The Solvency II Directive (the Directive) contains important new provisions to strengthen the supervision of insurance groups. Many of them are based on the provisions applicable to individual insurers (solo supervision), but there are additional requirements that address group-specific issues, such as those relating to group solvency, the reporting of group risk concentrations and intra-group transactions. Insurance holding companies (broadly parent undertakings that have mainly insurance or reinsurance subsidiaries) are subject to provisions under the new regime which regulate group solvency, group governance, group reporting, disclosure and group risk management. This newsletter considers key group supervisory requirements under the Solvency II regime.

Key points

Solvency II includes the following group level requirements:

  • Solvency calculations will be required at the group level as well as solo level.
  • Insurance holding companies and their (re)insurance subsidiaries will be jointly responsible for monitoring the group Solvency Capital Requirement (group SCR).
  • Insurance holding companies will need to have in place systems and reporting procedures, including appropriate systems of governance and written policies in relation to risk management, internal control, internal audit and, where relevant, outsourcing. 
  • Significant risk concentrations at group level and significant intra-group transactions will need to be regularly reported to the group’s supervisory authority. 
  • All persons who effectively run insurance holding companies or have key functions will be required to satisfy the fit and proper criteria.
  • Insurance holding companies will be required to carry out an own risk and solvency assessment (ORSA) at the group level, publish a solvency and financial condition report (SFCR) and provide to the supervisory authority a group regulatory supervisory report (RSR), although each of these can be combined with the corresponding assessment or report that is required for any (re)insurance subsidiary.

Application and scope of group supervision

Insurers will be supervised at group level and therefore it is critical to determine which entities are included within the Solvency II group. Existing groups should not assume that the scope of the group under the current Insurance Groups Directive (IGD) will be the same under Solvency II. If a firm is part of a group that is not currently captured under the group provisions of the IGD, it does not necessarily mean that the firm and the wider group will not be captured under the provisions of Solvency II.

Supervision at group level under Solvency II applies to EEA (re)insurers if:

  • they are participating undertakings (broadly they are the parent of or hold at least 20 per cent. of the capital or voting rights) in at least one other (re)insurer (article 213(2)(a) of the Directive);
  • their parent undertaking is an EEA insurance holding company or EEA mixed financial holding company (article 213(2)(b) of the Directive);
  • their parent undertaking is a non-EEA (i.e. third-country) insurance holding company or non-EEA mixed financial holding company (article 213(2)(c) of the Directive); or
  • their parent undertaking is a mixed-activity insurance holding company, in which case supervisory authorities responsible for the supervision of the insurer will also need to exercise general supervision over transactions between that insurer and its mixed-activity holding company (article 213(2)(d) of the Directive).

The diagram below illustrates the groups falling under articles 213(2)(a), 213(2)(b) and 213(2)(c) of the Directive.

Click here to view image.

Source: EIOPA Guidelines on Group Solvency

However, a supervisory authority may decide not to include in its group supervision an entity that (a) is based in a third country where there are legal impediments to the transfer of necessary information, (b) is of negligible interest with respect to the group supervision objectives; or (c) would be inappropriate or misleading to include with respect to those objectives.

Where an EEA insurance holding company is affiliated with a regulated entity or a mixed financial holding company that is subject to supplementary supervision by a Member State under certain EU legislation, the group supervisor may decide not to carry out the supervision of risk concentration or intra-group transactions at the level of that insurance holding company.

Level of group supervision

If the insurance holding company is itself a subsidiary of another EEA insurer or insurance holding company, group supervision only applies at the level of that ultimate EEA parent undertaking.

Where an EEA insurance holding company does not have its head office in the same Member State as the ultimate EEA parent company, supervisory authorities may subject the insurance holding company to group supervision at national level. What has been a concern of many global insurance groups is the power supervisory authorities have to carry out (subject to agreement by the relevant supervisory authority) group supervision at the level of a subgroup covering several Member States.

The Solvency II regime encourages and, indeed requires, all supervisory authorities who are involved in the supervision of a group to work together to effectively supervise the group. The Directive requires supervisors from all Member States where a group has subsidiaries to form a college of supervisors with the objective of regulating the specific group in question. It should be noted that group supervision may include groups headquartered, or with subsidiaries outside the EEA, but this will depend on the extent to which supervision in the relevant third country is deemed equivalent to that under Solvency II.

Group solvency calculation

Insurers are required to ensure that eligible own funds are available in the group that are always at least equal to the group SCR, which must be calculated not only at the individual “solo” level for insurers, but also at group level for insurance holding companies.

There are several methods available to calculate the group SCR. These are the consolidation method (which is based on treating the group as a single consolidated balance sheet), the deduction and aggregation method (which is based on the difference between the sum of the aggregated individual own funds in the group and the aggregated individual SCRs in the group), or a combination of both. The requirements for insurance holding companies will vary depending on which method is used. For this calculation, parent companies are treated as though they are insurers subject to the solvency calculation rules set out in the Directive.

The group SCR calculation must be carried out by either the insurer or the insurance holding company at least annually and submitted to the supervisory authority and there is an obligation on both insurers and their insurance holding companies to monitor the amount of eligible own funds they hold and the SCR on an ongoing basis. This obligation requires insurance holding companies to play a very active role in monitoring the capital position of the group.

To the extent that the risk profile of the group is not adequately reflected in the group SCR, the supervisor has the power to apply a capital add-on at group level.

System of governance

The Directive’s governance requirements apply at group level and require insurance holding companies to have in place certain systems and reporting procedures, which are subject to review and oversight by the group’s supervisory authority. The risk management and internal control systems and reporting procedures must be implemented consistently across all the group’s undertakings and must include at least: (a) adequate mechanisms as regards group solvency to identify and measure all material risks incurred and to appropriately relate eligible own funds to risks; and (b) sound reporting and accounting procedures to monitor and manage the intra-group transactions and risk concentration.

Effective system of governance

Insurance holding companies are required to have in place an effective system of governance which provides for the sound and prudent management of the business, proportionate to the nature, scale and complexity of the insurance holding company’s operations. This system must include at least an adequate transparent organisational structure with a clear allocation and appropriate segregation of responsibilities and an effective system for ensuring the transmission of information, which is subject to regular internal review.

An insurance holding company must take reasonable steps to ensure continuity and regularity in the performance of its activities, including the development of contingency plans. It must employ appropriate and proportionate systems, resources and procedures to this end and must also comply with the requirements relating to: (a) the fit and proper requirements for persons who effectively run it or have other key functions; (b) proof of good repute; and (c) risk management.

Written policies

Written policies must be put in place by insurance holding companies relating to at least risk management, internal control and audit, and, where relevant, outsourcing. Those policies, which must be implemented and reviewed at least annually, are subject to the company’s administrative, management or supervisory body’s prior approval and must be adapted in view of any significant change in the system or area concerned.

Internal control system

An effective internal control system must be established by the insurance holding company which incorporates at least administrative and accounting procedures, an internal control framework, appropriate reporting arrangements at all levels of the undertaking and a compliance function that includes advising the administrative, management or supervisory body on compliance with the Solvency II requirements. It should also include an assessment of the possible impact of any changes in the legal environment on the operations of the undertaking concerned and the identification and assessment of compliance risk.

Supervision of risk concentration

Insurers or their insurance holding companies must report on a regular basis (and at least annually) to the supervisory authority any significant risk concentration at group level, unless the supervisory authority has decided in accordance with the Directive not to supervise risk concentration at the level of that insurance holding company.

The supervisory authority is required to identify the type of risks that insurers and/or insurance holding companies must report in all circumstances. Where the group’s risk profile deviates significantly from the assumptions underlying the last reported group SCR calculation, the group SCR calculation must be recalculated and reported to the supervisory authority.

Supervision of intra-group transactions

Insurers and their parent holding companies must also report to their supervisor on a regular basis (and at least annually) all significant intra-group transactions by insurers within the group, unless the supervisory authority decides not to carry out the supervision of intra-group transactions at the level of that insurance holding company.

Very significant intra-group transactions must be reported to the group supervisor as soon as practicable. Such intra group transactions are likely to include significant intra group transfers of risk, borrowing or guarantees. Groups will have to ensure that they have adequate systems in place to monitor such transactions.

ORSA

An ORSA must be conducted by insurance holding companies at group level, which is subject to the supervisory authority’s review. Insurance holding companies may, subject to the supervisory authority’s agreement, undertake any ORSA required at group level and at the level of any subsidiary in the group at the same time, and may provide a single document covering all the assessments.

In assessing their overall solvency needs, insurance holding companies must have in place processes that are proportionate to the nature, scale and complexity of the risks inherent in their business. Insurance holding companies must carry out the ORSA regularly and without any delay following any significant change in risk profile and are required to inform the supervisory authority of the results of each ORSA. However, the ORSA is not intended to serve to calculate a capital requirement.

Internal audit

An effective internal audit function must be provided for by insurance holding companies which should include an evaluation of the adequacy and effectiveness of the internal control system and other elements of the system of governance. The internal audit function must be objective and independent from the operational functions and any findings and recommendations of the internal audit function should be reported to the administrative, management or supervisory body.

Actuarial function

An effective internal actuarial function must also be provided for by insurance holding companies to, amongst other things, coordinate the calculation of technical provisions and contribute to the effective implementation of the risk-management system ORSA. The actuarial function should be carried out by persons who have knowledge of actuarial and financial mathematics, commensurate with the nature, scale and complexity of the risks inherent in the business of the insurers or reinsurers, and who are able to demonstrate their relevant experience.

Outsourcing

Insurance holding companies remain fully responsible for discharging all of their obligations under the Directive if they outsource certain functions or any insurance activities. They must, in a timely manner, notify the supervisory authority prior to the outsourcing of critical or important functions or activities as well as of any subsequent material developments with respect to those functions or activities.

SFCR

Insurance holding companies must disclose publicly, on an annual basis, the SFCR at group level. Subject to the supervisory authority’s agreement, a single SFCR may be provided which includes both the information to be disclosed at group level and the information for any of the subsidiaries within the group.

The SFCR must include information relating to the business, system of governance, level of risk exposure, assets, liabilities and capital management at both group level and at the level of any subsidiaries within the group. Certain disclosure may not be required if, for instance, it could give competitors a significant undue advantage. The insurance holding company and/or the insurer must disclose any major development affecting the relevance of the information disclosed in the SFCR.

RSR

Insurance holding companies must provide to the supervisory authority an RSR which includes a summary highlighting any material changes that have occurred in the insurance holding company’s business and performance, system of governance, risk profile, valuation for solvency purposes and capital management over the reporting period, and provide a concise explanation of the causes and effects of such changes. The summary should also include information on the ORSA.

Conclusion

Insurance groups are starting to put in place new governance, reporting and risk management procedures, but there is a lot to do in a short space of time to meet the substantial new requirements that take effect on 1 January 2016. Further, there are still outstanding issues that insurers are grappling with from a practical perspective, especially where supervision will apply to group entities that were not previously supervised.

A number of insurers are working on setting up the necessary committees and trying to finalise exactly what the Solvency II group will look like. Insurers are having to consider carefully which entities in their group are subject to the new Solvency II regime and the specific allocation of responsibilities across the group. Alternatively, some insurers may consider ways to structure their groups so as to ensure that they are not disproportionately affected by the new regime.