CEIOPS’ Advice for Level 2 Implementing
Measures on Solvency II:
Own funds - Article 97 and 99 -
Classification and eligibility
October
2009
2. Extract from Level 1
text
2.1 Legal basis for implementing
measures
Article 97
implementing measures
1. The Commission
shall adopt implementing measures laying down the
following:
(a) a list of own fund items, including those referred to in Article 96, deemed to
fulfil the criteria, set out in Article 94, which contains for each
own fund item a precise description of the features which determine
its classification;
(b) the methods to be used by
supervisory authorities when approving the assessment and
classification of own fund items
which are not covered by the
list referred to in point (a).
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).
2. The Commission
shall regularly review and where appropriate update the list
referred to in point (a) of paragraph 1, in the light of market
developments.
Article 99 implementing
measures
The Commission
shall adopt implementing measures laying
down:
(a) the
quantitative limits referred to in Article 98(1) and
(2);
(b) the
adjustments that should be made to reflect the lack of
transferability of those own fund items that can only be used to
cover losses arising from a particular segment of liabilities or
from particular risks (ring-fenced funds).
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).
2.2 Other relevant Articles from the Level 1
text
Article 88
Basic own
funds
Basic own funds
shall consist of the following items:
(1) the excess of
assets over liabilities, valued in accordance with Article 75 and
Section 2;
(2) subordinated
liabilities.
The excess amount
referred to in point (1) shall be reduced by the amount of own
shares held by the insurance or reinsurance
undertaking.
Article 89
Ancillary own
funds
1. Ancillary own
funds shall consist of items other than basic own funds which can be
called up to absorb losses.
Ancillary own funds may comprise the
following items to the extent that they are not basic own funds
items:
(a) unpaid share capital or
initial fund that has not been called up;
(b) letters of
credit and guarantees;
(c) any other
legally binding commitments received by insurance and reinsurance
undertakings.
In the case of a
mutual or mutual-type association with variable contributions,
ancillary own funds may also comprise any future claims which that
association may have against its members by way of a call for
supplementary contribution, within the following 12
months.
2. Where an
ancillary own fund item has been paid in or called up, it shall be
treated as an asset and cease to form part of ancillary own fund
items.
Article 93
Characteristics and
features used to classify own funds into
tiers
1. Own fund items
shall be classified into three tiers.
The classification of
those items shall depend upon whether they are basic own fund or
ancillary own fund items and the extent to which they possess the
following characteristics:
(a) the item is
available, or can be called up on demand, to fully absorb losses on
a going-concern basis, as well as in the case of winding-up
(permanent availability);
(b) in the case
of winding-up, the total amount of the item is available to absorb
losses and the repayment of the item is
refused to its holder
until all other obligations, including insurance and reinsurance
obligations towards policyholders and
beneficiaries of insurance
and reinsurance contracts, have been met
(subordination).
2. When assessing
the extent to which own fund items possess the characteristics set
out in points (a) and (b) in paragraph 1, currently and in the
future, due consideration shall be given to the duration of the
item, in particular whether the item is dated or not.
Where an own fund
item is dated, the relative duration of the item as compared to the
duration of the insurance and reinsurance obligations of the
undertaking shall be considered (sufficient
duration).
In addition, the
following features shall be considered:
(a) whether the
item is free from requirements or incentives to redeem the nominal
sum (absence of incentives to redeem);
(b) whether the
item is free from mandatory fixed charges (absence of mandatory
servicing costs);
(c) whether the item is clear of
encumbrances (absence of encumbrances).
Article 94
Main criteria for the
classification into tiers
1. Basic own fund
items shall be classified in Tier 1 where they substantially possess
the characteristics set out in points (a) and (b) of Article 93(1),
taking into consideration the features set out in Article
93(2).
2. Basic own fund
items shall be classified in Tier 2 where they substantially possess
the characteristics set out in point (b) of Article 93(1), taking
into consideration the features set out in Article
93(2).
Ancillary own
fund items shall be classified in Tier 2 where they substantially
possess the characteristics set out in points (a) and (b) of Article
93(1), taking into consideration the features set out in Article
93(2).
3. Any basic and
ancillary own fund items which do not fall under paragraphs 1 and 2
shall be classified in Tier 3.
Article 95
Classification of own
funds into tiers
Member States
shall ensure that insurance and reinsurance undertakings classify
their own fund items on the basis of the criteria laid down in
Article 94.
For that purpose,
insurance and reinsurance undertakings shall refer to the list of
own funds referred to in point (a) of Article 97(1), where
applicable.
Where an own fund
item is not covered by that list, it shall be assessed and
classified by insurance and reinsurance undertakings, in accordance
with the first paragraph.
This classification
shall be subject to approval by the supervisory
authority.
Article 96
Classification of
specific insurance own-fund items
Without prejudice
to Article 95 and point (a) of Article 97(1), for the purposes of
[the Level 1 text] the following classifications shall be
applied:
(1) surplus funds
falling under Article 91(2) shall be classified in Tier
1;
(2) letters of
credit and guarantees which are held in trust for the benefit of
insurance creditors by an independent trustee and provided by credit
institutions authorised in accordance with Level 1 text 2006/48/EC,
shall be classified in Tier 2;
(3) any future
claims which mutual or mutual-type associations of ship owners with
variable contributions solely insuring risks listed in classes 6, 12
and 17 in point A of Annex 14 may have against their members by way
of a call for supplementary contributions, within the next twelve
months, shall be classified in Tier 2.
In accordance
with subparagraph 2 of Article 94(2), any future claims which mutual
or mutual-type associations with variable contributions may have
against their members by way of a call for supplementary
contributions, within the next twelve months, not falling under
point 3 of subparagraph 1 shall be classified in Tier 2 where they
substantially possess the characteristics set out in points (a) and
(b) of Article 93(1), taking into consideration the features set out
in Article 93(2).
Article 98
Eligibility and
limits applicable to Tier 1, Tier 2 and Tier
3
1. As far as the
compliance with the Solvency Capital Requirement is concerned, the
eligible amounts of Tier 2 and Tier 3 items shall be subject to
quantitative limits.
Those limits shall be
such as to ensure that at least the following conditions are
met:
(a) the
proportion of Tier 1 items in the eligible own funds is higher than
one third of the total amount of eligible own
funds;
(b) the eligible
amount of Tier 3 items is less than one third of the total amount of
eligible own funds.
2. As far as the
compliance with the Minimum Capital Requirement is concerned, the
amount of basic own fund items eligible to cover the Minimum Capital
Requirement which are classified in Tier 2 shall be subject to
quantitative limits.
Those limits shall be
such as to ensure, as a minimum, that the proportion of Tier 1 items
in the eligible basic own funds is higher than one half of the total
amount of eligible basic own funds.
4. The eligible
amount of own funds to cover the Solvency Capital Requirement set
out in Article 100 shall be equal to the sum of the amount of Tier
1, the eligible amount of Tier 2 and the eligible amount of Tier
3.
5. The eligible
amount of basic own funds to cover the Minimum Capital Requirement
set out in Article 128 shall be equal to the sum of the amount of
Tier 1 and the eligible amount of basic own fund items classified in
Tier 2.
3. Advice
3.1 Explanatory
text
3.1.1 QIS4 feedback
General
approach
3.1. The
objective of QIS4 in relation to own funds was
to collect further
information, especially on the implementation of the tiering
structure.
Specifically,
elements were classified in relation to how well and when they
absorb losses compared to paid-up ordinary share capital or the
paid-up equivalent capital of mutual and mutual-type
undertakings.
3.2. Overall, the
classification of own funds was deemed suitable and practicable by
undertakings and supervisors.
Some undertakings
continue to view the three-tier structure as
being too complex
although in the vast majority of cases the QIS4 specifications,
together with the tier structure and limits, do not result in
capital adequacy breaches and consequently the need to raise
additional capital.
3.3. Undertakings
generally supported the principle-based approach, although they
would welcome greater clarity on some aspects (e.g. the distinction
between other reserves that are loss-absorbent for all policyholders
and those with restricted loss-absorbency).
3.4. Some
supervisors noted some classification
difficulties for reserves not specified in the list.
Some undertakings and
supervisors commented that it was unclear how to classify reserves
and provisions such as equalisation
reserves/provisions.
3.5. Many
undertakings reported that the
treatment of deferred taxes is unclear and confusing.
Supervisors reported
that insurers have not all reported deferred taxes on the same
basis, although the impact on own funds
cannot be quantified.
3.6. Some supervisors
raised concerns about the reliability of the
reported classification of hybrid capital instruments and
subordinated liabilities.
Some reported
that a clearer definition of hybrid capital instruments is needed.
A number of
undertakings and supervisors stressed the importance of
grandfathering in relation to hybrid capital instruments and
subordinated liabilities.
3.7. The majority
of hybrid capital instruments and subordinated liabilities were
reported as Tier 2.
The main reason for
classification in this tier rather than in Tier 1 is that these
instruments do not satisfy the loss absorbency
requirements, i.e.
temporary write-down or conversion.
Also, several
instruments do not meet the criteria relating to permanence and
absence from requirements/incentives to redeem.
3.8. The
conclusion drawn by most countries is that the shift from issue date
to a reporting date approach when classifying capital instruments
into tiers would result in a significant number of instruments
changing classification from Tier 1 to Tier 2 or Tier 3, or from
Tier 2 to Tier 3.
The impact would be
particularly significant for Tier 1
instruments.
3.9.
Only a few undertakings reported ancillary own
funds.
There was no useful
feedback on the valuation of ancillary own
funds.
3.10. Among
specific issues tested in QIS4, there were also surplus funds and
ring-fenced funds.
More about surplus
funds can be found under the following subtitle, Quantitative
outcome. Ring-fenced funds are not
addressed in this
paper.
Quantitative
outcome
3.11. On average
95% of total own funds were reported in Tier
1, 4% in Tier 2 and 1% in Tier 3.
However, in some
countries, own funds reported in Tier 2
and Tier 3 were not negligible.
3.12. Out of
1,366 reporting undertakings in QIS4:
• 35 undertakings
reported Tier 1 below one third of SCR,
• 19 undertakings
reported Tier 3 above one third of SCR,
• 25 undertakings
reported Tier 1 below one half of MCR,
• 53 undertakings
reported Tier 2 above one half of MCR.
3.13. Out of the
most important capital component, Tier 1, the main proportions were
attributable to common equity, retained earnings, and valuation
adjustments.
3.14.
Subordinated loans represented 53% of Tier 2 and 40% of Tier 3%
capital.
The greatest part
of Tier 3, i.e. 58 %, consisted of supplementary member
calls.
3.15. The total
volume of hybrid capital instruments and subordinated liabilities in
issue across countries was EUR 42,581 million. Amounts reported
ranged from zero to EUR 13,076 million.
Issuance was
concentrated in four countries (DE, FR, IT, UK) which reported circa
85% of the total volume of hybrid capital instruments and
subordinated liabilities.
The amount of hybrid
capital instruments and subordinated liabilities as a proportion of
total own funds provided an overview of the relative significance of
these items, hence, the potential significance of grandfathering, in
those countries.
Hybrid capital
instruments and subordinated liabilities as a proportion of total
own funds ranged from zero (a number of countries did not report
hybrid capital instruments or subordinated liabilities) to 17%.
On average hybrid
capital instruments and subordinated liabilities as a percentage of
total own funds was circa 2%.
3.16. The volume
of ancillary own funds reported was small in relation to basic own
funds (2.5%) and total own funds (2.4%).
The percentage of
ancillary own funds in relation to basic own funds was lower than
10% in all countries.
3.17. Ancillary
own funds reported as Tier 2 were largely supplementary member calls
and letters of credits and guarantees. Tier 3 Ancillary Own Funds
were mainly made up of supplementary members’
calls.
3.18. Seven
countries (DE, ES, FI, FR, NL, NO, UK) reported supplementary member
calls other than Protection and Indemnity Associations (PIA) for an
overall amount of EUR 10.3 billion.
For two of these
countries (FR (EUR 7 billion) and DE (EUR 3 billion)) this equated
to more than 95% of the total amount reported.
The total amount of
ancillary own funds reported by undertakings of QIS4 (EUR 10.3
billion) was ten times higher than the
amount they reported under
the current Solvency I regime (EUR 948
million).
3.19. Overall,
48% of supplementary member calls other than PIA were classified in
Tier 2 and 52% in Tier 3.
The split was 40%-60%
in most countries, except for two (DE, UK), where the amounts
reported in Tier 2 were higher than the amounts reported in Tier
3.
3.20.
Surplus
funds were confirmed to exist in eight countries, totalling EUR 42
billion.
3.21. Significant
amounts were reported in three countries (DE, DK, SE).
In one of these
countries (SE) for the undertakings that reported surplus funds in
QIS4, 99% of own funds were surplus funds.
This country noted
that for undertakings with surplus funds it is of extreme importance
that surplus funds were classified as Tier 1 funds, so they can be
used in full to cover the Minimum Capital Requirement and the
Solvency Capital Requirement.
In another
country (DE), surplus funds usually are determined as the amount of
the current provision for bonuses and rebates that are not expected
to be distributed to current policyholders.
In a third country
(DK), surplus funds as special bonus provisions have similar
characteristics as equity.
3.22. Surplus
funds may also be significant for certain insurers in other
countries.
In QIS4, two
countries (BG, EL) reported a higher proportion of surplus funds to
own funds compared to the average.
3.23. In the
majority of these countries, surplus funds were reported in limited
undertakings, though in terms of volume this represented only one
quarter of total surplus funds.
The remaining three
quarters of surplus funds were held in mutuals and mutual type
undertakings, reported in two countries.
3.1.2 Key
issues
Lessons learned
from the crisis
3.24. A key
lesson learned from the crisis is that
own funds must be available in times of stress to absorb losses.
Own funds must be
built up when undertakings are not in stress.
3.25. In terms
of the Level 1 text, these are own fund items that
fully possess the
characteristic of permanent availability set out in point (a) of
Article 93(1).
3.26. Article
94(1) requires
Tier 1 own fund items to substantially possess this
characteristic.
Such Tier 1 own fund
items are of a lower quality than own fund items that fully possess
this characteristic.
3.27. This is
particularly relevant for hybrid capital instruments that insurance
and reinsurance undertakings have issued or will issue in the
future.
3.28.
Since the
start of the crisis in August 2007, CEIOPS has observed that very
few capital instruments that currently exist fully absorb losses in
times of stress, other than ordinary share capital or the equivalent
capital of mutual and mutual-type undertakings.
For example, CEIOPS
has observed virtually no deferral of interest on hybrid capital
instruments.
At the same time,
CEIOPS has observed that dividends on ordinary shares have been
reduced or withheld.
3.29. Another
observation that CEIOPS has made in the crisis is that undertakings
with a strong common equity base have, in general, been able to
withstand the crisis better because
they have held more own funds available
in times of stress to absorb losses.
Compared to banks
insurance and reinsurance undertakings have, on the whole, issued
hybrid capital instruments to a lesser degree and retained a higher
proportion of earnings.
3.30. Hence, in
addition to requiring Tier 1 to be the highest quality own funds,
CEIOPS is of the view that the proportion of Tier 1 items in
eligible own funds must be significantly higher than one third of
the total amount of eligible own funds.
3.31. Compared to
QIS4, putting CEIOPS’ view set out at in the paragraph above into
effect would mean increasing the average quality of own funds
by:
• increasing the
amount and quality of Tier 1;
• increasing the
quality of Tier 2; and
• decreasing the
amount, as well as increasing the quality, of Tier
3.
3.32. For Tier 1,
two possible ways of achieving this would be as
follows:
a) Restrict Tier
1 to ordinary share capital, or the equivalent capital of mutual and
mutual-type undertakings, and reserves - the use of which is not
restricted.
b) Restrict Tier
1 as in (a) above, plus hybrid capital instruments/subordinated
liabilities, provided they absorb losses first in a going concern.
Such items could
include, for example, automatically convertible instruments and
instruments subject to write down as long as
losses persist where
conversion or write down would take place as and when the
undertaking needs to absorb losses and in any case when the
insurance or reinsurance undertaking breaches its Solvency Capital
Requirement.
3.33. A number of
CEIOPS Members are of the view that only ordinary share capital or
the equivalent capital of mutual and mutual-type undertakings should
be allowed in Tier 1, as far as capital instruments are
concerned.
3.34. These Members do not consider other capital
instruments to be of sufficient quality for classification in Tier
1.
At the same time,
these Members acknowledge that there may be merit in providing the
possibility of classifying such other instruments in Tier 1 in
exceptional circumstances, subject to those instruments meeting the
necessary characteristics for
eligibility as Tier 1 own funds.
For example,
recalling recent government intervention, this might be the case
where capital market issuance is severely restricted or where this
is needed in order to aid a recapitalization.
The criteria for
inclusion in these circumstances would need to be discussed and
developed further and would need to be in line with the methods
developed to approve items not covered by the list of own funds in
accordance with Article 97 1 (b) (discussed below).
Such a compromise
approach could act as a counter-cyclical measure, as undertakings
would be required to establish a strong capital base during good
times and would not be able to grow their business using Tier 1
capital instruments that are of a lower quality.
However in an
economic downturn or where an undertaking is in a position of
stress, there would be greater flexibility for consideration of
other types of capital instruments such as mandatory convertible
instruments or instruments that have a
principal write-down on a
trigger event recognizing that as an undertaking’s position
deteriorates further, higher quality capital would be generated
through conversion or principal write-down.
However
CEIOPS notes
that the European Commission prefers an approach where no
distinction is made between economic circumstances for the
classification of own fund items.
3.35. A number of
other CEIOPS Members are of the view that hybrid capital
instruments/subordinated liabilities can be included in Tier 1,
provided they possess high-quality characteristics and features.
For instance, these
instruments should be available when needed due to a lock-in clause
upon a breach of the SCR or where it can reasonably be foreseen by
the supervisory authority or by the (re)insurance undertaking, as
part of the ORSA, that a breach could occur within the next twelve
months and redemption must be subject to supervisory
approval.
3.36. These
Members prefer to apply the same characteristics and features
applicable to Tier 1 both in normal and in stressed circumstances as
this would give undertakings a consistent view in assessing the
overall solvency position.
These Members point
to the extended recovery period set forth in the Article 138(4) of
the Level 1 text, i.e. in case of non
compliance with the SCR and
in the event of an exceptional fall in financial markets the
supervisory authority can extend the period required for the
re-establishment of the solvency position.
3.37. After due
consideration of these issues and the responses from consultation,
CEIOPS, acknowledges that there may be a role for high quality
hybrids in Tier 1, provided that in stressed situations ie. breach
of the SCR, they can convert or write down to provide higher quality
capital in the form of equity.
This addresses the
view that higher quality capital could be generated during times of
stress.
At the same time,
because it is not proposed that the characteristics of hybrids be
weakened, undertakings will have a consistent view in assessing the
overall solvency position.
3.38. CEIOPS cannot however,
support any regime in which hybrid instruments could represent all
or the most significant part of Tier 1.
Any inclusion of high
quality hybrids should therefore be restricted i.e. they should
account for no more than 20% of Tier 1.
3.39. Within the
context of these considerations, CEIOPS sees an inherent trade off
between the requirements for the quality of own funds eligible to
cover capital requirements and the limit structure applicable to the
tiers to which those own funds are
allocated.
3.40. Therefore,
it is not proposed that the limit for Tier 1 be lowered below 50%.
This limit is
supported by the majority as a reasonable position in light of the
quality of capital within this tier.
There is also a
minority view expressed that a 60% limit would be
appropriate.
3.41. This
approach would be consistent with the ladder of
intervention.
However, it is
acknowledged that the restriction applicable to Tier 1 will produce
an additional gearing effect (i.e. the amount of hybrid instruments
that will be counted as Tier 1 will rise and fall depending on the
fluctuations caused by unrestricted Tier 1 (share capital and
reserves)).
The alternative
is to limit hybrids by reference to a percentage of the SCR, but in
the case of (re)insurers with a higher percentage of Tier 1 covering
their SCR, they would be penalised from issuing additional hybrids
due to the restriction against the SCR. This effectively penalises
firms with better quality capital, which is
counterintuitive.
3.42. CEIOPS also
considered an alternative approach whereby hybrid instruments were
considered to be eligible Tier 1 own funds for the purposes of the
SCR, but coverage of the MCR was restricted to ordinary share
capital; the equivalent capital of mutuals and reserves.
However, it is not
clear whether this would be consistent with the Level 1 text.
In addition, the
situation could arise where there is a breach of the MCR ahead of
the SCR which would compromise the effective operation of the ladder
of intervention and would result in hybrids representing the most
significant part of Tier 1.
This approach was
rejected for these reasons.
3.43. Either way,
CEIOPS interprets the requirement for loss absorbency in a going
concern to mean that to be classified as Tier 1, capital instruments
must be fully paid in. CEIOPS considers that while capital that has
been called up but not paid in may provide sufficient loss
absorbency in a winding up it is not fully available to absorb
losses until it is paid in and is
therefore not of sufficient
quality to be considered Tier 1.
As a consequence,
called up but unpaid capital should be classified in Tier 2 or Tier
3, depending on the characteristics and features it possesses as set
forth in Article 93.
3.44. CEIOPS
recognizes that own funds that have been called up but not paid in
will also be subject to a capital charge for counterparty risk, as
is the case for other receivables which have not been paid in.
The purpose of this
requirement is to address the potential default risk and is still
considered necessary even if the called-up capital is included in
Tier 2.
This is because
counterparty default would also prevent
capital absorbing losses in a winding-up.
3.45. In
addition, for inclusion in own funds, CEIOPS is convinced that there
should be certain minimum qualitative requirements for subordinated
liabilities to be eligible for Tier 3, i.e. redemption should be
subject to supervisory approval, they must be free from encumbrances
and should have a minimum maturity.
Without such a
requirement subordination may not be effective and could be
undermined.
In particular, Tier 3
basic own funds should contribute towards avoiding insolvency as
well as towards avoiding any acceleration towards
insolvency.
3.46. CEIOPS’ aim
to improve the quality of Tier 1 own funds is consistent with
various initiatives that are currently underway in relation to the
banking regime to review the definition of own funds. CEIOPS
considers it more important to be consistent with the direction of
travel than with the current rules on own funds for
banks.
Proposed limit
structure
3.47.
The Level 1
text requires quantitative limits to be set for the components of
own funds that are eligible to cover the Solvency Capital
Requirement and the Minimum Capital Requirement in implementing
measures.
3.48. The limits
in the Level 1 text act as a backstop to these implementing
measures.
This approach was
adopted to reflect the growing consensus at the Level 1 negotiations
that the amount of Tier 1 needed to be
increased.
3.49. The impact
assessment for the proposed limit structure is annexed to this
advice.
3.50. CEIOPS
recommends that the limit structure is set so as to ensure
that:
• in relation to
compliance with the Solvency Capital Requirement the proportion of
Tier 1 is greater than the proportion of eligible Tier 2 and that
the proportion of eligible Tier 2 is greater than the proportion of
eligible Tier 3; Tier 3 may be included (subject to the limits),
regardless of whether undertakings have Tier 2 eligible own funds or
not;
• in relation to
compliance with the Minimum Capital Requirement, the proportion of
Tier 1 is greater than the proportion of eligible Tier 2 basic own
funds.
3.51. CEIOPS also
recommends that, as far as the compliance with the
Solvency Capital Requirement
is concerned:
• the proportion
of Tier 1 items in eligible own funds is at least 50% of the total
amount of eligible own funds (a minority of CEIOPS Members have
expressed a preference for at least 60%),
and
• the proportion
of Tier 3 items in eligible own funds is set at a maximum of 15% of
the total amount of eligible own funds.
This percentage is
considered appropriate due to the characteristics relating to the
quality of capital required for elements to be included in Tier 3,
taking into account the requirements proposed in this advice (see
paragraphs 3.64 and 3.137 to 3.145).
3.52. CEIOPS
interprets the term eligible own funds as own funds that count
towards covering the Solvency Capital Requirement and the Minimum
Capital Requirement, subject to the framework of the limit
structure.
3.53. Tier 1 own
funds and tier 2 basic own funds are part of eligible own
funds.
3.54. Tier 3 basic own funds eligible to cover the
Solvency Capital Requirement, but not eligible to cover the Minimum
Capital Requirement.
3.55. Ancillary
own funds are eligible to cover the Solvency Capital Requirement,
but not eligible to cover the Minimum Capital
Requirement.
3.56. With
regards to the comments made by the industry, CEIOPS does not
consider that convincing arguments have been put forward as to why
the proposed limits are inappropriate, given the need for the SCR
and the MCR to be met with own funds of an appropriate quality, so
it proposes to retain the limits set out
above.
3.57. In
addition, CEIOPS considers that the calculation methods for the MCR
and the SCR are sufficiently clear for the limits to be
established.
3.58. Considering
the corridor for the computation of the Minimum Capital Requirement,
this results in a proportion of Tier 1 items in eligible own funds
that fully covers the total amount of eligible own funds, as far as
the compliance with the Minimum Capital Requirement is
concerned.
3.59. The
following example, based on an SCR coverage of Tier 1 – 50%, Tier 2
–35% and Tier 3 – 15%, illustrates this.
Minimum characteristics for own
funds
3.62. The Level 1 text defines basic
owns funds as the excess of assets over liabilities and subordinated
liabilities.
Therefore, for a liability to be included
within own funds it must be at a minimum subordinated to all claims
of policyholders and all other senior creditors.
3.63. Article 94 states that any
basic and ancillary own funds that do not fall into paragraphs (1)
and (2) of Article 94 should be classified as Tier 3.
At the same time, the Level 1 text does
not stipulate which of the characteristics and features in Article
93, if any, Tier 3 subordinated liabilities must
display.
3.64. CEIOPS recommends that Tier 3
basic own funds demonstrate features to ensure that subordination is
effective and not just a nominal requirement.
Subordination would not be effective, and
would be undermined, if Tier 3 basic own funds were freely
redeemable (therefore redemption should be subject to supervisory
approval), or coupons on Tier 3 basic own funds were freely payable
when an undertaking's solvency position is deteriorating or is
foreseen to deteriorate.
3.65. CEIOPS also recommends that
providers of own funds are not permitted to cause an undertaking to
become insolvent, nor should they be permitted to be in a position
to accelerate the insolvency of the undertaking, because permitting
this would be contrary to the principle of policyholder/beneficiary
protection.
3.66. Also, CEIOPS recommends that
any redemption, conversion or exchange of capital instruments,
including any premiums paid in on those instruments, is subject to
prior supervisory approval, without which subordination may not be
effective, and could be undermined.
3.67. These
recommendations are consistent with the direction of travel of
prudential regulation of the banking industry.
Sufficient duration
3.68. Article 93.2 requires that,
when assessing the extent to which own fund items possess the
characteristics set out in points (a) and (b) in Article 93.1,
currently and in the future, due consideration shall be given to the
duration of the item, in particular whether the item is dated or
not.
Where an own fund item is dated, the
relative duration of the item as compared to the duration of the
insurance and reinsurance obligations of the undertaking shall be
considered (sufficient duration).
3.69. On the basis of this
requirement, in QIS4, CEIOPS tested whether capital instruments
should be included in own funds on the basis of their issue date or
their reporting date.
The results of the exercise were not
conclusive, largely due to the lack of comprehensive feedback from
participants.
3.70. Since QIS4, the discussions in
CEIOPS on how to address the sufficient duration feature have
evolved.
3.71. CEIOPS considers that an issue
date basis would provide an appropriate framework, based on the
following conclusions that CEIOPS has drawn in relation to own funds
from a broader perspective.
• For inclusion in own funds, capital
instruments must not be freely redeemable, or coupons freely
payable, when an undertaking's solvency position is deteriorating,
or is foreseen to deteriorate.
They must be available when needed
through the exercise of a lock-in clause at least upon a breach of
the SCR, and redemption must be subject to supervisory
approval.
• The redemption date is considered
to be the first contractual opportunity to redeem the instrument,
which would mean either the maturity date or the first call
date.
• Tier 1 should not include capital
instruments with an incentive to redeem (as defined in paragraph
3.84(iv) hereunder).
• Tier 3 capital instruments should
have a minimum maturity of 3 years at issue date.
3.72. In QIS4, the minimum maturity
at issue date for Tier 1 was set at 10 years and for Tier 2 at 5
years. In general, this worked well.
3.73. CEIOPS is sensitive to
stakeholders’ views that the concept of matching theduration of the
capital instruments against the duration of the liabilities may
result in difficulties, particularly when the duration for certain
liabilities is unknown and should the duration of the liabilities
change significantly over time.
Nonetheless it is important that issuers
take into account the maturity profile of their liabilities in order
to have in place
adequate capital management plans, and to ensure
consistency with the Level 1 text.
3.74. With this in mind, CEIOPS
recommends that the minimum maturity at issue date should
be:
10 years for Tier
1,
5 years for Tier
2,
3 years for Tier
3
3.75. The combination of safeguards
arising from the proposed restrictions on the amount of hybrids and
the criteria as to their quality as well as the features of capital
instruments in Tier 1, 2 and 3, means that CEIOPS is satisfied that
the sufficient duration of own funds instruments called for by the
Level 1 text can be achieved through the benchmark minimum
maturities proposed i.e. 10 years for T1, 5 years for T2, and 3
years for T3.
3.76. The duration of the capital
instrument is defined as the first contractual possibility of
repayment.
When determining duration, the time
horizon must be the expected duration, or anticipated duration over
the next
twelve months.
3.77. More broadly, within the issue
date approach, there should be a general principle that the average
duration of capital instruments should not be significantly lower
than the average duration of an undertaking’s
liabilities.
With this in mind, the undertaking
should be required to assess the sufficient duration of own fund
items as part of its risk management.
CEIOPS suggests that this assessment
would be part of the ORSA and the supervisory review
process.
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