Confirmation that Solvency II will only take effect from 1 January 2013 came in the European Commission’s package of “Omnibus II” proposals, which was published on 19 January. Omnibus II also:

  • recognises that transitional provisions are likely to be needed in a number of areas to safeguard a smooth transition to Solvency II;
  • confirms that transitional relief will be provided for non-EEA countries that are committed to achieving “equivalence”; and
  • defines the scope of EIOPA’s powers to resolve disagreements between regulators and formulate binding technical standards (BTS).

We consider some of the issues raised by Omnibus II below. Proposed amendments to the Prospectus Directive are not covered.

General issues and next steps

Unfortunately, although Omnibus II promised a lot, it actually delivers little in terms of clarifying the final shape of the Solvency II regime. For example, the proposals set out the broad areas that transitionals may cover and their maximum duration. However, the precise scope of any relief will only be defined in Level 2 Measures, which are not expected until the middle of the year.

The proposal is also extremely difficult to read, not least because it reflects new terminology and procedural requirements that are embedded in recent reforms of the European regulatory framework. For example, Level 2 “implementing measures” become “delegated acts” and references to BTS are included in the Solvency II Directive (Directive) for the first time.

Omnibus II now goes to the Council and the European Parliament for consideration. It is not subject to formal consultation, although no doubt both HM Treasury and the FSA are studying its content carefully. Firms also need to consider the proposals and any need to make representations. For example, while industry lobbying on the need for transitionals appears to have met with some success to date, it is clearly important that firms do not take anything for granted until the detail has been decided. Otherwise, it seems that industry must wait yet again for much-needed clarification of key areas of the new regime.

Transitionals vs policyholder protection

One issue for UK insurers and reinsurers may be how the FSA (or the Prudential Regulation Authority as its successor organisation) will approach supervision of firms if Solvency II transitionals are less stringent than the FSA’s current regime. Omnibus II stresses that transitional provisions should be at least equivalent in effect to existing requirements in the insurance and reinsurance directives, but the current FSA regime goes beyond those requirements in a number of areas.

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. However, the FSA risks being in breach of its obligations under Solvency II if it prevents UK firms from taking 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).

Even if it were not a breach of EU law to continue to apply the UK’s current regime in those areas in which transitional relief would be available, such an approach would appear to conflict with the “Guiding Principles for EU Legislation” recently adopted by the Department for Business Innovation & Skills, the object of which is that the UK should resist any further “gold-plating” of European legislation.

Background to Omnibus II

The primary purpose of Omnibus II is to ensure that Solvency II legislation reflects recent reforms of the European regulatory framework, including the establishment of the European Insurance and Occupational Pensions Authority (EIOPA). EIOPA has taken over responsibility for the work previously carried out by the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS), but has the enhanced powers that were thought necessary following the economic crisis to secure greater harmonisation of supervision.

These powers include:

  • power to develop BTS; and
  • an ability to resolve disputes between supervisory authorities.

Omnibus II will define the scope of EIOPA’s powers under Solvency II in each of these areas; this is required by the legislation that establishes EIOPA. Other changes that have made their way into Omnibus II include, as expected, extending the date for implementation of Solvency II by two months – the new regime will now take effect from 1 January 2013. Importantly, the draft also allows the Commission to develop transitional provisions.

Binding technical standards

BTS are the starting point for the “single rulebook” in financial services legislation that aims to ensure greater harmonisation of supervision. They will be developed by EIOPA in the first instance and then endorsed by the Commission to give them legal force. Omnibus II defines the areas in which EIOPA is to have power to develop BTS. However, as it has until the end of this year to prepare drafts, this is yet another area of uncertainty for insurers in their planning for January 2013.

Settlement of disagreements

EIOPA has a general power to challenge regulators if it thinks they have failed to comply with any aspect of the Solvency II regime. In addition, it can resolve disagreements between supervisory authorities where the Directive specifically gives it power to do so. For example, Omnibus II proposes that EIOPA should have power to resolve disagreements on a number of issues relating to group supervision (e.g. over group model approval under Article 231).

We wonder whether it is short-sighted not to have made this a more general power to resolve disputes between regulators as Solvency II seems to raise so many possible areas of contention. However, as this would require an amendment to the legislation establishing EIOPA’s powers, it seems unlikely that it will happen any time soon.

Transitionals

The Commission argues that transitional provisions should permit a smooth transition to the new regime, curb market disruption and address any negative impact of the Directive on important insurance products.

Consistent with these objectives and as stated above, transitional requirements should be at least equivalent in effect to the existing framework under the insurance and reinsurance directives and should not result in more favourable treatment for insurance and reinsurance undertakings, or lower protection for policyholders, than currently exists under those directives. For example, this means that, for the transitional period, the SCR must be no less than the sum of the MCR and half of the difference between the MCR and the SCR.

Unfortunately, whilst Omnibus II establishes the areas in which transitional relief may be given, the detail is left for Level 2, including how long the relief in each case will last. Omnibus II does little more, therefore, than establish the maximum duration in each area (see separate box) and firms must wait until later this year (probably, June) for more detail. Pending such clarification, firms would clearly be unwise to rely on transitional provisions lasting for the maximum period allowed. They should also consider the need for further lobbying while the precise scope of the relief remains under discussion.

Please click here to view table on maximum duration of transitional relief.

Equivalence

In a letter to CEIOPS in October 2010, the European Commission accepted CEIOPS’s recommendation to include Bermuda and Switzerland in the first wave of assessments for all three levels of equivalence (reinsurance, group solvency and group supervision). Japan will only be assessed for reinsurance considerations in the first wave. There is no guarantee, however, that a finding of equivalence will be made in respect of these three jurisdictions by the time Solvency II comes into force. Considerable doubt also surrounds whether assessments of other jurisdictions can be completed by the beginning of 2013 or at least in enough time for insurers to plan with certainty for Solvency II.

As expected, Omnibus II allows for the development of transitional provisions at Level 2 on third country equivalence. Countries wishing to benefit will need to satisfy certain prescribed criteria and commit to converging towards a solvency regime capable of meeting the equivalence assessment criteria by the end of the transitional period. During that period, which has been limited to five years or shorter, third countries would receive the same benefits from equivalence as if there been a positive equivalence finding.

It will be interesting to see how high the hurdle is set for third countries wishing to benefit from transitional relief on equivalence. The higher it is, the greater the burden on regulators’ resources to determine whether it has been jumped. However, given the importance of the issue for firms, it seems likely that at least Bermuda, Switzerland and Japan will benefit if they have not already been found to be equivalent. It remains to be seen whether the US is afforded relief, although it must be a prime candidate given its importance to European insurance markets.

Role of EIOPA in relation to non-binding guidance

One final note on Omnibus II is that it deletes Article 71(3) of the Directive, which currently provides for the development by CEIOPS of Level 3 Guidance. Level 3 Guidance, whilst non-binding, is intended to represent Member State supervisory authorities’ agreed approach on how the regulatory regime should be implemented and this deletion could suggest that there will no longer be a place for Level 3 guidance under Solvency II. A more likely explanation, however, is that Article 71(3) is replaced by EIOPA’s general powers to issue guidelines designed to achieve supervisory convergence.

More interestingly, perhaps, Article 71(2) of the Directive currently requires Member States to ensure that supervisory authorities “take duly into account” non-binding guidance published by CEIOPS. The importance of guidance developed by EIOPA appears to be significantly enhanced under Omnibus II, which instead requires Member States to ensure that supervisory authorities follow EIOPA’s guidelines and provide reasons where they fail to do so.