EUROPEAN COMMISSION Brussels, 22.9.2021 SWD(2021) 260 final COMMISSION STAFF WORKING DOCUMENT



IMPACT ASSESSMENT REPORT

Accompanying the documents Proposal for a Directive of the European Parliament and of the Council amending Directive 2009/138/EC as regards proportionality, quality of supervision, reporting, long-term guarantee measures, macro-prudential tools, sustainability risks, group and cross-border supervision



and



Proposal for a Directive of the European Parliament and of the Council establishing a framework for the recovery and resolution of insurance and reinsurance undertakings and amending Directives 2002/47/EC, 2004/25/EC, 2009/138/EC, (EU) 2017/1132 and Regulations (EU) No 1094/2010 and (EU) No 648/2012



{COM(2021) 581 final} - {SEC(2021) 620 final} - {SWD(2021) 261 final}



Table of contents 1.Introduction 1.1.Political and legal context 1.2.High-level overview of the main issues that the Solvency II review will aim to address 2.Problem definition 2.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy 2.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies 2.3.Insufficient proportionality of the current prudential rules generating unnecessary and unjustified administrative compliance costs for small and less complex insurers 2.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures 2.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector 2.6.How will the problems evolve if not addressed? 3.Why should the EU act? 3.1.Legal basis 3.2.Necessity and Added Value of EU action 4.Objectives: What is to be achieved? 4.1.General objectives 4.2.Specific objectives 5.What are the available policy options? 5.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy

5.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies 5.3.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers 5.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures 5.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector 6.What are the impacts of the policy options and how do they compare? 6.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy 6.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies 6.3.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers 6.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures 6.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector 7.Preferred combination of options 7.1.General impacts 7.2.Impact on SMEs 7.3.REFIT (simplification and improved efficiency) 8.How will actual impacts be monitored and evaluated? Annex 1: Procedural information 1.Lead DG, Decide Planning/CWP references 2.Organisation and timing 3.Consultation of the RSB 4.Evidence, sources and quality

Annex 2: Stakeholder consultation 1.Introduction 2.Consultation strategy 3.Conference on Solvency II 4.Inception impact assessment 4.1.Priorities of the Solvency II Review 4.2.Long termism and sustainability 4.3.Volatility and proportionality 4.4.Recovery, resolution, IGS, group supervision and cross-border supervision 5.Public consultation 5.1.Long-termism and sustainability of insurers’ activities and priorities of the European framework 5.2.Proportionality of the European framework and transparency towards the public 5.3.Improving trust and deepening the Single Market in insurance services 5.4.New emerging risks and opportunities 5.5.Additional or late feedback to the consultation 6.Targeted consultations of Member States Annex 3: Who is affected and how? 1.Practical implications of the initiative 2.Summary of costs and benefits of the combined set of options 3.Summary of costs and benefits per problem

3.1.Problem 1: Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy 3.2.Problem 2: Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of insurers’ solvency position 3.3.Problem 3: Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs 3.4.Problem 4: Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures 3.5.Problem 5: Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector Annex 4: Proportionality and simplification measures Annex 5: Discussion on the technical design of the minimum harmonising rules in relation to insurance guarantee schemes (IGSs) 1.Background 2.Introduction 2.1.A fragmented landscape 2.2.The failure of insurance companies 2.3.The default likelihood of insurers 2.4.Estimates of potential losses associated with the failures of insurance companies 2.5.Objectives of an EU action 3.Analysis of policy options 3.1.The need for harmonisation of national IGSs in the European Union 3.2.The harmonisation of the design of national IGSs 4.Are there alternative to specific EU action on IGS? 5.Conclusions Annex 6: Analytical methods

Annex 7: Impact assessment of technical topics that were not explicitly covered by the main body of the impact assessment 1.Safeguards in the use of internal models 1.1.Problem definition 1.2.What are the available policy options? 1.3.What are the impacts of the options and how do they compare? 2.Reporting and disclosure requirements 2.1.Background and problem definition 2.2.What are the available policy options? 2.3.What are the impacts of the options and how do they compare? Annex 8: “Zooming” on some issues covered in the impact assessment 1.Strengthening “pillar 2” requirements in relation to climate change and sustainability risks 2.Reducing undue volatility in Solvency II 2.1.Revising the volatility adjustment. 2.2.Revising the symmetric adjustment on equity risk 3.Balancing the cumulative impact of the review on capital requirements 3.1.Achieving the balance partly through phasing-in periods 3.2.Achieving the balance partly through “compensating measures” 4.Enhancing group supervision 4.1.Strengthening and harmonising supervisory powers towards groups 4.2.Clarifying prudential rules on capital requirements

5.Enhancing supervision of cross-border insurance companies 5.1.Ensuring more efficient information gathering/exchange during the authorisation process and ongoing supervision 5.2.Improving cooperation between Home and Host supervisory authorities, under the coordination/mediation of EIOPA 6.Incorporating a macro-prudential dimension in Solvency II Annex 9: Other initiatives that will have a material impact on the insurance sector Annex 10: Evaluation of the Solvency II framework



Glossary Term or acronym Meaning or definition CMU Capital Markets Union EEA European Economic Area EIOPA European Insurance and Occupational Pensions Authority ESRB European Systemic Risk Board EU European Union FoE / FoS Freedom of establishment / Freedom of services DG FISMA Directorate General for Financial Stability, Financial Services and Capital Markets Union FSB Financial Stability Board GWP / GDWP Gross written premiums / ¨Gross direct written premiums Home authority National Supervisory authority which granted licensing to an insurer Home Member State Member State where an insurance or reinsurance company obtained its license Host authorities National supervisory authorities other than the Home authority of the Member States where an insurance or reinsurance company is operating Host Member State Member States other than the Home Member State where an insurance or reinsurance company is operating IAIG(s) Internationally Active Insurance Group(s) IAIS International Association of Insurance Supervisors IGS(s) Insurance Guarantee Scheme(s) Insurance / Insurer Unless otherwise specified, the use of the term insurance refers to both insurance and reinsurance activities MCR Minimum Capital Requirement NCA / NCAs National Competent Authority / National Competent Authorities NSA / NSAs National Supervisory Authority / National Supervisory Authorities ORSA Own risk and solvency assessment RSR(s) Regular supervisory report(s) SCR Solvency capital requirement SFCR(s) Solvency and financial condition report(s) Solvency ratio Ratio of capital resources to solvency capital requirement VA Volatility adjustment The three “pillars” of Solvency II Solvency II constitutes a three-pillar framework (capital requirements, governance, transparency), which is risk-based and market-based. The “Pillar 1” sets out quantitative requirements, including the market-based rules to value assets and liabilities, the general design of capital requirements. The capital requirements are risk-based, forward-looking and economic, i.e. tailored to the specific risks borne by each insurer and taking into account risk diversification benefits, allowing an optimal allocation of capital across the EU. The framework is designed in such a way that an insurer complying with its requirements is supposed to be able to cope with an extreme adverse event, whose probability of occurrence is only 1 in every 200 years. In other words, the insurer is then supposed to be able to meet its obligations to policyholders and beneficiaries over the 12 following months, with a 99.5% probability. Hence, where the insurer complies with these risk management rules, the risk of an insurance failure over the following year should reach a very low probability (even though not null). The “Pillar 2” consists of requirements for the governance and risk management of insurers, as well as the details of the effective supervisory process with competent authorities. A key Pillar 2 requirement is the “own risk and solvency assessment” (ORSA). It aims at supporting insurers to get a holistic view of its risk profile and understand how risks affect the future solvency situation. It requires that the insurer undertakes its own “stress testing”, integrating all foreseeable risks such as a volatile and uncertain economic outlook. It also implies that insurers, when defining their own “risk appetite”, may (shall) look beyond the “purely quantitative” solvency requirements, and set level of “reserve”/available capital that are also forward-looking, as an additional cushion beyond the minimum regulatory quantitative requirements. Finally, the “Pillar 3” focuses on reporting to supervisory authorities and disclosure to the public, thereby enhancing market discipline and increasing comparability.



1.Introduction

1.1.Political and legal context The economic and social importance of insurance is such that intervention by public authorities, in the form of prudential supervision, is generally accepted to be necessary. Not only do insurers provide protection against future events that may result in a loss, they also channel household savings into the financial markets and into the real economy. With trillions of assets under management, the insurance sector remains a mainstay of the European financial industry. The rationale for EU insurance legislation is to facilitate the development of a Single Market in insurance services, whilst at the same time securing an adequate level of consumer protection. The Directive on the taking-up and pursuit of the business of insurance and reinsurance (Directive 2009/138/EC) is also known as the Solvency II Directive. The Solvency II Directive, as amended by the Omnibus II Directive (Directive 2014/51/EU), has entered into application in 2016. The supplementing Delegated Regulation (EU) 2015/35 was intended to further specify a range of aspects of the Solvency II Directive, with the aim to facilitate a consistent implementation throughout the European Union. Those two levels of legislation form the ‘Solvency II framework’, or regime. The Solvency II regime replaces fourteen existing directives commonly known as 'Solvency I'. The European Commission has a legal mandate to conduct a comprehensive review of the pivotal components of the Solvency II Directive by the end of 2020. This review is an opportunity to draw the lessons learned from five years of implementation of the Solvency II framework, including in crisis situations such as the one triggered by the Covid-19 outbreak, and to take into account the feedback received from insurers, consumers and public authorities. In order to appropriately take stock of the potential shortcomings in prudential rules, which have been highlighted by the pandemic crisis, the timeline of the review had to be extended by six months. Finally, the review of the framework needs to be coherent with the political priorities of the European Union. In particular, both the renewed Capital Markets Union (CMU) Action Plan and the communication on the European Green Deal explicitly refer to insurers as key institutional investors whose role will be instrumental to the so-called “re-equitisation” in the corporate sector and the greening of the European economy. The European Parliament and the European Council also identify the Solvency II Review as a pivotal initiative to support the objectives of the CMU. The European Parliament’s report on further development of the CMU of 16 September 2020 requests the Commission to assess, on the basis of an impact assessment, the potential benefits and prudential justification of adjusting capital requirements for investments in businesses, notably of small and medium-sized enterprises (SMEs) to ensure that capital requirements for insurers do not discourage long-term investments. The Council Conclusions of 2 December 2020 on the Commission’s CMU Action Plan urges the Commission, to prioritise and to accelerate its work in parallel on strengthening the role of insurers as long term investors and assessing ways to incentivise long-term investments in corporates and particularly SMEs without endangering financial stability or investor protection and ensuring risk adequate regulatory treatment of long term investments. At this stage, the Commission is pursuing several initiatives to increase private financing of the transition to a carbon-neutral economy and to ensure that climate and environmental risks are managed by the financial system. Those initiatives, which are listed in Annex 9, will have a significant impact on the insurance sector. Other horizontal EU political priorities are being tackled in parallel, without having yet identified the need for a legislative change. For instance, the recently adopted Digital Finance Strategy has defined the main priorities for the EU and these priorities are also relevant for insurers and reinsurers. In that context, the Commission invited the European Supervisory Authorities (ESas), including EIOPA, to provide technical advice on digital finance. If necessary, Commission services will propose targeted amendments to the financial services acquis, including the Solvency II framework (possibly via a cross-sectoral proposal). Following a formal request for advice that was sent by the European Commission to the European Insurance and Occupational Pensions Authority (EIOPA) in February 2019, EIOPA conducted three technical consultations covering the 19 topics of the Solvency II review that were identified by the European Commission. It also conducted two data collection exercises in order to quantify the cumulative impact of all policy proposals. EIOPA’s final Opinion on the Solvency II review, and the associated background analysis and holistic impact assessment , were published on 17 December 2020. The Commission services’ impact assessment largely leverage on the technical work and analysis conducted by EIOPA. 1.2.High-level overview of the main issues that the Solvency II review will aim to address Since 2016 when it entered into application, the Solvency II Directive has provided a harmonised and sound prudential framework for insurance and reinsurance companies in the EU, as evidenced in the Evaluation Annex. Based on the risk profile of individual firms, it promotes comparability, transparency and competitiveness. Solvency II has significantly enhanced the protection of policyholders and beneficiaries, by limiting the likelihood that their insurer fails. It has also provided strong incentives for insurers to better measure and manage their risks, and to improve their internal governance. Under the coordination of the European Insurance and Occupational Pensions Authority (EIOPA), Solvency II has also facilitated supervisory convergence within the Union and contributed to the integration of the Single Market for insurance services. Also thanks to Solvency II, the European insurance industry remained robust overall. With average levels of capital resources that remain more than twice as high as what is required by the legislation, insurers’ solvency position has so far proved to be sufficiently solid to weather the economic and financial consequences of the Covid-19 outbreak. However, due to the high level of uncertainty in the economic and financial outlook, regulators and supervisors still have to closely monitor future market developments. The primary objective of Solvency II is the protection of policyholders. Achieving this objective requires that insurance companies are subject to effective solvency requirements based on the actual risks they are facing (“risk-based” framework). The framework is defined in such a way that the risk of an insurance failure over the following year, even though not null, is of very low probability, as an insurer complying with its requirements is supposed to be able to cope with an extreme adverse event whose probability of occurrence is only 1 in every 200 years. The framework also relies on full market-based valuation of insurers’ assets and liabilities, which allows monitoring the impact of economic and financial conditions on insurers’ solvency in real time and on an ongoing basis. However, the market value and risk-based principles also raise some challenges. First, with regard to market risks faced by insurers, the risk-based approach implies that the definition of capital requirements on investments only depends on the relative riskiness of each asset over a one-year time horizon. Therefore, prudential rules do not take into account the instrumental role of insurers in financing long-term sustainable growth in the Union and in the economic recovery in the aftermath of the Covid-19 crisis. Both the European Green Deal and the Capital Markets Union Action Plan make this observation. While Solvency II is not the main driver of insurers’ investments, the framework may still provide disincentives to invest in assets such as equity, as insurance firms have to set aside more capital when holding such assets whose prices are generally more volatile than fixed-income securities. In addition, current rules do not capture the lower long-term risk of environmentally sustainable (“green”) activities/assets (all else equal). Hence, it should be explored whether barriers to long-term sustainable investments are unjustified and could be eliminated so as to facilitate insurers’ contribution to the financing of long-term sustainable growth, while preserving an appropriate level of policyholder protection. Second, in order to be effective in protecting policyholders, the framework needs to be regularly updated, so that it appropriately captures all risks that insurers are facing due to structural changes in financial markets. At this stage, Solvency II provisions and parameters may prove to be outdated, as they do not reflect key trends, such as the protracted low – and even negative – interest rates environment, and its consequences. Finally, reliance on market values can generate high volatility in the solvency position of insurers. Such volatility may unduly foster procyclical behaviours and short-termism in their underwriting and investment activities, although insurers are supposedly “long-term oriented” by nature. In particular, it can provide disincentives to the supply of (life) insurance products with guarantees, which are still highly sought by EU citizens, in particular for their pensions. In addition to the issues stemming from market valuation and risk-based rules, the review of Solvency II should aim to address other challenges.

Solvency II is a highly sophisticated framework, which provides strong incentives for robust risk management by insurers. However, the framework can prove to be very complex, and its implementation generates significant compliance costs, in particular for smaller insurers. Solvency II embeds an overarching principle of proportionality, which supposedly ensures that both the requirements imposed to companies and the intensity of supervisory activities by public authorities are commensurate to the “nature, scale and complexity” of the risks of each firm. However, in practice, this overarching principle is abstract and results in legal uncertainties and insufficient visibility for both national supervisory authorities (NSAs) and companies, as the framework neither specifies what the proportionate measures are nor clarifies the scope of firms that are eligible for such proportionality. Hence, at this stage, the implementation of proportionality is insufficient to effectively reduce the regulatory burden for smaller insurers. Solvency II has facilitated the integration of the Single Market for insurance services by improving the level-playing field and supervisory convergence. However, recent failures of insurance companies, which operated mainly outside the Member State where they were initially granted authorisation, highlighted shortcomings and deficiencies in the quality and coordination of insurance supervision, including of cross-border insurance groups. In addition, it also confirmed that policyholders are not consistently protected across the European Union in the event that their insurer fails, in particular in a cross-border context. Indeed, national resolution regimes are mostly incomplete and uncoordinated, and the patchwork of national insurance guarantee schemes (IGSs), which are expected to act as a safety net to pay policyholders’ claims in the event of their insurer’s insolvency, can leave some policyholders without any protection. Finally, while policyholder protection is the primary objective of Solvency II, regulators and supervisors also have to preserve financial stability according to the Directive. To this end, supervising insurers on an individual basis (“micro-prudential supervision”) may not allow addressing systemic risks in the insurance sector, since it does not really take into account their interconnections with other market participants and common risky (herding) behaviours among insurers. While some regulatory tools embedded in Solvency II already contribute to this objective, they may be insufficient and too narrow in terms of scope to effectively prevent the build-up of systemic risk in the insurance sector. 2.Problem definition The need for amending the Solvency II framework in order to either introduce new provisions or to review the existing ones has emerged as a result of both the conclusions of the evaluation of the Solvency II Directive (see Annex 10), and the outcome of the public consultation that was conducted between 1 July and 21 October 2020 (see Annex 2). This section presents the most important problems addressed by this impact assessment. Those problems are further identified and assessed as part of the Evaluation Annex. Please also refer to Annex 7 for specific discussions on internal models and on reporting and public disclosure, which fall under the broader issue of quality of supervision (See 2.4) but will not be assessed as such in the core part of the Impact assessment due to size limitations. Figure 1 summarizes the problems and problems drivers as well as their related consequences. Regarding the links between problems and consequences, the solid arrows correspond to the primary links whereas the dotted arrows correspond to the secondary links.



Figure 1: Problem tree 2.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy The main focus of Solvency II is policyholder protection and financial stability. To that end, Based on quantitative data (e.g. historical price and volatility behaviour of financial assets), it defines capital requirements, i.e. the amount of capital resources that insurers have to set aside in order for them to be able to cope with very extreme adverse events (1-year duration shocks whose probability of occurrence is only once in 200 years). Higher capital requirements on investments are therefore applied to assets, which are more volatile and/or more risky, for instance equity. However, since Solvency II was adopted, the European Commission set additional political objectives, notably the need to build-up a Capital Markets Union which can channel more funding to businesses and the European Green Deal to achieve a transition to carbon-neutrality. The capital requirements of Solvency II do not take into account the positive externalities of some investments in strengthening long-term sustainable growth and the economic recovery in the aftermath of the Covid-19 crisis and the limitation of the negative impact of climate change. Limited incentives for insurers to contribute to the long-term financing of the economy For the purpose of this impact assessment, the objective of fostering long-term investments will be actually related to the equity asset class only, since insurers are already largely investing in long-maturity bonds, as discussed in Sub-section 6.1.4 of the Evaluation Annex. In addition, the concept of long-term investment has no commonly agreed definition. It cannot be restricted to “buy-and-hold” strategies. For the purpose of this impact assessment, a long-term investment will be deemed an investment in an asset class (and not individual assets) with a long-term perspective (the Solvency II Delegated Regulation refers to a 5-year time horizon for long-term equity investments), including under stressed conditions. In other words, an insurer is deemed to make a long-term investment in equity if it can have a long-term perspective to hold a certain share of its investment portfolio in equities (listed, unlisted, private equity, etc.), even if it does some arbitrage operations from time to time (i.e. realising gains on certain equities and investing in other ones). From a prudential perspective, a long-term perspective encompasses the possibility for insurers to avoid forced selling under stressed market conditions. The Capital Markets Union Action Plan underlined the instrumental role that insurers can play in the “re-equitisation” and long-term financing of the European economy. Insurers can hence support the economic recovery in the aftermath of the Covid-19 crisis. As shown in the Evaluation Annex, Solvency II, which only entered into application in 2016, is not the main driver of insurers’ investments, since the downward trend in equity investments dates back to the beginning of the 21st century. The Commission made several amendments to the Solvency II Delegated Regulation to help insurers contribute to the long-term financing of the European economy, in particular by introducing a preferential treatment for long-term investments in equity, subject to some criteria. However, those amendments are not sufficiently effective and the framework still includes disincentives to investments in assets such as equity, as insurance firms have to set aside more capital when investing in more volatile assets. To achieve the political objective of facilitating insurers’ role in sustaining the economic recovery, prudential rules should be reviewed to facilitate long-term equity investments, while at the same time ensuring that such changes do not harm policyholder protection and financial stability. For further evidence, please refer to Sub-section 6.1.4 of the Evaluation Annex. Insurers could contribute more to the greening of the economy In relation to the European Green Deal, the Commission’s Communication states that climate and environmental risks should be managed and integrated into the financial system. As regards insurers, the objective concerns both how insurers invest their money and how they take into account sustainability risks in their risk management concerning investments and underwriting of insurance risks. With respect to the former, insurers can play a role in closing the investment gap for environmental-friendly assets and activities. However, EIOPA estimates that only up to 5 % of the total asset value held by insurers may be eligible investments in sustainable assets (as identified by the taxonomy), and therefore contribute to the climate objectives of the European Green Deal. This seems too low to achieve the Union’s objective of a climate-neutral continent. A first issue is probably the lack of available investable assets that are aligned with the taxonomy. While the review of Solvency II will not address the need to foster the supply of sustainable assets, there is currently no explicit prudential incentive for insurers to invest in such assets. Indeed, the rules on capital requirements do not distinguish between sustainable and other investments, and do not capture the possibly lower (respectively higher) level of risks over the long term of some categories of “green” (respectively “brown”) assets, all else equal. Also, the positive (respectively negative) externalities of investing in such assets are not captured. Furthermore, insurers are exposed to climate and environmental risks through their assets and liabilities towards policyholders. While Solvency II contains a general requirement on insurers to take into account all risks in their risk management, the Directive does also name particular risk categories explicitly. However, climate and environmental risks are not part of those risk categories and it would often materialise through other risk categories, e.g. market or underwriting risk. This may result in a lack of clarity as regards whether and where insurers are expected to reflect climate and environmental risks and, as a consequence, in insufficient management of those risks by insurers. For instance, only a small proportion of all insurance companies reflects climate change risks in their own risk and solvency assessment (ORSA). In 2020, EIOPA analysed a sample of ORSA reports from 1682 companies representing more than 80% of the EU insurance market. Only 13% of the analysed ORSA reports made a reference to climate change risk scenarios.

In conclusion, the prudential framework requires the same capital to be held for sustainable investment as for investment that do not qualify as sustainable. However, the financial risks of some categories of sustainable investments may already be lower or, notably with respect to transition risks, could be lower over a longer term. To achieve the political objective of private investments in the green transition, prudential rules should be reviewed to ensure that capital requirements on green assets are not higher than necessary to avoid harm to policyholder protection and financial stability. Furthermore, there is no clear obligation to manage and reflect climate and environmental risks. However, given their clear importance going forward, from both an economic and risk perspective, there may be room for appropriate regulatory adjustments in this area. 2.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies The economic and financial conditions faced by insurers over the recent years and months (in particular in relation to interest rate risks and market volatility) significantly differ from those present when the Solvency II framework was adopted. Therefore, the Directive may contain outdated parameters and provisions, possibly resulting in an insufficient risk sensitivity and excessive volatility in some areas of the framework. The below subsections provide a few examples of such shortcomings. Insufficient reflection of the low interest-rate environment in the Solvency II framework As insurers are large investors in fixed-income securities (i.e. debt instruments that pay a regular fixed amount of coupon interest), it is commonly accepted that the current low – and sometimes even negative – interest rate environment is one of the main risks that EU insurers have been facing over the recent years. This is because they earn only low returns (or even make losses) which impact their profitability and solvency. This limits them in their ability to provide adequate insurance products for their customers. As shown in Sub-section 6.3.2 of the Evaluation Annex, between 2018 and 2020, the level of interest rates (for the euro) has significantly decreased, with a material adverse impact of both insurers’ solvency position and profitability. In this regard, the underlying assumptions based on which the Solvency II capital requirements under the standard formula are designed are outdated, as they do not envisage the possibility for interest rates to move in negative territory, or when rates are already negative, to further decrease. Therefore, the prudential framework, which leads to an underestimation of the interest rate risk to which insurers are exposed, has not provided clear obligations to insurers for having capital to buffer for the risk of negative interest rates over a recent years, which has now materialised. If not addressed, this underestimation of the real risks to which insurers are exposed could become detrimental to policyholder protection, as insurers may not at some point have sufficient capital to absorb losses if the downward trend in interest rates continues in the future. Already in 2018, EIOPA estimated that this underestimation of interest rate risk represented on average 14 percentage points of solvency ratios at European level. Sub-section 6.1.1 of the Evaluation Annex also shows that the current low interest rate environment raises doubts about the appropriateness of the stipulated regulatory interest rate curves that have to be used by insurance companies when valuing their long-term liabilities towards policyholders. As an illustration, the yield at issuance on a 100-year Austrian government bond (AA-rated) was lower than the 33-year regulatory risk-free interest rate in June 2020. An underestimation of the value of insurers’ liabilities would lead to an overestimation of their solvency position, and may limit prudential incentives for insurers to establish robust asset-liability management strategies, with detrimental side effects on policyholder protection. Insufficient ability of the framework to mitigate the impact of financial market turmoil on the solvency position of insurers. In addition to being risk based, Solvency II relies on the pivotal principle of market-consistent valuation of assets and liabilities, which means that insurers have to rely as much as possible on market data when establishing their balance sheet. By nature, such characteristics imply high short-term volatility in insurers’ assets (the value of which evolves with financial market movements) and liabilities (for instance, when asset values and asset returns collapse, the cost for an insurer of providing a high guaranteed rate on a life insurance product increases significantly). Those fluctuations in asset and liability values lead to a high volatility in the level of insurers’ capital resources and more generally in their solvency position. Solvency II also includes several regulatory mechanisms (so-called "long-term guarantee measures and the measures on equity risk") which are aimed at mitigating the impact of short-term market turmoil on insurers solvency position. However, as evidenced in Sub-section 6.1.1 of the Evaluation Annex, those measures have proved to be insufficiently effective at mitigating excessive short-term volatility in the solvency position of insurers, in particular during market turmoil such as during March 2020 in the context of the Covid-19 outbreak. When the short-term volatility in insurers’ solvency ratios becomes excessively high, it fosters short-termism in insurers’ underwriting and investment activities. In particular, it may unduly incentivise life insurers to reduce their supply of long-term insurance products with guaranteed minimum returns, to shift a large part of the risk to policyholders (via the distribution of unit- or index-linked products), and to divest from real assets supporting the long-term financing of the European economy. Also, if the treatment of long-term insurance products is unduly penalising for EU insurers, they may be put at a disadvantage compared to their non-EU competitors and will have less stable surplus capital (capital minus capital requirements) to expand internationally. Therefore, excessive volatility is also impeding international competitiveness of the European industry. The Evaluation Annex also shows that the current parameters of the “long-term guarantee measures” sometimes give rise to unexpected improvements in the solvency position of some insurers, during crises such as the Covid-19 outbreak. Such unintended situations (called “over-shooting effect”) raise supervisory challenges, because the existing regulatory framework may not result in appropriate risk measurement under stressed situations. 2.3.Insufficient proportionality of the current prudential rules generating unnecessary and unjustified administrative compliance costs for small and less complex insurers Outdated thresholds of exclusion from the Solvency II framework The Solvency II Directive already provides that very small insurers are excluded from the application of the Directive if they meet a series of cumulative criteria, including limited revenues (lower than EUR 5 million) and risk volume (insurers’ liabilities towards policyholders of less than EUR 25 million). As outlined in Sub-section 6.2.2 of the Evaluation Annex, the thresholds for exclusion have not been amended since the adoption of the Solvency II Directive in 2009. Therefore, those thresholds may be considered as outdated, although they will have to be updated to reflect inflation every five years, provided that the inflation since the last update is greater than 5%. The first update will therefore take place in 2021. Still, the lack of reassessment of the appropriateness of thresholds may imply high compliance costs for small companies in the scope of Solvency II, which may not compensate the benefit of being subject to Solvency II. Insufficient application of proportionate rules in Solvency II The Solvency II framework broadly embeds the principle of proportionality, insofar as it requires ensuring that not only the requirements imposed to insurance companies, but also the intensity of the supervisory review process, are commensurate to the “nature, scale and complexity” of each company which is subject to Solvency II. Therefore, the application of the proportionality principle does not depend on the size of the companies but on the risks that they are facing. The framework as a whole is formulated in a modular manner, such that insurance and reinsurance companies must only apply those requirements, which are relevant to the risks they incur. As Solvency II does not clearly define which firms can be subject to proportionality and which measures can be implemented in a proportionate way, the current framework results in legal uncertainty and lack of predictability for both insurers and NSAs. There is no report on the effective application of proportionality under Solvency II. However, Sub-section 6.2.2 of the Evaluation Annex concludes that the current framework results in a limited implementation in practice of the proportionality principle. If not implemented in a proportionate way, Solvency II requirements become very challenging to comply with for smaller and less complex insurers, as their limited riskiness is not appropriately accounted for in supervisory review processes. This implies that the intensity of regulatory requirements is not sufficiently modulated so that they do not generate a disproportionate burden for small and non-complex insurers. The issue of proportionality concerns all three pillars of Solvency II. However, the lack of proportionality in the implementation of prudential issues is particularly acute in relation to reporting and disclosure requirements by insurance companies (“pillar 3”). In this regard, Sub-section 6.2.1 of the Evaluation Annex shows that the information that must be publicly disclosed to policyholders proves to be too complex and too detailed, lacking a high-level simple overview. As regards data collection and reporting to NSAs, the Evaluation Annex underlines that the number and frequency of submission of the quantitative templates for regular reporting (often on quarterly basis) generates costs to both insurers and supervisors.

2.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures Inconsistent and insufficiently coordinated supervision of insurance companies and groups, including in relation to cross-border activities Solvency II has facilitated the integration of the Single Market for insurance services by improving the level-playing field and supervisory convergence. However, as shown in Sub-section 6.1.3 of the Evaluation Annex, recent failures of insurance companies, which operated mainly outside the country where they initially obtained their license, highlighted shortcomings and deficiencies in the quality and coordination of insurance supervision including in relation to cross-border activities. It also shows the insufficient prioritisation of some NSAs on the supervision of cross-border business. EIOPA’s coordination role, although reinforced in the context of the review of the Regulation (EU) 2019/2175 establishing the European Supervisory Authorities, proves to be insufficient in ensuring a high-quality convergent supervision across Member States. In addition, the lack of data sharing between NSAs may hinder the effective supervision of insurers operating on a cross-border basis. Furthermore, the Evaluation Annex shows in the same Sub-section that due to legal uncertainties, several areas of the framework may not be sufficient for a harmonised implementation of the rules by insurers and NSAs, including in relation to the supervision of insurance groups. In particular, challenges arise from the supervision of groups that are headquartered or active in non-EEA countries, and of mixed financial groups combining banking and insurance activities (financial conglomerates). Insufficient supervisory toolkit to intervene when firms are in financial distress Although the Solvency II framework aims to minimise the likelihood of insurance failures, such likelihood is not brought to zero either. Recent failures, in particular of cross-border insurers, demonstrated that this risk remains not sufficiently addressed early, partly due to deficiencies in prudential supervision by some public authorities. However, experience has also shown that, despite the existing Solvency II arrangements, the efforts to recover an insurer in financial distress are sometimes inefficient or run into legal or operational difficulties for a lack of proper and timely preparation of recovery options. Likewise, public authorities may fall short of options that could effectively avoid the winding-up of the insurer as they have not looked at failure scenarios and have not anticipated possible impediments to deploying alternative measures. Furthermore, public authorities do not always have sufficient tools to avert the failure of insurers. As reported by EIOPA, one third of NSAs identified gaps and shortcomings in their range of recovery and resolution powers. Likewise, public authorities often lack alternatives to insolvency for failing insurers. Even traditional tools for an orderly wind-up such as run-off (i.e. a ban on writing new business while fulfilling existing obligations) and transfer of portfolios are either unavailable or subject to restrictions in some Member States. Other important powers to stabilise a failing insurer, such as stays on early termination rights, are only available in a small minority of Member States. Even in the few Member States equipped with the necessary tools, resolution approaches remain tailored to national objectives and constraints and could therefore differ widely (i.e. legal frameworks, scope of powers and tools, conditions for exercising these powers). Finally, despite general cross-border coordination mechanisms for supervision, there is no clear framework for coordination and cooperation between authorities to prepare and manage a (near) failure of an insurance company operating across borders. As illustrated by EIOPA, this can result in conflicts of interest and a misalignment between the national accountability and mandate of supervisors (protecting the interest of policyholders at national level) and the cross-border nature of the insurance industry that is not coherent with the objectives of the Single Market. Cross-border cooperation and coordination is however essential to support recovery, eliminate impediments to an orderly resolution process and reduce suboptimal outcomes at the EU level. For further details, see Sub-section 6.1.3 of the Evaluation Annex. Inadequate / insufficient protection of policyholders in case of failure Currently, 17 Member States (and Norway) operate one or more IGS(s). This means that a significant share of gross written premiums are not covered by any IGS and that losses stemming from the failure of insurance companies can still be passed onto EU policyholders or taxpayers. The current patchwork of national guarantee schemes means that policyholders across the EU are not equally protected. Gaps, but also overlaps , in the protection of policyholders can stem from substantial differences in the design features of existing national IGSs, notably in terms of geographical coverage. Therefore, for the same type of insurance policy, policyholders might benefit from a different level of IGS protection or no protection at all, depending on where they live and on where they have contracted the policy. For further details, see Annex 5 and Sub-section 6.1.3 of the Evaluation Annex. Insurers in the EU may therefore face different costs and incentive structures, which can lead to an uneven level-playing field and add to the regulatory arbitrage previously described. 2.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector While policyholder protection is the primary objective of Solvency II, regulators and supervisors also have to preserve financial stability. To this end, supervising insurers and reinsurers on an individual basis without taking into account their interconnections with other market participants and common risky (herding) behaviours may not be sufficient to preserve financial stability. Most rules of the Solvency II Directive are targeted to individual insurers (so-called “micro-prudential supervision”). Those provisions, for instance risk-based capital requirements, can help preventing systemic risk as they provide disincentives for excessive risk-taking. There are also several regulatory tools embedded in Solvency II that more directly contribute to preventing systemic risk, for instance by avoiding forced-sales of assets during market turmoil, which could amplify negative market movements. However, according to EIOPA and ESRB, there are several shortcomings in the existing framework, which may limit public authorities’ ability to preserve financial stability, and to address risks generated by the insurance sector itself. In particular, as further detailed in the Sub-section 6.3.2 of the Evaluation Annex, the current set of rules may not appropriately address issues of search-for-yield behaviours, high concentration of investment portfolios in certain assets and sectors, potential liquidity strains and insufficient coordination of macro-prudential measures, as illustrated during the Covid-19 crisis. 2.6.How will the problems evolve if not addressed? For the purpose of this impact assessment, the baseline scenario will be to “do nothing” (this “baseline scenario” will be “Option 1” for each problem).

Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy Doing nothing would generate opportunity costs for the wider economy in the form of lost output and overall welfare, by possibly preventing insurers from providing capital injections to businesses, notably SMEs, and from financing the transition to a carbon-neutral economy. This would not be coherent with the objectives of the CMU and the European Green Deal. It could also affect international competitiveness. Still, it can be argued that the higher risk of investing in equity justifies higher capital requirements, and that such an approach actually makes insurers’ solvency more resilient to financial shocks in the long- run. Similarly, insurers that have already invested in sustainable assets may have less “free capital” which may affect competitiveness and the ability to offer products with guarantees to consumers. For further evidence on those different issues, please refer to Sub-sections 6.1.4 and 6.3.3 of the Evaluation Annex. Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies Not addressing the issue of insufficient risk sensitivity of the framework would have detrimental effect on the overall level of policyholder protection, and could foster risk-taking activities by insurers, with potential negative side effects on financial stability risks. While volatility had been very low in recent years, it has sharply moved upwards as the Covid-19 crisis became virulent, and higher volatility seems to remain entrenched in the financial system. In consequence, without policy action, insurers might tend to reduce their investment time horizon and aim to shift market risks to policyholders (via the supply of unit-linked products) in a higher volatility environment. Finally, excessive volatility can generate procyclical behaviours, and therefore raise financial stability risks. Doing nothing would not be coherent with the renewed Action Plan on the CMU where it is acknowledged that volatility mitigation is key to help insurers provide long-term (capital) financing to the EU economy. For further evidence on those different issues, please refer to Sub-sections 6.1.1 and 6.3.2 of the Evaluation Annex. 2.6.1.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers The high compliance cost of Solvency II (3.18% of total operating costs, the highest one-off costs among the financial services frameworks ), could be a barrier to the entry and growth of new competitors in the Single Market, with undesirable effects in the offer of insurance products and/or in their price for policyholders (higher fees). Therefore, doing nothing on proportionality may progressively lead to a less diversified landscape of insurers in terms of size and more concentration. The reduced competition in the sector could be detrimental to consumers. In addition, as the conditions to apply the principle of proportionality are not clearly defined, insurers with a similar risk profile, could be subject to different rules depending on the Member State in which they are located, which is detrimental to the level-playing field in the EU. Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures Doing nothing would leave unaddressed the inconsistencies and gaps identified in the Solvency II framework on the quality of supervision. Only relying on EIOPA’s soft (non-binding) tools to ensure convergence in supervision is of limited effectiveness as supervisory authorities have no legal obligation to comply with those principles. Similarly, the problem drivers identified in Sub-section 6.1.3 of the Evaluation Annex and in the problem definition on policyholder protection in case of insurers’ (near-)failures would remain, with the risk of late and not sufficiently prepared measures by insurers and/or public authorities in case of an insurer’s distress. This could have a negative impact on policyholder protection and level-playing field as further Member States would probably establish national recovery and resolution frameworks to implement international guidance. Finally, doing nothing on IGSs would mean that Member States continue to take different approaches to IGS, including a total absence of IGS in some Member States. Uneven and insufficient levels of protection could undermine consumers’ trust in the Single Market for insurance services. For further details, see Annex 5 and Sub-section 6.1.3 of the Evaluation Annex. Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector The baseline scenario would not impose new requirements on insurers and reinsurers, and therefore would allow avoiding additional compliance costs for them. In addition, the absence on new rules on investments or quantitative requirements (capital surcharge for systemic risk, concentration limits, etc.) would ensure that EU insurers’ short-term competitiveness is not affected. However, doing nothing would not guarantee that supervisors have the powers to address systemic risk, which is not coherent with one of the main objectives of Solvency II (preserving financial stability). Furthermore, a lack of sufficient supervisory tools to prevent financial instability risks originating from the insurance sector would be negative for policyholders in the long term, since insurance failures may require public intervention and indirect costs for taxpayers. Furthermore, the economic and financial consequences of a crisis on social welfare go far beyond the sole insurance sector, and may concern the wider economy. It should be noted that the “holistic framework” for systemic risk, adopted by the Insurance Association of Insurance Supervisors and the Financial Stability board in November 2019, provides that supervisory authorities should have the power and mandate to identify, monitor and address, where necessary, the build-up and transmission of systemic risk in the insurance sector. 3.Why should the EU act? 3.1.Legal basis The Solvency II Directive provides for a comprehensive regulatory framework regarding the taking up and the pursuit of insurance and reinsurance (hereafter “insurance”) business within the Union. The principle of regulating the taking-up and pursuit of the business of insurance is long established at European level, and leaving this matter to the discretion of Member States would highly hinder the right of establishment and the freedom to provide services which European insurance companies benefit from to date. The legal bases of the current Directive are Articles 53(1) and 62 of the Treaty on the Functioning of the European Union. This would also be the legal basis for the envisaged introduction of a new minimum harmonised framework for insurance guarantee schemes. In order to continue to harmonise the rules at stake, or introduce these new harmonised rules, EU action in accordance with these Articles is needed. On the envisaged harmonised framework for recovery and resolution of (re)insurers, which aims at ensuring a minimum level of harmonisation across the EU, the legal basis is Article 114 of the Treaty on the Functioning of the European Union. Necessity and Added Value of EU action

The review aims to amend certain provisions of the Solvency II Directive, in particular those on capital requirements, on valuation of insurance liabilities towards policyholders, on cross-border supervision and on preventive recovery planning. It also aims at providing necessary clarifications and changes to the principle of proportionality. With regard to these particular issues, only EU action to clarify these provisions will ensure that going forward, these regulatory provisions are applied uniformly and guarantee the existence of the well-established regulatory framework regarding the taking up and the pursuit of insurance and business, which are essential for the Single Market. In addition to amendments of existing rules, the review will consider the introduction of new dimensions in Solvency II, notably in relation to climate change and environmental risks, to the harmonisation of national frameworks for resolution, and to macro-prudential tools. In addition, the impact assessment will contemplate putting forward a stand-alone proposal for a minimum harmonisation framework for insurance guarantee schemes. The necessity and added value of EU action on those areas is justified in the next paragraphs. Climate change and environmental risks: The limited incentives for insurers to contribute to the greening of the economy could possibly be addressed through individual actions by Member States. In fact, given the commitments to environmental and climate policy goals, both at international (e.g. Paris Agreement) and at Union level, it is very likely that more Member States and NSAs will explore options of ensuring a contribution by the insurance sector. The lack of clarity on the relevance of sustainability risks in current prudential rules could however be exacerbated by parallel and uncoordinated attempts by Member States in that field which would undermine the Single Market for insurance services. Thus, such clarification needs to be provided at Union level so that insurance companies operating in several Member States comply with rules within a single framework and for supervisory authorities to coordinate and align actions within that framework (instead of segmenting the market via different actions and rules). Resolution: A minimum harmonised resolution framework for insurers, aiming to address situations where an insurer is no longer viable or likely to be no longer viable, would ensure a common approach to address and mitigate the consequences of an insurer’s failure across the EU, thereby fostering cross-border cooperation and coordination. If applied in a proportionate manner, this could improve the functioning of the Single Market, ensure that the overall framework is suitable to maintain a high level of protection for policyholders and beneficiaries and contribute to preserving financial stability in the EU. Insurance guarantee schemes: Currently, in the event an insurer fails, a patchwork of national schemes is in place across the Member States, which can step in. These guarantee schemes offer different levels of protection, cover a different scope of insurance products and have different geographical scopes. Solvency II does not contain substantive provisions on IGS. It only contains a provision providing that host Member States may require non-life insurers from other Member States selling insurance products on their territories through branches or cross-border sales to join and participate in their IGS. Combined with the increasing share of cross-border activities within the EU Single Market and the absence of adequate cross-border mechanisms for compensation, the current situation results in an inefficient and incomplete protection for policyholders and other beneficiaries. Establishing mechanisms that would address these issues would not be possible without EU action. Only an EU action can ensure consistently that all policyholders and beneficiaries acquiring insurance policies in the EU benefit from a minimum level of protection in the event that their insurer fails, and in particular in cross-border situations. EU action would also be necessary to create an appropriate and consistent incentive structure across the EU that is conducive of market discipline by involving the insurance industry in the financial consequences of an insurance failure. Macro-prudential supervision: Solvency II is at this stage mainly focused on micro-prudential supervision (i.e. the supervision of individual insurers) with the aim of protecting policyholders, but the Directive also mandates supervisors to preserve financial stability. Under certain (and so far limited) circumstances, insurance activities can indeed originate or amplify systemic risk. An action at EU level to integrate (targeted) macro-prudential elements within the Solvency II Directive would ensure uniform application of the new provisions. As financial stability does not have national borders (in particular since insurance companies and groups largely operate on a cross-border basis), an EU action (aiming to ensure that public authorities are granted sufficient powers allowing them to adopt appropriate and coordinated supervisory responses to systemic risks in all Member States) would contribute to the financial stability in the whole Union. This would also be consistent with the approach followed by banking regulation where macro-prudential supervision is framed at EU level. Finally, the scope of the amendments would have to be sufficiently targeted in order to ensure consistency with the existing instruments that have been designed as micro-prudential but may also have a macro-prudential relevance (e.g. the ORSA, which is the process by insurers to assess their exposures to all quantitative and qualitative risks, or the prudent person principle which requires insurers to monitor risks related to their investment activities,). 4.Objectives: What is to be achieved? General objectives The review of Solvency II will aim to achieve the following general objectives: ·Increase insurers’ contribution to the long-term and sustainable financing of the economy; ·Enhance the protection of policyholders; ·Contribute to financial stability; ·Preserve the international competitiveness of the European insurance industry and improving the efficiency of the EU insurance industry. Specific objectives The impact assessment will consider the following five specific objectives: ·Provide incentives for insurers to long-term sustainable financing of the economy (hereafter “LT green financing”) ·Improve risk-sensitivity (hereafter “risk sensitivity”) ·Mitigate excessive short-term volatility in insurers’ solvency position (hereafter “volatility”); ·Increase proportionality of prudential rules aiming to remove unnecessary and unjustified administrative burden and compliance costs (hereafter “proportionality”) ; ·Enhance quality, consistency and coordination of insurance supervision across the EU, and improve the protection of policyholders and beneficiaries, including when their insurer fails (hereafter “supervision / protection against failure”);

·Better address the potential build-up of systemic risk in the insurance sector (hereafter “financial stability”). Figure 2: links between general and specific objectives 5.What are the available policy options? 5.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy The “preferred policy option” may be a combination of one option in relation to the long-term financing of the European economy (among Options 2 or 3) and another one in relation to the greening of the European economy (among Options 4 and 5). Option label Option description Option 1: Do nothing This is the baseline scenario. Option 2: Facilitate long-term investments in equity Loosen eligibility criteria for the preferential treatment on long-term equity investments, with the aim of extending the scope of equities that may be subject to that preferential treatment. This is in line with EIOPA’s general approach. Option 3: Reduce capital requirements on all equity investments Proceed to a general decrease in capital requirements on all equity investments, without any restriction (no reference to any long-term perspective or long-term nature of the investment). Option 4: Strengthen “Pillar 2” requirements in relation to climate change and sustainability risks Strengthen the qualitative risk-management requirements to ensure that insurers appropriately monitor, manage and mitigate climate change and sustainability risks, as recommended by EIOPA Option 5: Strengthen “Pillar 2” requirements and incorporate climate change and sustainability risks in quantitative rules In addition to Option 4, quantitative rules would be amended so that they depend on the “green” nature of insurers’ investments, i.e. all else equal, insurers investing more in “green” assets would have a better solvency position (i.e. higher capital resources over capital requirements) than others. Options discarded at an early stage A complement to Option 5 could have been an option where additional disclosure requirements in relation to climate change and environmental risks are introduced in Solvency II, so that external stakeholders are fully informed about the sustainability of insurers’ activities. However, the communication on the European Green Deal underlined that the Commission intends to review the Non-Financial Reporting Directive (NFRD) the scope of which goes beyond the insurance sector, in order to extend “green” disclosure requirements to all types of financial market participants through one single piece of legislation. Therefore, in order to avoid overlapping disclosure requirements for insurers in different Directives, the option of introducing specific green disclosure requirements for insurers is not assessed in the context of this initiative. However, should gaps in the disclosure requirement for the insurance sector remain after the review of NFRD, amendments to Solvency II rules on disclosures could be considered. In relation to amendments of quantitative requirements, an alternative or a complement to Option 5 could have been to amend quantitative rules so that all else equal, insurers investing in environmentally harmful (“brown”) assets would have a lower solvency position than other insurers (i.e. prudential rules would penalise “brown investments”). However, contrary to green assets, there is no commonly accepted European definition of “brown” investments. Without such a definition, it would be very challenging (if not impossible) to define penalising factors for brown investments and to assess the quantitative impact of such an option. Therefore, such an option has been discarded at this stage, but could be reconsidered if a taxonomy for “brown assets” were to be developed. In addition, a standalone approach for the insurance sector which would not be consistent with other financial market participants is not deemed appropriate. 5.2.Insufficient risk sensitivity and limited ability of the framework to mitigate volatility of the solvency position of insurance companies Option label Option description Option 1: Do nothing. This is the baseline scenario. Option 2: Fix all technical flaws in relation to risk sensitivity and volatility Under this option, changes that are technically justified and aiming to address risk-sensitivity and/or volatility would be adopted, broadly in line with EIOPA’s advice: -To improve risk-sensitivity, incorporate negative interest rates in standard formula capital requirements and better take into account market rates used to value long-term insurance liabilities; -To reduce undue volatility, amend the long-term guarantee measures in order to improve the volatility-mitigating effect of the framework. Option 3: Address issues of risk sensitivity and volatility while balancing the cumulative effect of the changes Under this option, the changes presented in Option 2 would be implemented, subject to a phasing-in period aiming to smoothen the impact of the amendments over time. In addition, some additional measures would be taken in order to mitigate (part of) the long-term increase in capital requirements resulting from those changes. No option was discarded at an early stage. 5.3.Insufficient proportionality of the current prudential rules generating unnecessary administrative and compliance costs for small and less complex insurers In order to avoid excessive compliance costs, two elements can be combined: first, a further extension of the thresholds of the Directive (see Article 4) which would directly exclude from its mandatory scope a higher number of small insurers; second, new measures to reduce and simplify prudential rules for those insurers that would continue being in the scope of Solvency II. While the first element would address the problem of lack of proportionality for the smallest firms, only the second element would improve the application of the proportionality principle for the rest of firms, by not relying only on size. Therefore, only a combination of elements would allow an optimal solution. Option label Option description Option 1: Do nothing This is the baseline scenario. Option 2: Exclude a significant number of firms from Solvency II and enhance the proportionality principle within Solvency II Proportionality would be implemented as follows, in line with EIOPA’s general approach: -Increase significantly the thresholds of exclusion from Solvency II. The thresholds on risk volume would be doubled (from EUR 25 million to EUR 50 million) in order to ensure that only the less risky insurers are left out of the scope of Solvency II, and the thresholds on revenues would be extended from EUR 5 million to EUR 25 million. -Consequently, a large number of firms would no longer have to apply Solvency II, but would be subject to national specific regimes. -A certain number of additional firms subject to Solvency II would be identified, based on criteria, as being of “low-risk profile” and would benefit from automatic application of all Solvency II proportionality measures which would be clearly specified in the legislation. Option 3: Give priority to enhancing the proportionality principle within Solvency II and make a smaller change to the exclusion thresholds. Proportionality would be implemented in the following way: -Less firms would be excluded from the application of Solvency II than under Option 2 (the thresholds on revenues would be multiplied by 3 instead by 5, as in Option 2). Solvency II would still apply to more firms than in Option 2, but a larger number of those firms would be classified as low-risk profile and would benefit from automatic application of Solvency II proportionality measures, which would be clearly specified in the legislation and extended compared to Option 2. -A larger number of insurers would remain in the scope of the European framework, but compliance costs would be significantly reduced for those that meet the conditions to benefit from proportionality measures. Options discarded at an early stage

Alternative options could have been different exclusion thresholds that are lower than the changes proposed in Options 2 and 3. However, in view of the limited impact of such lower changes, those options, which were also tested by EIOPA, were discarded. Similarly, one could have envisaged a further increase in thresholds than the one proposed by EIOPA (as reflected in Option 2). However, in view of the downsides of Option 2 which are specified in the next section, this alternative option, which was also discarded by EIOPA, has not been considered in this impact assessment. 5.4.Deficiencies in the supervision of (cross-border) insurance companies and groups, and inadequate protection of policyholders against insurers’ failures For the purpose of analysing this problem, different policy options will be considered in order to address the issues of: I.Inconsistent and insufficiently coordinated supervision of insurance companies and groups, including in relation to cross-border activities II.Insufficient supervisory and resolution toolkit to address insurers’ distress III.Inadequate protection of policyholders in case of failure. Option label Option description Option 1: Do nothing This is the baseline scenario. Option 2: Improve the quality of supervision by strengthening or clarifying rules on certain aspects, in particular in relation to cross-border supervision Under this option, the framework would be clarified and strengthened so as to ensure more quality and convergence of supervision of insurance firms and groups. More requirements for cooperation between Home and Host supervisory authorities would be introduced, and EIOPA’s coordination role would be strengthened. This is in line with EIOPA’s general approach. Option 3: Introduce minimum harmonising rules to ensure that insurance failures can be better averted or managed in an orderly manner. Under this approach, minimum harmonising rules would be introduced, with the aim of providing public authorities with a toolkit to prevent and manage insurance failures, in particular by requiring ex ante planning of remedial actions in case of insurers’ (near-)failures, and by strengthening cooperation rules between authorities. This is in line with EIOPA’s advice. Option 4: Introduce minimum harmonising rules to protect policyholders in the event of an insurer’s failure Under this approach, minimum harmonising rules would be introduced so that each Member State has to establish safety nets to protect policyholders when their insurer fails (“IGSs”). This is in line with EIOPA’s general approach. Note that due to size constraints, the policy options do not explicitly refer to topics of internal models, and reporting and disclosure, although those aspects fall under the issue of quality of supervision. The dedicated impact assessment of each of those topics is presented in Annex 7. In addition, Annex 5 provides a further technical analysis of the different features of the design of harmonised rules on insurance guarantee schemes. Options discarded at an early stage Further options which could have been considered include an EU-centralisation of supervision and resolution. However, in view of the outcome of the ESAs review, the integration of micro-prudential supervision and of resolution is not deemed politically mature at this stage. Similarly, a further option for policyholder protection in cases of failure would be the creation of a single IGS for the entire EU. This would increase the insurance effect of mutualisation and would thus require lower resources from the insurance industry. However, a single EU-wide IGS would not be consistent with the existing national micro-prudential supervisory framework. 5.5.Limited specific supervisory tools to address the potential build-up of systemic risk in the insurance sector Option label Option description Option 1: Do nothing This is the baseline scenario. Option 2: make targeted amendments to prevent financial stability Under this option, targeted changes would be made to the framework, in order to incorporate macroeconomic and macro-prudential considerations in requirements on insurers’ investment and underwriting activities, and to better monitor liquidity risk. Option 3: introduce an extensive macro-prudential framework An extensive macro-prudential framework would be introduced, which would include, in addition to the changes envisaged as part of Option 2, the power for supervisors to impose systemic or countercyclical capital buffers, or concentration limits on investments. This is the approach put forward by EIOPA and the ESRB. Options discarded at an early stage An additional consideration could have been to fully centralise macro-prudential supervision at European level (e.g. at the level of EIOPA or the ESRB). While such an approach could be effective in addressing European-wide systemic risks (as systemic risks do not have borders and coordination of national responses is probably needed to effectively preserve financial stability in the Union), this idea has been discarded as too far-reaching. Indeed, the macro-prudential dimension in Solvency II remains limited at this stage according to some stakeholders. It is therefore needed, as a first step, to contemplate enhancements of the current set of rules (where deemed justified) before considering significant changes to institutional/governance arrangements on the use and implementation of such new tools. In addition, in light of the limited success of the Commission’s attempt to strengthen the centralisation of micro-prudential supervision by EIOPA, it would be unlikely that the centralisation of macro-prudential supervision would receive meaningful political support from Member States, before agreeing on the necessity to embed a macro-prudential dimension in Solvency II. 6.What are the impacts of the policy options and how do they compare? In this section, each policy option considered (other than Option 1 – “No change”) will be assessed against the specific objectives presented in Section 4. The baseline scenario (“Option 1 – no change” of each problem) will not be assessed in this section. The consequences of doing nothing are outlined in Section 2 of this impact assessment. 6.1.Limited incentives for insurers to contribute to the long-term financing and the greening of the European economy 6.1.1.Option 2: Facilitate long-term investments in equity

Under this option, the eligibility criteria for benefiting from the preferential treatment applicable to “long-term equity” assets would be loosened, with the aim of expanding the share of equity investments that can fall under this regulatory asset class. This is the general approach recommended by EIOPA in its advice. The revised criteria would still rely on the principle that an insurer may only benefit from a preferential treatment if it is able to avoid forced selling under stressed conditions. Other criteria would ensure that insurers have a long-term perspective when making equity investments which they want to classify as long-term equities. Benefits Option 2 would positively contribute to remedying the lack of incentives for insurers to contribute to the long-term and sustainable financing of the European economy. As demonstrated in Sub-section 6.1.4 of the Evaluation Annex, although Solvency II is not the main driver of equity investments, the prudential framework can also bias insurers’ investment behaviours. By relaxing some of the eligibility criteria for long-term investments in equity (while still ensuring that insurers’ policies incorporate the long-term perspective in their investment decisions), insurers would be able to apply the preferential treatment to a wider scope of equities and therefore to increase the amount of equity investments. In other words, facilitating long-term investments in equity would imply increasing insurers’ equity exposures. More capital could hence be injected in businesses, in particular SMEs. In addition, as the greening of the economy also requires stable financing, a facilitated preferential treatment for long-term investments in equity could also contribute to financing sustainable activities (indeed, criteria for long-term equities leverage on the objective of long-term investing time horizon). EIOPA has asked the industry to quantify the impact of one set of criteria, but its final advice goes further than what was tested, notably by allowing for more flexibility in the way life insurers may demonstrate their ability to stick to their investments. Therefore, EIOPA’s impact assessment (related to the initial set of criteria) provides a lower bound estimate of the impact of its final advice. Therefore, based on those figures, Option 2 could thus result at least in a doubling of the number of insurance firms which are willing to use the long-term equity asset class, and a multiplication by almost six of the amount of equities eligible to a preferential treatment (from € 4.2 billion to € 26 billion). This implies that at least € 3 billion in capital would become available for covering capital requirements for further investments in equity (assuming insurers are willing to maintain their solvency ratio constant). Option 2 would also have a moderately positive impact on international competitiveness. Indeed, if insurers are required to establish lower buffers when investing in equity, they would have more free capital surplus (i.e. excess capital resources over capital requirements) to expand internationally. The likely beneficiaries would be the shareholders of insurance companies. Finally, Option 2 would also allow improving supervisory convergence and level-playing field by providing more clear-cut and unambiguous criteria to the eligibility of equities for the preferential treatment. Costs EIOPA’s analysis suggests that the existing calibrations for equity are appropriate and that financial data do not support the preferential treatment on long-term equity investments which was introduced by the Commission in 2019. However, EIOPA did not recommend removing the long-term equity category, but concluded on the contrary that policyholder protection and risk sensitivity would remain at a very high level if the revised eligibility criteria remain sufficiently robust and clear. Therefore, Option 2 would have a moderate negative impact on the risk-sensitivity of the framework (i.e. only in relation to equity investments). While Option 2 is not aimed at addressing the issue of volatility, one may note that since equity can prove to be more volatile than other asset classes, more investments in equity (stemming from the further use of the long-term equity asset class) could lead to further volatility in insurers’ assets. On the other hand, those additional (long-term) equity investments would be possible to the extent that the insurer is able to stick to its investments, including under stressed conditions, and is therefore not exposed to short term volatility in stock markets. Option 2 could also have a limited but negative impact on financial stability. Indeed, insurers would have more incentives to invest in equity, and therefore to hold on average assets with higher risks of material loss in market value in a short period of time (i.e. more volatile assets). On the other hand, the prudential criteria would be defined in such way that supervisors have the assurance that insurers would not be subject to forced-selling of equities at deteriorated price under stressed conditions. Therefore, the revised eligibility criteria would be such that insurers would not be likely to amplify the negative externalities of an exogenous shock on stock markets, as they could weather the drop in equity prices due to the long-term nature of their investments. On balance, it is thus expected that this option would not generate material systemic risk. In terms of implementation costs, based on a survey conducted by EIOPA, there would be significant one-off implementation cost of applying Option 2 in the view of about 20% of participants to the holistic impact assessment. A similar share (24%) are of the view that there would be material increase in on-going compliance costs. Those costs are associated with updating IT systems to comply with updated requirements and trainings to ensure staff is aware of regulatory changes. However, as the criteria are assumed to be clearer than under current framework, those costs are expected to decrease relatively quickly over time. Overall assessment Effectiveness, efficiency and coherence: Option 2 would contribute to removing barriers to equity investments. Hence, it would enlarge the productive capacity of the economy and thus generate welfare. It would also have a positive impact on international competitiveness as evoked above. Option 2 would generate limited implementation costs and have limited negative impact on policyholder protection and financial stability, since the preferential treatment would only be possible if insurers meet a set of robust eligibility criteria. It is also coherent with the CMU objectives which explicitly refer to the need to facilitate insurers’ contribution to the “re-equitisation” of the European economy, and overall does not materially affect the risk-based nature of Solvency II (limited negative effect). Finally, it generates a necessary condition for enabling the European Green Deal, as “green” assets and activities require long-term funding including in equity investments, although it must be understood that there is no guarantee that all insurers’ long term investments are “green”. Winners and losers: Policyholders would be “winners” to a certain extent. Indeed, despite limited negative impact on policyholder protection, they may benefit from the moderate increase in risk-taking by insurers by receiving higher returns on their life insurance policies as insurance companies would generate higher returns on their investments. By being allowed to take additional risks, insurance companies can generate a higher return to their shareholders at limited additional costs. The impact of supervisors would also be positive, as the new criteria would be clearer than the existing ones, making it less complex to supervise insurers’ compliance with regulatory requirements. Finally, businesses, in particular SMEs and those conducting green activities, would benefit from easier access to equity funding by insurance companies. Stakeholder views: In the context of the Commission’s public consultation, among those stakeholders who expressed a view on equity financing, more than 50% of stakeholders consider that the current framework still includes obstacles to long-term investments. This is particularly the case for insurance companies (66%) and public authorities (75%). Only 30% of citizens/consumers/NGOs share this view, but the remaining 70% expressed no opinion on this question. In the context of EIOPA’s technical consultations on the review, the vast majority of insurance stakeholders support an alleviation of the criteria on long-term equity, although they may disagree on the very specific criteria that should be retained. 6.1.2.Option 3: Reduce capital requirements on all equity investments Under this option, all capital charges on equity would be reduced. Therefore, the average cost of investing in equity would be reduced for all insurers, without any criteria, and regardless of whether the investment is “long-term” or not. This option, which has been put forward by a few stakeholders, including public authorities in different Member States, would be justified by the choice of giving priority to the political objective of facilitating insurers’ capital financing of the economy, in accordance with the objectives of the Capital Markets Union Action Plan, even if the lack of evidence to justify such an approach would be in conflict with the primary objectives of Solvency II, namely policyholder protection and financial stability. Benefits Option 3 would be more effective than Options 1 and 2 in addressing the insufficient incentives for insurers to contribute to the long-term and sustainable financing of the European economy. By proceeding to a general decrease in capital requirements on equity regardless as to whether the investment is intended to be held for the long term or not, the prudential cost of investing in equity would be materially reduced, which implies a larger amount of additional “free capital” which may be invested in equity. EIOPA did not conduct any impact assessment of this option. However, on the basis of the quantitative data submitted by insurers to NSAs, and based on simplified assumptions, one can estimate that a 3 percentage point decrease in capital charges on equity frees about € 5 billion of capital (which could potentially be used to invest in equity). In principle, this additional capital could also be invested in “green” assets and therefore contribute to the objectives of the European Green Deal. However, as no conditionality would apply, there is no guarantee that capital be invested in climate-friendly activities, or even in equity more broadly. Option 3 would also be more effective than the previous options in improving EU insurers’ competitiveness at international level and thus benefitting insurers and their shareholders. Option 3 would free-up more capital than under Option 2, which could be used to expand internationally and thus generate additional profit for insurance companies. Finally, depending on the way this option is implemented, Option 3 could have a positive impact on the simplification of the framework. Indeed, if capital requirements on all equity investments were lowered to the same level regardless of their nature, this would materially simplify the framework by removing the existing patchwork of regulatory asset classes of equity investments (currently, they are at least eight different classes of equity investments in Solvency II). Costs Option 3 would materially reduce the risk-sensitivity of the framework. EIOPA notes that calibrations of capital charges on equity investments are already lower than what it advised when finalising the Solvency II framework before 2016. Therefore, a further general decrease in capital requirements on equity investments would not be justified based on available evidence. In addition, a general decrease of capital requirements in equity investments regardless of their nature (listed or unlisted equity, strategic or not strategic, etc.) would undermine the risk-based nature of the framework. This would also affect policyholder protection, by incentivising insurers to take much more risks, with a greater likelihood of insurance failure. While not aiming at affecting volatility, the expected effect of Option 3 is to dramatically increase insurers’ exposure to equity. As equity investments prove to be relatively more volatile than other asset classes, a significant increase in equity exposures would probably make insurers’ assets, and therefore solvency positions, materially more volatile.

Option 3 would imply a deviation from the risk-based approach whereby capital requirements are calibrated using evidence on their riskiness. This may cause supervisory authorities to pursue other tools to address the potential underestimation of the risk in the calculation of capital requirements, such as intensified supervisory monitoring, or even a capital add-on or requests by the supervisory authority to calculate capital requirements with an internal model that models equity risk in a fully risk-based manner. In such a scenario, the tools chosen by supervisory authorities are likely to differ and the option would therefore be detrimental to the consistency and coordination of supervisory practices and thus undermine the Single Market for insurance services. On the other hand, Option 3 would simplify the prudential framework for equity investments compared to the current situation where criteria for long-term equities are subject to interpretation. Therefore, the Option 3 would allow simplifying the framework, but at the cost of materially increasing risk exposure by insurers. Option 3 would have a potential very negative impact on financial stability. By proceeding to a general decrease in capital requirements which would not be supported by quantitative evidence (but would be justified by the priority given to achieving the CMU objectives over the primary objectives of the Solvency II Directive), Option 3 would provide wrong risk-management and investment incentives to insurance companies. The risk of excessive risk-taking (search for higher return) could generate bubbles and would expose insurers to sudden trend reversals in stock markets. In addition, Option 3 could imply windfall effects by generating an immediate broad increase in free capital, which could be simply used by insurers to make more dividend distributions to shareholders or share buy-backs instead of providing additional funding to the real economy. This risk is material. Option 3 would allow reducing capital requirements without any change in insurers’ behaviours. This would imply that without any change in the risk profile, the average solvency ratio could be maintained constant despite the level of capital resources would be reduced due to opportunistic higher dividend distributions. In comparison, this risk would be deemed minor in Option 2 because in order to benefit from a capital relief, insurers would still have to revise their internal investment policies and change their approach to equity investments so as to embed long-termism in their investment decisions. They would also have to document their ability to stick to their investments under stressed situations (which implies that their solvency ratio would be sufficiently high to not be subject to forced selling of equities with the aim to de-risk their investment portfolio and reduce capital requirements). Therefore, opportunistic dividend distributions would be less likely or would make it more difficult for insurers to demonstrate their intention and ability to invest for the long term. As regards implementation costs, although there is no available data, as this option could simplify the framework, it is expected that the one-off implementation cost would be lower than in Option 2 (need to update IT systems) and the on-going implementation costs would be almost null (simplified approach compared to today). Overall assessment Effectiveness, efficiency and coherence: Option 3 would probably be the most effective in removing barriers to equity investments, and improving insurers’ international competitiveness, but at the cost of materially deteriorated policyholder protection and risk sensitivity and higher financial stability risks. There would also be a lack of coherence with the primary objective of Solvency II (policyholder protection). Also, the CMU Action Plan highlights that the facilitation of insurers’ long-term sustainable financing of the economy should not be to the detriment of financial stability. Winners and losers: In the short term, policyholders would probably benefit from the increased risk-taking by insurers by receiving higher returns on their life insurance policies as insurance companies would generate higher returns on their investments. However, in the long run, they would be the losers due to the higher risk of failure of their insurer. Insurers and their shareholders would be the winners as insurance companies would have more free capital to invest (and therefore higher return to pay to shareholder) with no conditionality. On the other hand, it is clear that in the long run, if excessive risk taking in equity leads to an insurance failure, this would be detrimental to shareholders. For supervisory authorities, while this approach would probably simplify the supervision of compliance with regulatory requirements, this would also require more active supervisory dialogue with insurers in order to compensate the higher risk of failure stemming from potential excessive risk-taking. This would also entail the need for a more active macro-prudential supervision. Stakeholder views: The same remarks as in Option 2 apply as regards the need to bring changes to the prudential framework on equity. The principles embedded in Option 3 have not been formally consulted by EIOPA. However, while it can be expected that a majority of insurance stakeholders would support Option 3, only a minority of supervisory authorities expressed interest in such an option. In addition, in the context of the Commission’s consultation, several stakeholders, including citizens/consumers/NGOs, highlighted the need to ensure that the changes brought to Solvency II do not generate financial stability risks (which may imply dismissing Option 3). 6.1.3.Option 4: Strengthen “Pillar 2” requirements in relation to climate change and sustainability risks Under this option, qualitative requirements on risk-management would be strengthened in order to ensure that insurers appropriately monitor, manage and mitigate climate change and sustainability risks as indicated by EIOPA in an opinion. While earlier initiatives already require insurers to take into account sustainability risk in their disclosures and risk management, those initiatives do not ensure that the sustainability risks are taken into account in insurers’ business strategy. Option 4 would imply integrating longer-term scenario analysis in relation to climate change in the own risk and solvency assessment. The own risk and solvency assessment aims, among others, to address risk that are not well reflected in the calculation of capital requirements and more generally risks that are hard to quantify, like risks related to climate change. By clarifying the relevance of climate change risks in the own risk and solvency assessment, Option 4 would ensure that those risks are taken into account in insurers’ business strategy. The option would also aim to ensure insurers put in place internal procedures to avoid overreliance on data from past events with respect to climate change-related risks. Further details are provided in Section 1 of Annex 8. However, no changes would be made to capital requirements for sustainable investments. Instead, EIOPA would for the first time receive a legal mandate similar to the European Banking Authority’s mandate in Regulation (EU) 575/2013, Article 501c, point (c). In particular, EIOPA would be asked to monitor the evidence on the riskiness of sustainable investments and, where justified, propose changes to Solvency II capital requirements. Benefits Option 4 would have a positive impact on policyholder protection and some positive impact on funding for the sustainable recovery of the EU. Stronger qualitative requirements on the management of climate and environmental risks would set incentives to reduce exposure to such risks on the asset and liability side of the balance sheet. As regards the asset side, a reduction to sustainable risks can be achieved by a shift to “green” investments. Furthermore, EIOPA’s work under a new mandate may provide evidence on lower riskiness of some or all sustainable investments. In that case, the Commission would be in a position to use existing empowerments for delegated acts to amend Solvency II capital requirements accordingly. Option 4 would also have limited (but possibly positive) impact on the consistency and quality of supervision. The lack of references to sustainability risks in the Solvency II Directive may result in varying approaches by supervisors to sustainabilit