A European framework for recovery and resolution for the consistent protection of EU consumers

The protection of consumers is the overarching objective of the common European prudential supervisory regime, Solvency II. Other objectives such as financial stability, are only secondary. As a result, it is understandable that the upcoming review of Solvency II legislation is being used to ascertain how the system can be improved.

One of the issues that was identified as part of this review is the system of policyholder protection in cases where an insurer is likely to fail or failing. In Ireland, the lessons of failures of Irish insurers and foreign insurers conducting business in Ireland have been learned and the Insurance Compensation Fund (ICF) has been established. However, different EU Member States implemented different or no systems for these situations and, consequently, different models have evolved. A number of countries have implemented funds, known as Insurance Guarantee Schemes, that guarantee that claims are still paid even if an insurer is failing, however, other models have also been developed to ensure that:

a) insurers can take the right measures to prevent a failure;

b) the policies of consumers can continue to be fulfilled; or

c) the insurance portfolio will be specifically reviewed in cases where a liquidation of the insurer cannot be avoided.

These systems are generally described as Recovery and Resolution frameworks and, in the last few years, a few Member States – such as France, Romania and the Netherlands – have developed frameworks of this nature.

The review of Solvency II is an opportunity to review the existing national measures and develop a common and consistent EU framework for the protection of consumers. Consistency is key, particularly for a small, open and export-oriented economy like Ireland. Irish insurers serve consumers in nearly all EU Member States and insurers from other EU countries provide their services to Irish consumers. As a result, it is crucial for the consumer that a consistent system is in place across all EU Member States. For insurers, this consistency is equally important. For internationally active insurers, a piecemeal approach of different systems and provisions increases the regulatory burden on their business. Furthermore, where national systems fall behind a certain standard, we could see competitive imbalances.

The European Commission have already been working for some time to develop a common EU framework for the recovery and resolution of insurance undertakings. They asked the European Insurance and Occupational Pensions Authority (EIOPA) to provide their advice on how a system of this nature would operate, and EIPOA are expected to submit their conclusions by the end of 2020. The European Commission will then present a legislative proposal to its co-legislators in the European Parliament and the Council after the summer of 2021.

The recovery and resolution framework is not an addition or top-up to the existing rules. Instead, it will need to be tailored into the existing system and respond to the needs of consumers and jurisdictions across the EU. Nevertheless, it will be essential that a sensible balance is struck in creating the framework. It will also be crucial that we see as little fragmentation and divergence as possible created by EU Member States. Due to the specific position of Ireland as an international hub for insurance, it is particularly important to our insurers and consumers that policymakers ensure a common approach and avoid fragmentation at national level.

National action on core elements of recovery and resolution, as well as on technical elements of the future framework, will lead to fragmentation of the single market. Furthermore, the implementation of national solutions just before the legislative process at EU level commences, leads to unnecessary costs for insurance businesses – firstly, to implement a system that is unlikely to stay the course and, secondly, for the changes required to move to a consistent EU approach.

Unfortunately, a process was recently commenced here in Ireland that may lead to that precise outcome. Only recently, the Central Bank of Ireland’s (CBI) public consultation on pre-emptive recovery measures closed. Insurance Ireland contributed to this consultation, providing technical feedback and sharing our concerns about the divergence from the EU single market.

The proposals presented by the CBI will most likely lead to the situation that we are urging Irish policymakers to avoid. Pre-emptive recovery planning is only one single aspect of a comprehensive framework on recovery and resolution. It is not clear why this specific aspect was identified by the CBI for action. Furthermore, the CBI’s proposals significantly diverge from the discussions at international level and the existing measures in other Member States in a very fundamental way.

A good example is the scope of the measures. The International Association of Insurance Supervisors (IAIS) focuses on so-called Internationally Active Insurance Groups (in total, there are nine such insurance groups across the EU). Similarly, national systems within EU Member States focus their efforts on larger insurance groups. In contrast, the CBI applies its system to all market participants and looks at entities of groups rather than group level. This approach would create a considerable additional regulatory burden on smaller insurance businesses.

In addressing concerns about the pre-emptive nature of these proposals and their likely inconsistency with a future EU framework, the CBI references an EIOPA opinion, which was consulted on last year. It is important to note that this is neither the technical advice of EIOPA, the position that the European Commission will present as a legislative proposal, nor a stable agreement by EU co-legislators.

Notwithstanding the significant issue of the scope of their proposals, this is not a reasonable approach. In addition, the CBI justifies its wide-ranging approach with evidence collected between 1999 and 2016. While we agree that the big number of failures during this time presented a challenge to the market and consumers, it is important to note that Solvency II has only been applied since 2016. Furthermore, Solvency II was created and shaped in accordance with the lessons learned from the financial crisis, which was the main driver of the evidence referred to by the CBI.

With regards to the CBI’s focus on pre-emptive recovery specifically, the insurance industry considers this to be a minor aspect of the wider recovery and resolution framework, and not the starting point for the development of the framework. It should also be noted that Solvency II already includes measures requiring insurers to plan for a potential recovery. In fact, the implementation of these measures was triggered by observations during the financial market disruption in the early 2000s and further defined based on the lessons learned from the recent financial crisis.

Insurers constantly monitor their risks and consider measures to recover from potential external shocks in the own risk and solvency assessment (the central element of Solvency II). Under Solvency II, the first line of defence is the Solvency Capital Requirement (SCR), the total amount of own funds that insurance and reinsurance companies in the EU are required to hold. Where an insurer is likely to breach the SCR, it must present plans to its supervisor on how to recover from this (potential) situation and comply with the SCR. If an insurer’s available resources fall below the SCR, then supervisors are required to take action with the aim of restoring the insurer’s finances back into the level of the SCR as soon as possible. Notwithstanding any measures foreseen at national or EU level, the SCR should be maintained as a core principle of Solvency II.

We would also like to highlight that the insurance industry overall is well capitalised. The SCR requires that an insurer is able to meet its obligations over the next 12 months with a probability of at least 99.5%. The average ratio at the worst moment of the Covid-19 crisis at the end of the Q2 2020 was 225 % across the EU. For the second line of defence, the Minimum Capital Requirement (MCR), which is considered to be the “hard floor”, the coverage ratio was 593% across the EU.

A broad and market-wide intervention across all entities, as foreseen by the CBI, might not be justified. The IAIS recommendation and the systems that exist in other EU Member States recognise this point in the scope of their frameworks as mentioned above.

In light of the ongoing legislative initiative at EU level and the challenges relating to the CBI’s approach, Insurance Ireland urges the CBI to reconsider its own proposal. Rather than taking a standalone national approach, which we fear would negatively impact on consumer protection and the competitiveness of the Irish insurance market, we would encourage the CBI to contribute to the EU discussion to ensure an effective and efficient EU recovery and resolution framework.

The CBI’s role in the further integration of the EU single market is crucial. Regulatory and supervisory convergence are the backbone of the internal market and the CBI’s voice is essential in this discussion.

Insurance Ireland identified the creation of a consistent recovery and resolution framework as one of our priorities for the Solvency II framework. In this regard, we would like to see a system that consistently protects consumers, acknowledges the existing measures in Solvency II, contributes to the integration of the EU single market and ensures the global competitiveness of EU insurers.

In order to ensure that a framework of this nature can be achieved, a consistent and harmonised EU proposal is necessary that considers the following points:

• Acknowledgement of the measures already existing under Solvency II and a common supervisory approach regarding their application rather than another layer of measures,
• A consistent set of measures for supervisors in cases of the resolution of insurance undertakings following the general principles that any exceptional measures need to be evaluated against public interest and the assumption that “no policyholder is worse off” than in an ordinary procedure.
• Market-based resolution procedures focussed on administrative procedures and funded ex-post where additional funds might be required.
• A clear distinction between the objectives of guarantee schemes and resolution mechanisms.

If you would like to know more about this or if you have any questions, please contact Florian Wimber (florian.wimber@insuranceireland.eu) or Jacqueline Thornton (jacqueline.thornton@insuranceireland.eu).