Public Hearing on Solvency II 21 June 2006 European Commission Insurance and Pensions Unit
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1 Check against delivery Public Hearing on Solvency II 21 June 2006 European Commission Insurance and Pensions Unit by Henrik Bjerre-Nielsen, Chair of CEIOPS Ladies and Gentlemen, Thank you for the opportunity to present some thoughts, as the CEIOPS Chair, in this important hearing on the Solvency II project. As you know CEIOPS is working hard to fulfill its role in the project. We recently delivered our answer to the third wave of calls for advice and, at the same time, we started to work on what I call the fourth call for advice, in the light of the letter we received from Mr Schaub in January. This letter kept the pressure on our work load and timeframe very high, but I have to say, it did not really change our plans. In preparing our advice on the first three waves, we were aware that some aspects had to be reviewed or integrated in the light of further analysis or observations coming from the impact studies. This was CEIOPS declared approach since the beginning of our work. We shaped the answers to the calls for advice consistent with a progressive construction of the system, even within the challenging deadlines set by the Commission s road map. Nobody, I think, would have expected CEIOPS to define all the aspects of the forthcoming system all in once and before any field tests. The evolutionary nature of our advice should be kept in mind when reading our papers. Under this approach, at the end of this month we expect to issue for consultation some papers on Pillar II and group issues and in autumn, based on the results of the second round of QIS, we plan to consult on, among others, some critical Pillar I aspects, such as technical provisions and capital requirements. 1
2 I am sure that during this public hearing most of the topics included in the forthcoming CEIOPS advice will be widely analyzed and debated. Today I rather focus on some general aspects which in my view should be taken into due consideration at this phase of the project. The first relates to the process itself, the functioning of the Lamfalussy process. I think all the parties involved in the Solvency II project should be aware that we are not only developing a new regulatory and supervisory system, but also that we are using a new method from a procedural point of view: the Lamfalussy process. Attention is needed to tackling its challenges and exploiting its added value. The Lamfalussy process is complex. The achievement of its goals requires good calibration of the scope, the timing and the interactions between the levels and the actors involved in each of them. Insurance, with the Solvency II project, will be a real test for the Lamfalussy process, as it will be one of the first to be entirely driven by it. At this stage, let me just mention three considerations. First, the need to exploit the characteristics of the measures included in each level. Now we are assisting in drafting the Level 1 directive, which should create the fundamentals of the system. It should include principles and leave technical measures at level 2. I am aware there are some problems of political legitimacy in this regard and that drawing the borderline between principles and technical measures in practice is not easy, but I am also aware that concerns of excessive detail in Level 1 have been already underlined in the first reviews of the applications of the model. Dealing with a wide and complex issue like Solvency II, we should be keen to ensure appropriate flexibility of the EU legislation, allowing easy calibration of the legislation and quick updating in view of market changes. This will be particularly relevant with regard to the rules on capital requirements. In addition to that, I am convinced that successful implementation of the EU legislation will be enhanced by action to seek greater supervisory convergence through Level 3 work. In this respect, I have to emphasise the importance of leaving sufficient room for Level 3 measures when Levels 1 and 2 are being decided. A robust and appropriately harmonised regulatory framework will profit from a substantial Level 3. Standards, guidelines and recommendations, as tools for enacting Level 3 measures, will enable the system to respond to relevant changes quickly and flexibly, to strike a better balance between the need for harmonization and recognition of diversities in national 2
3 environments, as well as to cover aspects which are not considered appropriate to deal with in the EU prudential framework. In delivering advice to the Commission, CEIOPS anticipates considerable ongoing effort to secure these achievements, paving the way for future supervisory measures. Prominent examples of present CEIOPS work-streams for this purpose are in the areas of the conceptual framework and criteria for validation of internal models and of the methods and tools for defining requirements for additional capital (capital add-on) based on for the supervisory review process. The second aspect I would like to stress is the need to consider the dynamic value of the process when targeting convergence of supervisory practices. We should not be too ambitious in our wish to define an unchangeable and harmonized supervisory system based on a legislative framework from the very beginning. In my view, the complexity of the project, the number of elements and profiles to be taken into account and the objective diversities in the national environments, require an evolving approach, based in particular on building best practices through the issuance of level 3 measures, monitoring and calibrating their implementation and, only at a later stage, assessing whether some elements should be translated in EU Legislation. Thirdly, I would like to stress the need for the cooperative attitude and transparency of all the parties involved in the process. Overlaps and inconsistencies of consultations and discussions can be avoided or, at least, limited if each party is aware of its role, respects the competence of the others and behaves transparently. As an example of good practice, I can mention the good interaction we had with the Commission and the Level 2 Committee when we realized the need to get political guidance on basic aspects, such as the prudential margin to be included in the valuation of technical provisions. Indeed, we should not conceal that CEIOPS members, due to long lasting divergent traditions and practices, could have different approaches for pursuing the same prudential objectives. In such a situation, it appeared too difficult for CEIOPS to progress in developing the technical advice within the tight timeframe fixed by the Commission. The guidance given by integrating the framework for consultation of the Commission can be seen as a prompt reaction to this need. Adopting the same transparent approach, we are going to explain clearly the reasons for any divergence of our advice from the framework for consultation. We expect the Commission to behave in a similar way when reacting to our advice. The Commission actually work together with us when preparing the advice and is able to raise concerns and diverging views while the advice is under discussion within CEIOPS. The Commission 3
4 has the responsibility of the legislative initiative. We are clearly aware that it has the duty and the power to shape the legislative proposal as it deems more appropriate. Nevertheless, we presume that its initiatives will be substantially in line with our final advice and that, in the case of divergences, it openly expresses the reasons for diverging. Based on our experience to date, I am confident this presumption turn out to be true. Another aspect I would like to stress today is related to the desired level of harmonization we should achieve with Solvency II. It is clear that one of the main purposes of this project is to ensure a level playing field with regard to prudential regulation and supervision of insurers throughout EU. We should be aware that this purpose should be pursued in a system where, even though within a harmonized regulatory framework, much more room for discretion will inevitably be left to supervisors. This is inherent in the three pillar structure, where the supervisory review process in pillar II, i.e. the assessment of the capital adequacy of the individual company, represents the essential component for reaching the goal of having an upper (relative) bound on the expected shortfall of any European insurer. But this will also make the current differences in terms of supervisory culture and practice which still exist in EU, more critical. These differences, in addition, are often underpinned by the objective variety of market environments. How to strike the right balance between harmonization of the regime and recognition of diversities is, again, a problem which requires a pragmatic and evolutionary approach. In my view, in designing the new legislative framework we should target a high level of harmonization of the Pillar I and III aspects. Actual harmonization of financial and disclosure requirements appears to be a precondition for ensuring a level playing field of supervision in EU and fostering the creation of a stable and truly single market in this sector. More flexibility should be given to the provisions regulating the supervisory review process. A clear, principle-based EU legislation, supported by widely shared and effective supervisory measures and fostered by appropriate initiatives at CEIOPS level, represent, at this stage, the most convincing way for improving convergence of supervisory practices. In the current situation, actual convergence is better achieved by facilitating equal reactions to similar problems than by forcing supervisors to use the same procedures and tools. In other words, priority should be given to the creation of a European supervisory culture, rather than to the identification of too detailed harmonized rules which could result in being less effective or even becoming a constraint when applied to varying situations. Solvency II should represent not only a package of rules, but a new principles for conducting supervision. 4
5 Proceeding in this way, however, requires that at least two preconditions are fulfilled. The first is that CEIOPS fully covers its role as a level 3 committee. This requires not only full commitment of all the members, but also appropriate political backing as well as stakeholders recognition of the role CEIOPS is asked to play. Issuance of standards, assistance and peer pressure mechanisms for their actual implementation, a platform for the creation of European operational networking and a sharing of experience: all the level 3 activities should be exploited and developed. The second precondition I see is that the supervisors are actually able to develop their supervisory practices in line with the European standards and practices agreed within CEIOPS. This requires that competent authorities are sufficiently resourced to allow for active engagement in the work of CEIOPS and to develop their own practices. My experience to date suggests that it would be beneficial if there would be more equivalence of the powers of competent authorities and that some of the competent authorities would be more resourced. But, I am also aware that this is not necessarily enough to achieve convergence of practices. Convergence of objectives - and hence the independence of supervisors in line with the IAIS-standards - is also an important precondition. For this reason CEIOPS delivered to the EU Commission, on its own initiative, recommendations on this issue. Now I would like to highlight a couple of considerations which I consider particularly relevant in developing the future work on the project. The first one relates to the need to start focusing the Pillar III issues and ensuring an appropriate relationship with the IASB. Up to now, Pillar I and II issues have been widely analyzed and discussed. Prudential rules for recognition and measurement of technical provisions and other quantitative and qualitative requirements are in the way to be identified. Time is ripe now to start paying attention to Pillar III issues and, more generally, to the link between prudential rules and public financial statements. It is well known that Solvency II should be IFRS compatible. Even though the scope of application of the IFRS in Europe is still incomplete and variable, this would allow, at least as a tendency, better alignment between financial statements and supervisory reporting. Prudential rules compatible to IFRS would also foster the extensive application of these accounting standards and harmonization of reporting in general. All of us know that, in particular with regard to recognition and measurement of assets and liabilities, reconciling prudential and financial information purposes is not an easy task. I think, however, we have now, with Solvency II, a unique opportunity for achieving 5
6 this goal. Close links are necessary at this stage between Solvency II and the development of IFRS, in particular of the second phase of the IFRS standard on Insurance Contracts. I am glad to know that tomorrow CEIOPS will present the development of Solvency II to the IASB Board. I expect further cooperation in the future in the interest of both organizations. I would like to conclude this brief list of considerations by expressing some thoughts on what I consider the most critical step in the current phase of the project: the QIS2 exercise. In our first answers to the calls for advice on technical provisions and capital requirements, in line with the approach we adopted in advising, we only highlighted the relevant issues and tentatively indicated possible solutions. Now, before progressing in the advice, we need to test those solutions. In the specifications to this impact exercise we presented fixed instructions and a range of different methodologies on a number of aspects, for calculating both the technical provisions and the capital requirements. This modular approach has the purpose of giving CEIOPS more elements for refining the technical advice. Quantitative feed-back on the calculation of the technical provisions according to the different methods for defining the risk margin, will help in further discussion on the level of prudence to be embedded in them, while the results of calculation of the capital will help in identifying the appropriate structure for the standard formula. With regard to this latter aspect, let me stress that, at this stage, the focus of QIS2 is on design rather than on calibration. Further QIS exercises will most likely be necessary to refine the calibration of parameters and ensure its consistency with our prudential objective. As already declared, the purpose of this first round of studies is to identify the specific areas where the proposals under test seem to materially overstate or understate the level of risk. CEIOPS will then consider whether parameters or assumptions underlying the QIS2 proposals are capable of fine-tuning, or whether modeling approaches need to be replaced altogether to enable the true risk drivers to be captured. Until further work is done, therefore, it is not advisable to draw conclusions as to how Solvency II capital requirements will compare to Solvency I. In addition, it is worthwhile to remind that Solvency II follows an overall approach, including all the quantitative and qualitative aspects which can influence the capital adequacy of an undertaking. Any assessment on the level of prudence of the new regime should therefore consider all the parts of the system and their interactions. 6
7 I cannot avoid, finally, underlining again the crucial role of QIS2 and the importance of a wide and keen participation of the industry to this exercise. Even though further exercises are envisaged, progressing on the project will highly depend on the reliability and significance of its results. CEIOPS is using its best efforts for fostering a better understanding of the QIS2 specifications. A transparent Q&A procedure has been activated using our web-site. Close and constructive cooperation is under way with the industry representatives. More in general, CEIOPS is working and intends to continue to work closely with the industry and other interested parties on developing its contribution to the creation of the new system and, also, in view of the radical change needed in culture and management practices to implement the system. We are aware of market differences. Some undertakings are up to speed. Others have a long way to go. CEIOPS is deeply involved, together with the Commission, on fostering these reforms to business. They will go to the heart of Solvency II s success. One panel session in CEIOPS next Conference is exclusively devoted to Solvency II and the industry. I cannot conclude my contribution without underlining the world-wide dimension of Solvency II. CEIOPS is conscious of the great interest and, possibly, some concerns outside the EU. Together with the Commission we are working on the most pressing, from the US, starting a longer-perspective dialogue with China, and have exchanged approaches with the Swiss. We recognize that the global position is high in economic and commercial importance, as well as politically. My focus today has been necessarily selective. These are just a few of the issues which preoccupy CEIOPS. I believe they are important enough to outline to you today. I hope they provide you with a flavor of our present position, and some food for thought. Thank you for listening. 7
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