sound capital requirements are in effect suspended until the
situation is back to normal, should be avoided.
Also due
consideration should be given to the fact that a reduced maximum
period will enhance harmonisation of supervisory practices and
limit the use of national discretion in setting the length of
extension periods in individual cases.
It could also be
argued that since the SCR is based on a one-year horizon, the
maximum extension available should not be significantly longer
than a year, as non-coverage of the SCR may significantly
increase the risk of default beyond this horizon. However this
argument does not take into account that the decision on the
extension is to be considered only when there is an exceptional
fall in financial markets, i.e. in exceptional circumstances.
Therefore the maximum extension period should not be as
long as possible but be limited to what is considered strictly
necessary to provide sufficient flexibility for the recovery
measures of a larger number of undertakings to be spread out so
as to avoid significant adverse effects on an already stressed
market situation.
CEIOPS is
of the opinion that, as the recovery period should be neither
very short nor very long, the middle ground in option 3 provides
the best solution for the maximum extension period, by allowing
a maximum period in total of 30 months.
CEIOPS’ advice
The maximum
extension available under Article 138(4) shall be set at 21
months in the event of exceptional falls in financial markets.
Resulting in a maximum period of up to 30 months (i.e. 6+3+21
months)
Specification of factors to be
taken into account
Explanatory text
In the event of an exceptional fall in financial markets
supervisory authorities may decide to extend the time available
to an undertaking for re-establishing compliance with the SCR,
which is normally six months from the observation of the
non-compliance (with an additional three months if appropriate),
by an appropriate period of time.
An extension would only
be granted following an explicit request
by the undertaking concerned.
The decision to
permit an extension as well as the duration of any extension
is at the discretion of the supervisory
authority.
In using this discretion the Level 1
text requires the supervisory authority to take all relevant
factors into account.
The period of
time for which supervisory authorities can extend the normal
recovery period is limited.
The maximum possible
timeframe for the extension according to Article 138(4) will be
established at Level 2.
This maximum possible timeframe
is the same for all (re)insurance undertakings.
However, the length of the extension for individual undertakings
following the same trigger event will vary according to the
specific factors that apply.
Supervisory authorities
should give proper consideration to whether an extension of time
to re-establish compliance with the SCR is an adequate measure,
considering the position of the undertaking and potential
consequences of requiring short-term rectification.
Whether an extension should be permitted, and the length of any
extension, should be determined having regard to the severity of
the exceptional fall in financial markets experienced, the means
available to re-comply with the SCR in those circumstances and
the best interests of policyholders.
While it is
no precondition for granting the extension
that the “exceptional fall in financial markets” is the
cause of an undertaking’s non-compliance with the SCR, an
undertaking would have to show that and how the “exceptional
fall” seriously affected its ability to re-establish coverage of
the SCR as these are considerations the supervisory authority
has to take into account in deciding whether an extension is in
order and what is its adequate duration.
Article 143
requires the Commission to specify the factors to be taken into
account in accordance with Article 138(4). This does however not
necessarily mean that Level 2 has to provide a comprehensive
list of all relevant factors.
Factors to consider should reflect all the circumstances
associated with each individual case. Decisions on whether to
grant an extension need to be made on a case-by-case basis using
the relevant factors.
Prescription at Level 2 on
this part of the Directive through a definitive, closed list of
factors may therefore inhibit supervisors in taking account of
all relevant factors and in assessing cases on their specific
merits; in order
to avoid any such barriers it may therefore
be expedient to keep the list of factors open to admit the
possibility of additional relevant factors.
On the other
hand CEIOPS is aware that the level playing field and European
harmonisation in the way the exceptional supervisory powers
bestowed by Article 138(4) are used may be better served with a
comprehensive list of relevant factors.
A compromise
solution could be to leave the list open on Level 2 and to
prescribe factors that cannot be taken into account in order to
limit supervisory authorities’ scope for using Article 138(4)
and to provide for further harmonisation
of the open list through Level 3 guidance.
Further
it should be acknowledged that the relevance and weight given to
factors will depend on the particular circumstances of the
situation. So there can be no “formula” as to how the supervisor
arrives at the appropriate timeframe for any extension.
However, CEIOPS may seek, through Level 3
guidance, to come to a common understanding with regard to the
relative importance of the different factors identified, for
determining whether an extension should be granted, and its
adequate duration.
Any extension granted needs to
balance the policyholder protection objective and the need to
ensure market stability through avoidance of adverse
pro-cyclical effects that may result from regulatory
intervention forcing similar actions to be taken by a number of
undertakings in a short period of time.
This approach will require a high degree
of communication between supervisory authorities as experience
is gathered and shared between supervisory authorities, the
degree of harmonisation will be higher, leading to a more
effective and suitable consistency between supervisory actions.
In CEIOPS’ view the factors to be taken into account can be
external (independent of the undertaking) as well as internal
(entity-specific).
While external factors play a major role in evaluating potential
procyclical effects, the individual situation of an undertaking
– and additionally the situation of the group in a group context
- is also important, in particular for the assessment of the
duration of the extension period.
CEIOPS considers that the relevant factors should include the
following:
External Factors:
a) Detrimental impact on policyholders
Since the protection of policyholders and beneficiaries
remains the main objective of supervision, the supervisory
authority may consider granting an extension of the recovery
period to an undertaking when more severe supervisory actions,
and the subsequent effect on the financial system, could have a
significant detrimental impact on all policyholders.
b) Financial market stability (including
systemic risk), in particular the procyclical impact of
distressed sales of assets on the financial markets;
Supervisors should consider the possible effects on the
stability of severely stressed financial markets if a number of
undertakings that are having difficulty meeting their SCR seek
to remedy this by derisking or raising capital via the financial
markets.
This is necessary in order to establish a general idea as to how
long recovery periods need to be under specific circumstances,
so these additional demands on financial markets do not happen
simultaneously in a way that creates de-stabilising effects.
Avoiding the procyclical effect of distressed sales of assets on
financial markets is one of the main reasons why the Level 1
text provides for the supervisory power to extend the recovery
period.
However, in assessing how this factor affects individual
undertakings, supervisors need to consider the scale of such
sales for the undertaking concerned and other available options
the undertaking has in order to close the gap between the SCR
and the level of own funds.
c)
Ability of financial markets to provide extra capital at a
reasonable price;
Where undertakings could
increase their level of own funds to the necessary degree by
raising new capital on financial markets the duration of any
extension granted would potentially be shorter.
d) Availability of an active market and
liquidity of the market
The availability of an
active market and its liquidity of assets will have an impact on
the valuation of assets and the ability to sell them. If an
undertaking does not have a readily available source of funds to
finance short-term commitments, it will need to address this
alongside any capital preservation or enhancement activities.
e) Availability in financial markets
of financial mitigation instruments (e.g. hedges) at a
reasonable price;
Undertakings have more than one
option when they seek to reestablish compliance with the SCR. A
way to close the gap between the SCR and the level of own funds
would be to take measures to reduce the SCR through enhanced
financial mitigation instruments.
How feasible an option this is, depends not only on the
availability of such instruments in the financial markets but
also on the ability of the undertaking to manage, monitor and
control the instruments.
When this is an available and adequate means, this option would
potentially reduce any extension being granted.
f) Capacity of the reinsurance market to
provide reinsurance cover at a reasonable price;
Undertakings in breach of the SCR would be expected to consider
reducing their risk profile through the use of reinsurance
arrangements they are able to manage, monitor and control.
When this is an adequate and available means to re-establish
compliance with the SCR, this would potentially reduce any
extension period.
g) Anticipated
policyholders’ behaviour
Anticipated
policyholders’ behaviour should also be considered as an
external factor, as it may have significant impact on solvency
and financial condition of the undertaking.
Internal Factors:
a) The causes leading to the
non-compliance with the SCR;
Supervisors have to
consider the causes leading to non-compliance with the SCR. If
factors, other than factors arising from the exceptional fall in
financial markets or consequences of this fall, have played a
significant role in the non-compliance, there is less reason to
extend the recovery period beyond what is strictly necessary to
avoid a
negative impact on financial stability.
b) Degree of non-compliance with the SCR;
The nearer the level of own funds has decreased towards the
MCR the more urgent is the need for the undertaking to improve
its solvency position. How fast the solvency position is
deteriorating and whether there is a risk of the undertaking
becoming insolvent also needs to be considered.
c) The composition of own funds held by
the undertaking;
Own funds are categorised into tiers. This tier system may
restrict an undertaking’s ability to solve the situation
quickly. While it may be easier to raise tier 3 capital than
higher level capital, an undertaking may need additional tier 1
or 2 capital to comply with the SCR. This could potentially
induce the supervisor to consider a longer extension period.
d) The composition of the
undertaking’s assets;
The assets of the
undertaking are worth considering, as the undertaking could have
a large stake in assets that would affect the market adversely
if they were to be sold.
Also the undertaking may be exposed to other risks via its
assets.
The effect of the crisis on the undertaking’s asset portfolio is
relevant in that in some cases undertakings may be able to get
rid of assets more easily.
On
the other hand the quality of the assets held could be below
average or more concentrated, thus increasing the risk to the
undertaking independently from temporary market fluctuations.
e) Nature and duration of technical
provisions and other liabilities;
Where relevant,
supervisors should consider the nature and duration of the
undertaking’s liabilities from an ALM point of view. It could be
appropriate to give a longer extension period to undertakings
whose liabilities have a longer duration.
f) Solutions effectively available to the
undertaking;
While some solutions may generally
help to improve the solvency position of an undertaking, this
may not provide an adequate solution in individual cases as the
costs are disproportionate to the benefits.
Also other decisions taken by the undertaking in the past could
limit its ability to fall back on certain solutions for solving
its solvency problems.
Seriously limited options for remedial actions could lead
supervisors to grant a longer extension of the recovery period –
within the boundaries of the extension of the maximum extension
of the recovery period – than would otherwise be granted.
g) Potential availability of financial
help from other group entities (if applicable);
Where other undertakings in the group are in a position to help
an undertaking in financial difficulties this is a possible way
out of the situation.
Where there are such remedies for the undertaking this
potentially reduces the necessary recovery period.
h) The size or significance of the
undertaking relative to the market, i.e. the impact on the
market and on policyholders if the undertaking were to
experience severe financial problems;
Since the
rationale of Article 138(4) is not to provide undertakings with
a sufficiently long timeframe for recovery but to avoid negative
effects for the insurance market in particular or financial
markets in general, supervisors do not have to grant an
extension if neither the interests of policyholders and
beneficiaries nor the insurance market as such would be
materially affected.
i) Steps taken
by the undertaking to limit the outflow of capital and the
deterioration of its solvency situation;
Undertakings cannot expect to be granted extensions of the
recovery period if they choose not to use the measures available
to them to ameliorate their situation.
Failing to make use of possible restrictions on payments of
dividends or coupons/principal on hybrid debt for example or
writing (additional) new business in spite of material SCR
problems could lead supervisors to refuse an extension.
Factors not to be taken into
account:
• The point in time when normal conditions
are expected to be reestablished;
While supervisors will take into account how long they
expect the exceptional fall in financial markets to last in
order not to grant longer timeframes than are necessary to avoid
procyclical effects, extension periods should not be chosen with
a view to allowing undertakings to “sit out” a financial crisis.
So
the expected duration of the exceptional fall would not provide
the minimum extension period.
As
the requirement to demonstrate significant progress towards
reestablishing compliance with the SCR on a regular basis shows,
undertakings need to take active steps to improve their solvency
situation.
• How much time the
undertaking needs to resolve the breach of the SCR without
negative economic effects on its standing;
The power to grant extension periods is vested in
supervisors in order to provide them with the necessary
flexibility not to have to take decisions they consider would
have significant negative effects for the stability of the
financial systems in the European Union or
generate procyclical consequences.
The point is not to enable supervisors to provide undertakings
with sufficiently long recovery periods so they can avoid
negative economical effects as far as possible while
reestablishing compliance with the SCR.
In order to
enhance harmonisation and to ensure that supervisors use the
power vested in them by Article 138(4) properly, CEIOPS will
consider a coordination process of the extension periods
provided across different
Member States so that procyclical
effects are not only duly considered on the national level but
on the European level as well.
The decision on an
extension in an individual case should follow a due process.
An
undertaking has to submit a realistic
recovery plan for supervisory approval within two months of the
observation of the SCR breach.
In
order that the recovery plan can take into account any extension
to be granted supervisors should provide a short-term
supervisory decision about the extension and its potential
length where possible.
The undertaking should be given the opportunity to give its
views on short notice before any such decision is taken.
The supervisor may also ask for additional
information it needs to be able to take all relevant factors
into account.
If the supervisory authority has
already approved a recovery plan following the undertaking’s
breach of the SCR, the later determination of an exceptional
fall in financial markets could – if it affects the
undertaking’s ability to re-establish compliance with the SCR –
lead the supervisor to grant an extension.
The extension would require a request by the undertaking
concerned, which would have to include an adapted recovery plan.
The undertaking would have to submit this within two months from
the moment it realises that it will not be able to comply with
the original plan.
Regular
progress reports
Following
an exceptional fall in financial markets, and the
submission of a recovery plan with an
extended recovery period, the supervisory authority
considers it appropriate to extend the
recovery period available to an
undertaking, Article
138(4) of the Level 1 text requires the undertaking to report to
the supervisory authority every three months the measures taken
and the progress made to re-establish the level of eligible own
funds covering the SCR or to reduce the risk profile to ensure
compliance with the SCR.
In case such a report shows that
no significant progress has been achieved
in reaching the aim of re-establishing compliance, the extension
is to be withdrawn.
Since a withdrawal of the
extension has serious consequences for the undertaking concerned
and the withdrawal according to the Level 1 text is mandatory
for the supervisor if no significant progress is shown, it is
important for the undertaking as well as for the supervisor to
know what constitutes “no significant progress”.
Significant progress could be judged against a prescribed
benchmark or individually against the undertaking’s own recovery
plan.
CEIOPS favours the latter approach.
Following this approach undertakings would be expected to
propose a recovery plan and supervisors to
approve a recovery plan that would include well defined and
realistic interim milestones (measures, re-establishment of own
funds or reduction of risk profile) and timelines, according to
which progress can be assessed.
Every well defined and realistic interim milestone would not
necessarily on a quarterly basis imply a quantifiable
improvement of own funds or reduction of the risk profile
although such milestones should evidence a realistic and
reasonable prospect of such a quantifiable improvement of own
funds of reduction of the risk profile. The undertaking’s
progress should be assessed against these milestones.
In
order to make the withdrawal of an extension predictable,
supervisors would however still have to establish what degree of
fulfilment of the recovery plan’s milestones is required for the
progress to be taken as significant. CEIOPS proposes to settle
this question in its Level 3 guidance.
When an extension originally granted is withdrawn under such
circumstances, the undertaking is still in breach of the SCR but
is no longer provided the extended time to remedy the situation,
the supervisor will have the power to take appropriate measures
against the undertaking concerned.
As when the normal recovery
period has run out without remedy of the SCR breach, these can
be any measures necessary to close the gap between the SCR and
the level of own funds as long as they are proportionate, i.e.
no other adequate, less onerous measures are available.
How the supervisor is to react in such a situation will be
subject to further consideration in the work on the Supervisory
Review Process.br>
The fact that the extension of the
recovery period originally provided by the supervisor had to be
withdrawn would also be subject to public disclosure according
to Article 54(1) of the Level 1 text as it would have to be
considered as a major development significantly affecting the
relevance of the information disclosed in the Solvency and
Financial Condition Report (SFCR).
This would be a publication that could be detrimental to the
financial situation of the undertaking.
CEIOPS considers
that supervisory authorities themselves should also disclose
information in connection with the application of Article
138(4).
This publication should cover the number and range of extensions
the supervisor has granted and the average duration of the
extensions.
CEIOPS’ final Advice
following its Consultation Papers on Supervisory Reporting and
Disclosure and on Transparency and Accountability has been
updated to take these expected publications by undertakings and
supervisory authorities into account.
With the objective
of promoting compatibility of prudential supervision of
insurance and banking and the potential need for some
cross-sectoral anticyclical measures, it is likely that the
identification of ‘an exceptional fall in
financial markets’
will be determined in a compatible manner across sectors.
There
are no equivalent provisions in the CRD to Article 138(4a) of
the Level 1 text.
On that
basis, all of the options will rank equally in terms of
effectiveness and efficiency against this operational objective.
In a similar vein, it is not clear how widely the
‘exceptional fall in financial markets’ will need to be when
assessed to tell whether that is compatible with the work of the
IAIS and IAA, especially in the light of
the recent G20 advice to regulators and other bodies to develop
recommendations to mitigate pro-cyclicality.
However, as it reflects the circumstances in the recent crisis,
it is likely that equivalent measures may be developed by IAIS
and IAA. However, all of the options score equally on
effectiveness and efficiency in terms of introducing an
extension period that will apply.
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