The FSA's confirmation at the beginning of October that it is working towards a 1 January 2014 start date for Solvency II provided much-needed certainty for firms. Since then, it has tried to clarify what this delay means for firms through the release of Q&As and in its first consultation paper on implementation of the new regime (CP11/22). Nonetheless, a number of questions remain unanswered, including:

  • When can firms expect outstanding issues to be resolved? 
  • To what extent will firms be able to opt into aspects of Solvency II from January 2013? 
  • Does later implementation of Solvency II reduce the need for transitional relief and, if so, to what extent? 
  • What reporting obligations will apply to firms during and at the end of 2013?

Adoption of the Omnibus II Directive (Omnibus II) would undoubtedly represent a significant step forward in addressing these issues, but this will not now happen before Q1 2012. Further, the respective positions of the European Parliament, Council and Commission suggest that there are a number of issues to be resolved in negotiations over the next few months, making it difficult to be sure when the final shape of the regime will be known.

We consider below some of the legal issues raised by the decision to delay full implementation of Solvency II until 2014. We also look at next steps in the process for finalising the regime.

The importance of Omnibus II

From a legal perspective, the date on which Solvency II comes into force can only be changed by amendment of the Solvency II Framework Directive (Framework Directive). This in turn depends on political agreement being reached on all aspects of Omnibus II, albeit that the January 2014 start date seems now to be a matter of rubber-stamping.

Omnibus II amends the Framework Directive to reflect recent reforms of the European regulatory framework, including the establishment of EIOPA (which replaced CEIOPS from the beginning of this year). In particular, Omnibus II will define the scope of the Commission's powers to make Level 2 delegated acts (previously known as "implementing measures"). It will also establish EIOPA's powers to develop binding technical standards and to resolve disputes between supervisory authorities. Other changes that have made their way into Omnibus II reflect the new Solvency II timetable and the need for transitional provisions. Further substantive changes to the regime are also proposed.

After considerable delay, current indications are that the European Parliament will consider Omnibus II in its 13-16 February 2012 plenary session although this date could still change. Before February, the Parliament's Committee on Economic and Monetary Affairs (ECON) is due to finalise its position on Omnibus II by 22 November 2011, taking account of some 472 proposed amendments. This will be followed by trilogue discussions between the Commission, Council and Parliament, which aim to resolve outstanding differences (see Solvency II timeline, here).

A review of current Council proposals (set out in its 21 September Presidency compromise text), as compared with the Commission's original proposals and the position that is likely to be taken by Parliament (to the extent that this can be determined before the outcome of discussions on 22 November is known), shows that there are significant differences that will need to be ironed out over the next few months. This means that, although we have some indication of the direction of travel for Omnibus II, considerable uncertainty about how it will finally look remains.

Once Omnibus II has been agreed, the process for adopting Level 2 delegated acts can at last begin. Formal consultation by EIOPA on binding technical standards and Level 3 guidance (other than as is covered in current consultations on the ORSA and reporting) is only expected after the Level 2 legislation has been finalised. Whilst there has been some consultation with key stakeholders in relation to both, a failure to publish drafts more widely has been frustrating and has undoubtedly stifled debate over the detailed requirements of the new regime. From a legal perspective, it is particularly unfortunate that public scrutiny of proposed Level 2 legislation has been limited, given that it will apply directly in the UK and will not require transposition here.

What has the FSA said about the delay?

On 4 October 2011, the FSA published revised implementation planning assumptions. It commented as follows:

  • Issues still to be resolved in Europe include the approach to groups, equivalence, reporting and transitionals. 
  • Whilst Solvency II will be "switched on" for firms on 1 January 2014, EEA states will need to transpose the Framework Directive into national law by 1 January 2103, bringing the responsibilities of supervisors and EIOPA into effect from this earlier date. 
  • For firms that are currently in the pre-application phase of the FSA's internal model application process (IMAP), the FSA will be open to receive applications from 30 March 2012.
  • The FSA will allocate submission slots between 30 March 2012 and mid-2013 to other firms wishing to enter IMAP. 
  • For standard formula firms, the FSA's working assumption is that they will be able to apply from 1 January 2013 for approvals that they will need from 1 January 2014 (e.g. requirements to use Undertaking Specific Parameters (USPs) for SCR calculations), although the FSA may choose to deal with more complex issues earlier.

Q&As published by the FSA and CP11/22 confirm the above and provide some detail on what the additional delay means for firms. They also acknowledge that a number of issues, in particular on how firms will transition from the current regime to Solvency II, remain under consideration.

Implications of Solvency II delay for firms

While so much of the new regime remains unsettled, firms might be expected to welcome the FSA's confirmation of a further delay to the Solvency II timetable. For some, though, the position is more complicated. The ABI has noted that many UK firms' preparations for Solvency II are well-advanced in the expectation that their internal models need to be fully functional by the beginning of 2013. Requiring these firms to stick with the current ICAS regime for a further year will come at some considerable cost. Lloyd's has similarly expressed concern about the cost of running parallel regimes during 2013.

The FSA has confirmed that it is looking at how firms might be allowed to use their Solvency II model or the standard formula calculation as a proxy for the ICA/ICG although it does not expect to reach a decision before Omnibus II is finalised. This proposal raises a number of legal issues:

  • If the UK chose to implement all or any part of Solvency II from the beginning of 2013, it would be inconsistent with the government's latest pronouncements that UK businesses should not be put at a relative disadvantage to firms operating from elsewhere in Europe1. It would mean that UK firms are required to meet higher capital requirements than other EEA insurers that remain subject to Solvency I during 2013 (although UK insurers are, of course, already subject to higher standards than are required by Solvency I)

In practice, subject to satisfying other concerns described below, the FSA is likely to allow UK insurers and reinsurers to opt in to a Solvency II regime for the calendar year 2013, rather than making the new standards mandatory during this period. Latest indications from the FSA are that, once it has defined its position on this issue, it will be available to all firms applying to use an internal model or the standard formula subject to their ability to demonstrate the suitability of the methodology and to the FSA's acceptance of it. The requirement for FSA acceptance should allay concerns about cherry-picking by firms.

  • Another issue for the FSA is that UK firms will still need to demonstrate that they are meeting Solvency I standards during 2013 if they opt in to Solvency II. The FSA will need to decide how best to reconcile its obligations under the Solvency I regime with early implementation of Solvency II, including whether firms will have to complete a Solvency I-style return for the 2013 financial year-end. 
  • It is not clear whether the delay to the Solvency II timetable will affect how quickly more detailed aspects of the regime are finalised, including matters covered by technical standards being developed by EIOPA. Early implementation by the FSA of Solvency II requirements will be difficult, if not impossible, pending political agreement on outstanding issues. Otherwise there must be a risk, at least, that firms are not required to meet either Solvency I or Solvency II requirements for a year, again leaving the FSA open to challenge.
  • Finally, whilst the FSA may be willing to take a pragmatic approach to the introduction of Solvency II, where it is able to do so, other supervisory authorities may be less flexible. This may cause particular problems in the context of group supervision, irrespective of the relevant legal analysis.

Wherever the FSA comes out on early implementation, both the Council and Parliament envisage that during 2013 firms should show supervisors that they are on course to comply with the new regime when it comes into force. The Council wants firms to prepare an implementation plan by 1 June 2013, which describes their state of preparedness and how they intend to achieve compliance by the end of the year. The Parliament's proposal seems to go further in requiring, by 1 July 2013, firms to calculate their SII balance sheet, SCR, MCR and own funds although the date for submitting this information to the relevant supervisor, and the extent to which such calculations will be permitted to take transitional provisions into account, are unclear.

Firms will need clarity on what is expected of them and by when. Under the Council's proposal, EIOPA will be required to issue guidelines by 31 March 2013 on what the implementation plan should cover. This seems late given a 1 June deadline for the plan's submission. Helpfully, neither proposal involves public disclosure of a firm's position.

Impact of delay on transitionals

The Commission has said that transitional provisions should permit a smooth transition to the new regime, curb market disruption and address any negative impact of the Framework Directive on important insurance products. Arguably, a further twelve month delay to the introduction of the new regime reduces the need for transitional provisions when judged against these criteria. Subject to the needs of industry, the FSA may welcome such an outcome, at least to the extent that transitional requirements are less onerous than the FSA's current regime.

This is because, whilst Omnibus II stresses that transitional provisions should be at least equivalent in effect to existing Solvency I requirements, the current FSA regime goes beyond those requirements in a number of areas. Where this is the case, it is not clear how the FSA (or the Prudential Regulation Authority as its successor organisation) will approach supervision of firms but we think it unlikely that the FSA will be comfortable for firms to drop their standards to the level of transitional provisions in these circumstances. The only indication we have on the approach it expects to take is that its current regime will stay in place until Solvency II comes into effect, but this comment appears in the FSA's 31 October 2011 Q&As on implementation generally and not against a background of the transitionals and what they may say.

The FSA risks being in breach of its obligations under Solvency II, though, if it does not allow UK firms to take the benefit of relief that is automatically available to other firms across Europe. The position is, of course, different if Member States have discretion whether to allow transitional relief, although it would still be necessary to consider the UK government's own "Guiding Principles for EU legislation".

Outstanding issues

Until the Parliament has finalised its position on Omnibus II, analysis of precisely where the differences lie between the Council, Commission and Parliament is difficult. However, some general comments flow from what we have seen to date:

  • Amendments proposed by both the Council and Parliament would define the scope of transitional provisions more closely in the Framework Directive itself than has been proposed by the Commission. This approach has the advantage of making the position on transitionals more certain at an earlier stage than under the Commission's proposals. It does not, though, have the same flexibility as an approach that leaves the detailed provisions for the Commission to define at Level 2.
  • Although the Council and Parliament agree in a number of respects on transitional provisions (e.g. 10 year grandfathering of own funds; five year transitionals for equivalence findings), there are also some significant differences between them. Resolving these differences, and other different proposals for technical amendments, may take some time during trilogue discussions.
  • Parliament proposes that EIOPA should submit all draft technical standards to the Commission by 1 June 2012; the Council envisages a longer period overall for the delivery of drafts by EIOPA, with different deadlines between 30 September 2012 and 31 December 2016. For firms that are concerned about uncertainty under Solvency II, clearly the Parliament's timing would be preferable.

Conclusion

Full implementation of Solvency II by the beginning of 2013 was always likely to present insurers and supervisors with a huge challenge and this latest delay to the timetable provides welcome breathing space. It also raises issues, though, about whether firms should be able to choose to be regulated according to Solvency II standards during 2013 and, if so, how this can be achieved in the absence of final rules. However this issue is resolved, it is clear that firms must continue to progress their Solvency II preparations if they are to meet the new 2014 deadline and any 2013 requirements that may ultimately be agreed under Omnibus II.