The Basel II Accord and the Solvency II Directive
have been both criticized for their procyclicality.
{What is procyclicality?
It is true that we have failed time
and again to take into account the business cycles in
our solvency and capital calculations. A business
cycle is the expansion of above-average economic growth,
followed by a contraction of below-average economic
growth.
Procyclical Approach:
In good times we face less risks, so
we are able to allocate less capital for future risks.
When bad times come, we usually have the minimum capital
of the cycle, and it is dangerous. On top of that
supervisors ask for more capital immediately... and
everybody sells assets in a bad illiquid market.
So it is difficult to maintain macroeconomic
stability.
Countercyclical
Approach: During good
times, although we face less risks we allocate more
capital, just to be prepared for the bad
times}
From the Solvency ii
Directive / European Parliament legislative
resolution of 22 April 2009:
"(35a) In order to mitigate undue potential pro-cyclical
effects of the financial system and avoid that
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 comply
with their Solvency Capital Requirement, provision
should be made to allow supervisory authorities to
extend the time period within which insurance and
reinsurance undertakings have to re-establish the level
of eligible own funds covering the Solvency Capital
Requirement.
Article 27a
Maintaining financial stability
and pro-cyclicality
Without prejudice to the main
objective of supervision as set out in Article 27 Member
States shall ensure that, in the exercise of their
general duties, supervisory
authorities shall duly consider the potential impact of
their decisions on the stability of the financial
systems concerned in the European Union, in
particular in emergency situations, taking into account
the information available at the relevant
time.
In times of exceptional movements in the financial
markets, supervisory authorities shall take into account the potential
procyclical effects of their actions.
B. SMALL AND MEDIUM SIZED
UNDERTAKINS
From the
Solvency ii Directive / European Parliament
legislative resolution of 22 April
2009:
(14a) The new solvency regime should
not be too burdensome for
small and medium-sized insurance undertakings. One of
the tools to achieve this objective is a proper
application of the proportionality principle. This principle should apply both to the
requirements on the insurance and reinsurance
undertakings and on the exercise of supervisory
powers.
(14b) In particular, the
new solvency regime should not be too burdensome for
insurance undertakings that specialise in
providing specific types of insurance or providing
services to specific customer segments, and it should
recognise that specialising in this way can be a
valuable tool for efficiently and effectively managing
risk.
In order to achieve this
objective, as well as the proper application of the
proportionality principle, provision should also be made
to specifically allow undertakings to use their own data to calibrate the
parameters in the underwriting risk modules of
the standard formula of the Solvency
Capital Requirement.
(14c) The new solvency
regime should also take account of the specific nature
of captive insurance and
reinsurance undertakings. As those undertakings only cover risks
associated with the industrial or commercial group to
which they belong, appropriate approaches should thus be
provided in line with the principle of proportionality
to reflect the nature, scale and complexity of their
business.
C. FINITE INSURANCE AND
REINSURANCE ACTIVITIES AND... REGULATORY
ARBITRAGE
From the Solvency ii
Directive / European Parliament legislative
resolution of 22 April 2009:
(63a) Due to the
special nature of finite reinsurance activities, Member
States should ensure
that insurance and reinsurance
undertakings concluding finite reinsurance contracts or
pursuing finite reinsurance activities can properly identify, measure and control
the risks arising from those
contracts or activities.
(63b) Appropriate rules
should be provided for special purpose vehicles which assume risks from insurance and
reinsurance undertakings without being an insurance or
reinsurance undertaking. Recoverable amounts from a
special purpose vehicle should be considered as amounts
deductible under reinsurance or retrocession
contracts.
(63c) Special purpose
vehicles authorised before 31 October 2012 should be
subject to the law of the Member State having authorised
the special purpose vehicle. However, in order to avoid regulatory
arbitrage, any new activity
commenced by such a special purpose vehicle after 31
October 2012 should be subject to the provisions of this
Directive.
(63d) Given the
increasing cross-border nature of insurance business,
divergences between Member States' regimes on special
purpose vehicles, which are subject to the provisions of
this Directive, should be reduced to the greatest extent
possible, taking account of
their supervisory structures.
(63e) Further work on
special purpose vehicles should be conducted taking into
account the work undertaken in other financial
sectors.
Article 208
Finite reinsurance
1. Member States shall
ensure that insurance and reinsurance undertakings which
conclude finite reinsurance contracts or carry on finite
reinsurance activities are able to
properly identify, measure, monitor, manage, control and
report the risks arising from those contracts or
activities.
2. In order to ensure that
a harmonised approach is adopted with respect to finite
reinsurance activities, the Commission may adopt
implementing measures specifying the provisions of
paragraph 1 with respect to the monitoring, management
and control of risks arising from finite reinsurance
activities.
Those implementing
measures designed to amend non-essential elements of
this Directive inter alia by supplementing it, shall be
adopted in accordance with the regulatory procedure with
scrutiny referred to in Article 304
(3).
3. For the purposes of
paragraphs 1 and 2 finite
reinsurance means reinsurance under which the
explicit maximum loss potential, expressed as the
maximum economic risk transferred, arising both from a
significant underwriting risk and timing risk transfer,
exceeds the premium over the lifetime of the contract by
a limited but significant amount, together with at least
one of the following features:
(a) explicit and
material consideration of the time value of
money;
(b) contractual
provisions to moderate the balance of economic
experience between the parties over time to achieve the
target risk transfer.
D. MINIMUM CAPITAL REQUIREMENT -
ABSOLUTE FLOOR
From the Solvency ii
Directive / European Parliament legislative
resolution of 22 April 2009:
Article 127
Calculation of the Minimum
Capital Requirement
The Minimum Capital Requirement shall have an
absolute floor of
(i) 2 200 000
EUR for non-life insurance
undertakings, including captive insurance undertakings,
except in the case where all or some of the risks
included in one of the classes 10 to 15 listed in point
A of Annex 1 are covered, in which case it shall not be
less than 3 200 000 EUR,
(ii) 3 200
000 EUR for life insurance
undertakings, including captive insurance
undertakings,
(iii) 3 200
000 EUR for reinsurance undertakings, except in the case
of captive reinsurance undertakings, in which case the
Minimum Capital Requirement shall not be less than a
minimum of 1 000 000 EUR,
The Minimum Capital Requirement shall
not fall below 25% nor exceed 45%, of the
undertaking's Solvency Capital Requirement
Insurance and reinsurance
undertakings shall calculate the Minimum Capital
Requirement at least quarterly and report the results of
that calculation to supervisory
authorities.
E. GROUP SUPERVISION AND
SUPERVISORY COLLEGES
To improve supervision and risk
management, the European Parliament sought and obtained
the creation of supervisory
colleges - made up of the various national
supervisors responsible for a group and its subsidiaries
- to facilitate cooperation,
exchange of information and consultation between the
supervisors.
The new supervisory system would also mean economic
gains for company.
EU companies
would no longer need to deal with several national
regulators, but just with one group.
F.
ENTRY INTO FORCE AND REVIEW
CLAUSE
Member
States will have to transpose the new directive by at
the latest 31 October
2012.
Two years
after entry into force, the Commission is
requested to put forward a legislative proposal to
improve, if necessary, the application some aspects of
the Directive, including the cooperation of supervisory
authorities within the colleges.
Three years after entry into force,
Commission will have to propose legislation to enhance
group supervision and capital management within a group
of insurance. This would also include the provision,
proposed by Parliament representatives, on group
support, (i.e. that part of the capital requirement for
a subsidiary could be met by a guarantee that funds
would be transferred from the group if
needed).
