Principles without pensions for Solvency II

The forthcoming Solvency II directive will follow a principles-based, rather than a rules-based approach, according to the European Commission. The move, announced in April by the Commission's director of financial institutions, Elemer Tertak, represents a victory for the UK regulatory camp at the Committee of European Insurance & Occupational Pensions Supervisors (CEIOPS).

To obtain consensus on principles, the Commission had to overcome fierce resistance from the traditionalist wing of CEIOPS, led by France's insurance regulator ACAM (see Life & Pensions, February 2006, p28). These traditionalists argue that when principles are used as the basis for Pillar I quantitative requirements, the freedom of firms to make their own judgements poses too much risk to policyholders. Instead, technical rules should be in place to determine liabilities.

The compromise brokered by the Commission borrowed the concept of deposit insurance from banking, which Tertak also regulates as part of his responsibility at the Commission's internal market and services division. In an interview with Life & Pensions, Tertak said that the next draft of Solvency II will include proposals for a pan-European insurance guarantee scheme, which will protect policyholders from insolvent insurers. The scheme will be nationally administered but harmonised across the EU.

The influence of the UK is apparent in the other significant Solvency II decision reached in April. Under pressure from the national government representatives making up the European Insurance & Occupational Pensions Committee (EIOPC), the commission has decided to drop occupational pensions from the Solvency II process.

The chronic problem of UK pension deficits, and the equally chronic problem of unsustainable continental state pensions, was acting as "ballast", in the words of Tertak, which threatened to prevent Solvency II from getting off the ground. The commission has imposed a tight schedule on the process. It plans to have a so-called framework directive presented to the European parliament by July 2007, and the final directive signed into EU law by 2010.

With the framework directive likely to include a standard Pillar I formula, this timetable gives the second Solvency II quantitative impact study (QIS2) particular importance. Completed in March, the first study (QIS1) required CEIOPS members to compile estimates of liabilities based on the traditionalist percentile approach, but the results were contradictory or inconclusive.

QIS2 will allow a re-run of the percentile calculations, along with a concurrent test of the rival cost-of-capital/market value margin approach favoured by the UK regulatory camp and large industry players such as the chief risk officer (CRO) forum. The Commission has set an October 2006 deadline for the completion of QIS2 - potentially making it the last such study before the framework directive is drafted.

Tertak has identified asset-liability mismatch risk as a priority for the framework directive and the way the two competing approaches pick this up is likely to be closely watched in Brussels. Tertak urged practitioners to participate in QIS2, warning that "you will get the Solvency II you deserve".

The full interview with Elemer Tertak will be published in the June issue of Life & Pensions.