Opinion of the Economic and Social Committee on the "Proposal for a Directive of the European Parliament and of the Council amending Council Directive 79/267/EEC as regards the solvency margin requirements for life assurance undertakings"

(2001/C 193/04)

The Council decided to consult the Economic and Social Committee, under Article 262 of the Treaty establishing the European Community, on 13 December 2000 on the above-mentioned proposal.

The Section for the Single Market, Production and Consumption, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 10 April 2001. The rapporteur was Mr Pelletier, and the co-rapporteur was Mr Vaucoret.

At its 381st plenary session on 25 and 26 April 2001 (meeting of 25 April), the Economic and Social Committee unanimously adopted the following opinion.

1. Introduction

1.1. The solvency margin constitutes a key element in the supervision of insurance companies. It allows the financial soundness of these businesses to be ascertained and with that their ability to honour their commitments in the event of risks materialising unexpectedly. The required solvency margin is one of the most long-standing items of European insurance harmonisation, since it was established with the first life and non-life directives(1). Because it was introduced such a long time ago, it has become necessary to bring the required solvency margins up to date, and it is for this reason that two proposals for directives have been prepared by the European Commission(2).

1.2. The two proposed directives are designed to enhance the protection of insurance policyholders by improving the rules regarding the solvency margin of insurance undertakings. The two proposals have many measures in common.

1.3. The proposed directives are only aimed at the regulatory principles for determining the solvency margin and exclude other elements which might also contribute to a company's solvency in the broadest sense of the term, such as carefully estimated technical provisions and properly invested assets.

2. Background

2.1. Required solvency margins (RSMs) were established by the first non-life directive of 24 July 1973 (73/239/EEC) and the first life directive of 5 March 1979 (79/267/EEC).

2.2. Directives 92/49/EEC of 18 June 1992 (third non-life directive)(3) and 92/96/EEC of the Council on 10 November 1992 (third life directive)(4) did not alter the required solvency margins, as any amendments to these would have held up their adoption. However, in view of the fact that such amendments might be necessary, in Article 25 and Article 26 respectively of these two directives the Community legislator provided for the Commission to "submit a report to the Insurance Committee on the need for further harmonisation of the solvency margin".

2.3. Subsequently, the Conference of the Insurance Supervisory Authorities of the Member States of the European Union, under the chairmanship of Dr Muller, drafted a report on the solvency of insurance undertakings, known as the "Muller Report". This report was approved by the Conference of Supervisory Authorities in April 1997. The final European Commission report, dated 24 July 1997(5), was to a great extent based on the study carried out in the Muller report and concluded that there might be a need to improve the solvency margin.

2.4. The Commission's work on this subject, from summer 1997 onwards, produced the two proposals submitted on 25 October 2000.

2.5. In the longer term, particularly in the context of the reports on the implementation of the draft directives, the intention is to carry out a fundamental review of the methods employed for analysing the overall financial position of insurance companies. This exercise is known as "Solvency II".

3. General comments

3.1. The Economic and Social Committee considers that the European Commission's working methods in the "Solvency I" exercise have been exemplary as regards the consultation of people in the profession. Professional bodies, including the CEA, the ACME, AISAM(6) and the consultative group of European actuaries were indeed consulted by the Commission from February 1996 onwards and throughout the "Solvency I" exercise.

3.2. The main changes proposed by the Commission relate to the following seven points:

3.2.1. The new directives would only apply to mutual associations whose contribution income is EUR 5 million or above, compared to EUR 500000 for life and EUR 100000000 for non-life at the moment. Mutual associations whose contribution income is below the EUR 5 million threshold would not have the benefit of the single passport and would remain subject to national prudential requirements. Nevertheless, even if their contribution income lies below this threshold, a mutual association satisfying the solvency margin requirements could ask to come under the new directive and benefit from the single passport.

3.2.2. The value of the minimum guarantee fund (MGF) will be increased and in the future indexed in line with inflation.

3.2.3. The new directives would grant life insurers the right to count 50% of the undertaking's future profits in the available solvency margin; these future profits would no longer be estimated on a retrospective basis, as today, but on the basis of the following six years. Nevertheless, they would have to be confirmed by an actuarial report and their annual average could not exceed that of the five previous years.

3.2.4. Amongst the items eligible for the solvency margin, cumulative preferential share capital, subordinated loans and securities with no specified maturity dates would be subject to a number of restrictions, while the unpaid share capital or initial fund would no longer be accepted unless with the agreement of the competent authorities, and then only up to 50% of the solvency margin. Moreover, insurance companies would lose the possibility of counting, in the solvency margin, own shares which they hold directly and would also lose the benefit of discounting non-life technical provisions (hitherto Member States could authorise explicit discounting, taking account of investment income in accordance with Article 60 paragraph 1(g) of Directive 91/674/EEC)(7). Moreover, whether or not supplementary contributions by members for mutual insurance companies in the non-life sector can be taken into account in the solvency margin would be subject to approval by the supervisory authorities. It should be added that the list of eligible items for the solvency margin would henceforth be divided into three "closed" categories; hitherto this list was "open" and items other than those listed could potentially be included. Lastly, it should be noted that the minimum guarantee fund would henceforth only be constituted from higher quality items, which would exclude in particular future profits (although these would still be included in the solvency margin) and the unpaid share capital or initial fund. Hidden reserves may on the other hand be included if they are part of the solvency margin.

3.2.5. Calculation of the required solvency margin would undergo a major change in non-life insurance: the solvency margin requirement would be increased by 50% for classes 11, 12 and 13, corresponding to general liability and aviation and marine liability.

3.2.6. The directive would authorise the competent authorities to intervene on a pro-active basis before the available solvency margin dipped below permitted levels, as soon as policyholders' rights were threatened. The authorities could in this case require a financial recovery plan to be submitted and/or a higher solvency margin to be introduced and could downvalue some assets.

3.2.7. This directive would remove the current ambiguity about whether Member States are free to establish more stringent rules for the undertakings they authorise. The Commission proposes giving Member States the freedom to decide on this issue, thereby operating a "minimum harmonisation".

3.3. The proposed directives therefore update the solvency requirements by changing a number of thresholds: the level of contribution income above which the directives apply to mutual associations and the minimum value of the guarantee fund; the premium levels separating the two portions to which the rates of 18% and 16% are applied for calculating the solvency requirements for non-life undertakings; and the level of claims also determining the two portions to which the rates of 26% and 23% are applied for calculating the solvency margin requirements. The proposed directives also detail the solvency rules, setting out a complete list of the items eligible for establishing the margin and adjusting the calculation of the solvency margin for those classes of business with particularly volatile risk profiles. Lastly, the proposed directives strengthen policyholders' protection by granting supervisory authorities power of early intervention.

3.4. For these three reasons the Committee approves the proposed directives. It nevertheless raises a number of technical points which it recommends be altered; these points are set out below in the specific comments. More generally, the Committee is in favour of the spirit of the proposed texts except the part concerning the principle of minimum harmonisation.

3.5. The principle of minimum harmonisation

3.5.1. The proposed directives stipulate that Member States would be free to establish more stringent rules for the undertakings they authorise than those contained in the directives, so as to take into account the specific features of their national markets. This is clearly set out in the fourteenth recital of the proposed non-life directive and the eleventh recital of the proposed life directive.

3.5.2. The Committee is aware that this may be just one stage in the process of building up the single insurance market, but it deems it absolutely necessary that a more global harmonisation be sought in the future. The Committee approves in particular a number of provisions in the proposed directives which are working to this end, for example withdrawal of the benefit granted to undertakings which were discounting technical provisions. However, under the minimum harmonisation principle, some undertakings could be subjected to more stringent solvency requirements by their national supervisory bodies than undertakings in other Member States; this obligation to comply with a stricter solvency margin requirement would increase the cost of their capital and could therefore reduce their profitability. That would create distortions of competition and run counter to the principle that the single market should be a level playing field. This concern is all the greater with the prospect of the enlargement of the single market.

3.5.3. It therefore seems to the Committee that other phases will have to be introduced once these proposals have been adopted. These should work towards maximum harmonisation of competition rules so that European insurance companies can carry out their activities in perfectly fair conditions which protect policyholders' rights.

3.6. Power of early intervention by supervisors

3.6.1. The new Articles 20a in the non-life directive and 24a (2) in the life directive grant supervisory authorities the power of early intervention in the event of these authorities deeming policyholders' rights to be threatened. Under these circumstances, the supervisory authorities can require an undertaking to submit a financial recovery plan or increase its required solvency margin.

3.6.2. The Committee supports a measure of this type in principle because it allows the supervisory authorities to intervene at an early stage where it is easier to turn around a company's financial situation. Such a measure improves policyholders' protection by encouraging a risk prevention approach.

3.6.3. However, the Committee recommends that such a preventive approach be framed by a minimum of objective rules: in short, this would involve a precise definition of the early intervention conditions to ensure that such intervention is warranted, in keeping with the scale of the financial problems involved and effective for solving these problems.

4. Specific comments

4.1. Provisions common to the proposed life and non-life directives

4.1.1. Articles 17 and 17a non-life and Articles 20 and 20a life: minimum guarantee fund

4.1.1.1. These articles raise the value of the minimum guarantee fund to EUR 3 million, for both life assurance undertakings and non-life insurance undertakings classes 10 to 15, and to EUR 2 million for other non-life insurance undertakings. For the future they establish an indexation of these minimum levels in line with inflation.

4.1.1.2. The Committee approves inflation-linked indexation because this means that the values of the minimum guarantee funds can keep pace with economic developments. However, the Committee does regret that the new values of the minimum guarantee funds and the solvency margin requirements are not consistent with each other: with the proposed threshold, the solvency margin requirements could fall below the guarantee fund requirement, which goes against the idea behind these two prudential requirements.

4.1.1.3. Thus the amounts set out in the proposed directive could turn out to be inconsistent for small mutual associations with contribution incomes near to EUR 5 million. For example, a mutual association reinsured at 50% carrying out a non-life insurance activity and with an annual contribution income of EUR 5 million would be subject to a solvency margin requirement equal to a maximum of 18% × 5 million × 50%, i.e. EUR 450000. Now, under Article 17 of the directive, the guarantee fund for a mutual association of this type should not be below EUR 1,5 million (EUR 2 million less the specific reduction granted to mutual associations); the guarantee fund requirement would therefore be higher than the solvency margin requirement and this would be in contradiction with the definitions of these two amounts, since the guarantee fund is defined as being one-third of the solvency margin requirement. It therefore seems necessary to review the two thresholds so as to make them consistent with one another.

4.1.1.4. Moreover, so that the rise in the cost of the "entrance ticket" does not slow down new companies' penetration of this market sector, the Committee proposes that, for newly formed companies, the establishment of the additional margin necessary for achieving the minimum level for the guarantee funds be staggered over a maximum of five years, with the agreement of the supervisory authorities. For example, an insurance company which has just been set up and which, because it still does not have a great deal of business, has a margin requirement of EUR 2 million and has to have available a minimum guarantee fund of EUR 3 million, would be able to establish the additional million euros over five years. This would in no way jeopardize policyholder security, since the advantage of this five year period would be that it coincides with the special supervision period for new companies.

4.1.2. Articles 20a non-life and 24a (4) life: reinsurance

4.1.2.1. The solvency margin requirement is at present reduced in proportion to the percentage of risks underwritten by the reinsurance, within given limits (50% for non-life insurance for example): therefore, the more an undertaking is reinsured, the lower its margin requirement. Even where the reinsurance percentage is lower than the maximum possible, the supervisory authorities would henceforth be empowered to decrease the reduction to the required solvency margin, applicable on the basis of the reinsurance, when the quality of the primary insurer's reinsurance programme is deemed by them to be inadequate.

4.1.2.2. The Committee recommends that, in addition to this possibility of a downward adjustment, there should also be the possibility of an upward adjustment which would likewise take account of the quality of the reinsurance programme, particularly the level of solvency of the reinsurers. In fact the 50% ceiling laid down in the current directives is an arbitrary one and is not verified by an assessment of the optimum potential quality of the reinsurance. However, as soon as this concept of quality is introduced, the possibility of assessing the quality of the reinsurer is implicitly recognised, and it must then be possible to use this assessment for both increasing and decreasing the ceiling for reducing the margin requirement.

4.1.2.3. This possibility could be referred to at the end of paragraph 4 using the following wording: "Member States shall also ensure that the competent authorities have the power to increase the reduction to the solvency margin as determined in accordance with Article 19, where they deem that the quality of a reinsurance programme warrants an increase of this type".

4.1.2.4. The Committee underlines that any change to the ceiling, be it upwards or downwards, would be optional and subject to authorisation from the supervisory authorities. In order to avoid any distortion of competition, the assessment of the reinsurer's quality should therefore be based on objective criteria: the Committee would like the establishment of reinsurance supervision in Europe ultimately to allow the definition of these objective and harmonised criteria.

4.1.3. The existence of a guarantee fund for policyholders

4.1.3.1. Some European countries have "collective" arrangements for (fully or partially) underwriting liabilities taken with regard to policyholders in the case of run-off.

4.1.3.2. Two types of fund are being established: private funds and public funds. The private funds serve to protect all the companies grouped under those funds; public or semi-public funds are set up to cover the whole of a given profession and are designed to compensate policyholders in the event of run-offs in the sector.

4.1.3.3. Neither the proposed directives nor the Muller report broached this issue. However, in some cases the solution has consisted of accepting all or part of the reserves of contribution income not paid into the guarantee fund in establishing the solvency margin. The Committee feels that the treatment of contribution income in the guarantee funds should be examined at European level.

4.1.4. The specific case of substitution

4.1.4.1. In the event of a mutual insurance association passing on all its liabilities to another association, the transferee is then in a situation where it is providing complete substitution for the liability of the transferor. In this case it should only be possible to calculate the solvency margin on the basis of the transferee's situation. This substitution option was introduced under Article 3(2) of Directive 79/267/EEC (non-life) and, it would seem, under Article 3(2) of Directive 79/267/EEC (life). There is an obvious conflict between the provisions of Article 3(2) authorising substitution and Article 16(a) point 4 which limits to 50 % the reinsurance borne by the transferor. Subject to analyses or opinions to the contrary from the European Commission, we suggest that the end of paragraph 7 of Article 16(a) point 4 read as follows: "this ratio may in no case be less than 50 %, except in the event of the application of Article 3(2) of the present Directive".

4.2. Provisions specific to the proposed life directive

4.2.1. Article 18(4)(a): future profits

4.2.1.1. This paragraph alters the conditions for the inclusion of future profits in the available solvency margin. The period for advance estimation of profits is reduced from 10 years to 6 and must now be justified by an actuarial report. Moreover, the annual average of future profits must not exceed that of the profits of the five previous years.

4.2.1.2. An upper limit on future profits is valuable: such estimates anticipate the future and their amount is likely to be significantly affected by unforeseen events; they must therefore not make up too large a part of the solvency margin.

4.2.1.3. However, the Committee would recommend a more forward-looking approach to these future profits. Such an approach is hampered by the proposed mechanism of setting an upper limit on future profits using the average profits over the last five years. This penalises those companies which, against a background of falling interest rates, have demonstrated caution by raising their provisions, thus reducing their past profits. It runs counter to the thinking behind future profits.

4.2.1.4. An upper limit of another type, i.e. a percentage of the margin, could be envisaged here. Moreover, insofar as an upper limit of this type were to be established and a calculation of future profits were to be justified by an actuarial report, the reduction of the calculation period from ten to six years would no longer be necessary.

Following this line of thinking, the Committee suggests replacing the first sentence of Article 18(4)(a) with the following:

"An amount equal to 50 % of the undertaking's future profits. The amount of future profits shall be evaluated as the net current value of the net overall profits of the undertaking calculated over the following ten years. This amount cannot exceed 50 % of the total of all the other elements making up the solvency margin mentioned in this article."

4.2.1.5. It should be noted that the actuarial report submitted to the supervisory authorities would really be useful here because it would help justify the calculation of the net (discounted) current value of the net overall profits. Thus the actuarial report could clarify the method for calculating the different values of profits forecast over the next few years and give the updating rate used.

4.2.2. Article 19(2)(a): the basis on which the solvency margin is calculated

4.2.2.1. As regards the basis used for calculating the solvency margin, it is recommended that the meaning of the expression "life assurance provision" be clearly set out in the text.

4.2.2.2. In fact, the term "life assurance provision" seems here to mean a "mathematical provision", but it can be understood as covering a broader field than just "mathematical provision". In addition to mathematical provisions, it would cover all technical life assurance provisions, such as provision for financial risks or provision for technical liability underwriting risks. While the mathematical provisions do represent the net actuarial value of liabilities to policyholders, the other technical provisions of life assurance cover specific risks such as sharp fluctuations in share prices. Taking these technical provisions into account in the calculation of the solvency margin would in fact boil down to requiring capital for risks which, by definition, have already been covered. For this reason the Committee advocates clarification of the meaning of the term "life assurance provision"; this can be done by referring to the 1991 accounting directive as follows: after "life assurance provision", add "as defined by Article 27 of Directive 91/674/EEC"(8).

5. Conclusions

5.1. The Committee welcomes the European Commission proposal for a directive and approves it as a whole.

5.1.1. Although the new measures are likely to improve the quantity aspect of the solvency margin, the other approach, consisting of improving its quality by more precise regulation of its component assets, has not been dealt with in this review exercise. The ESC therefore hopes that the Solvency II project will provide an opportunity to explore this second approach.

5.2. A number of points nevertheless seem to merit clarification or amendment. In particular, the Committee calls on the Commission to take account of its concerns in the following areas:

- harmonisation of the solvency margin requirements and the minimum guarantee funds for small companies (points 4.1.1 onwards);

- the account taken of reinsurance and its quality to be taken into account (4.1.2);

- the existence of a guarantee fund for policyholders (4.1.3);

- the specific case of substitution (point 4.1.4);

- the account taken of future profits (4.2.1);

- the basis on which the solvency margin is calculated (4.2.2).

Brussels, 25 April 2001.

The President

of the Economic and Social Committee

Göke Frerichs

(1) First non-life Directive 73/239/EEC - OJ L 228, 16.8.1973, p. 3; First life Directive 79/267/EEC - OJ L 63, 13.3.1979, p. 1.

(2) COM(2000) final - 2000/0249 (COD) and COM(2000) 634 final - 2000/0251 (COD), of 25.10.2000.

(3) OJ L 228, 11.8.1992, p. 1.

(4) OJ L 360, 9.9.1992, p. 1.

(5) Report to the insurance committee on the need for further harmonisation of the solvency margin, COM(97) 398 of 24.7. 1997.

(6) CEA - European Insurance Committee; ACME - European Cooperative and Mutual Insurers' Association; AISAM - a European mutual association with a particular focus on small mutuals.

(7) Council Directive 91/674/EEC on the annual accounts and consolidated accounts of insurance undertakings, OJ L 374, 31.12.1991, p. 7.

(8) Council Directive 91/674/EEC on the annual accounts and consolidated accounts of insurance undertakings, OJ L 374, 31.12.1991, p. 7.