Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Council Directive 73/239/EEC as regards the solvency margin requirements for non-life insurance undertakings

(presented by the Commission)

EXPLANATORY MEMORANDUM

The basic purpose of this Directive is to improve the protection of insurance policyholders by improving the rules regarding the solvency margin of insurance undertakings.

A companion proposal to amend the solvency margin for life assurance undertakings has also been prepared. The two proposals have many common measures and for coherence should be read together.

1. Part A - General presentation

1.1. Introduction

The Financial Services Action Plan, as endorsed by Heads of State and Government at the Cologne and Lisbon European Councils, stressed [1] the importance of the financial services sector as a motor for growth and job-creation. Users and suppliers of financial services should be able to exploit freely the commercial opportunities offered by a single financial market, while benefiting from a high level of consumer protection.

[1] COM(1999) 232 final, 11.5.1999.

One of the most important regulatory instruments to protect consumers is the requirement for insurance undertakings to establish an adequate solvency margin. This fulfils a warning role and provides an additional buffer capital beyond that strictly required to cover policyholder liabilities. In adverse underwriting and investment conditions, undertakings have extra capital to protect policyholders' interests and this capital provides managers, supervisors and regulators with a breathing space to remedy difficulties.

The amendment of the solvency margin was included in the Financial Services Action Plan with a target date of mid-2000 for adoption of the proposal for the Directive.

1.2. Background

The existing solvency margin requirements were established more than 20 years ago; in 1973 under the First Non-Life Directive [2] and in 1979 under the First Life Directive [3]. Since then they have remained substantially unchanged. In particular, the various minimum guarantee funds which correspond to the minimum regulatory capital required by an insurance undertaking have not been increased, notwithstanding the fact that there has been considerable claims and expense inflation in the intervening years.

[2] Directive 73/239/EEC.

[3] Directive 79/267/EEC.

This need to review to review the solvency margin requirements was already recognised at the time of the adoption of the Third Life and Non-Life Insurance Directives. However, in order not to delay matters, a provision [4] was established in each requiring the Commission to submit a report to the Insurance Committee on the need for further harmonisation of the solvency margin.

[4] Article 26, Third Life Directive; Article 25 Third Non-Life Directive.

The essential conclusions of the Commission Report [5] were that:

[5] COM(97) 398 final, 24.7.1997.

- the simple, robust nature of the current system had proved satisfactory;

- the superiority of more sophisticated systems [6] had not yet been proved;

[6] e.g. the US style, Risk-Based-Capital approach.

- scope for improvement existed;

- unnecessary additional cost for industry should be avoided.

This Commission Report was largely inspired by the Report on the Solvency of Insurance Undertakings prepared by the Conference of the Insurance Supervisory Authorities of the Member States of the European Union under the chairmanship of Dr Muller, the current President of the Bundesaufsichtsamt für das Versicherungswesen (Federal Insurance Supervisory Authority of Germany), the so-called 'Muller Report'.

In the light of these two reports, the Commission has conducted an in-depth analysis with national experts of the solvency margin working group of the Insurance Committee over the last three years. Industry too has been closely involved and consulted. Extensive analysis and discussion has taken place and all this work has culminated in the present package of proposals.

The present proposal for a Directive significantly clarifies, simplifies, improves and updates the existing rules. Taken as a whole, it represents a significant strengthening and improvement of the current system.

1.3. Some essential concepts

For a proper comprehension of this Directive, it is necessary to clearly understand some essential concepts:

The required solvency margin (RSM): the amount of regulatory capital required by an insurer to write the insurance business for which authorised.

The available solvency margin (ASM): represents those capital items that may be used to meet the required solvency margin.

The guarantee fund: corresponds to a third of the required solvency margin. This is subject to an over-riding minimum - called the minimum guarantee fund (MGF). The capital items used to cover the guarantee fund requirement must be of a higher quality.

1.4. Summary of proposals

The proposals represent a package of measures (the so-called Solvency I package) which taken together significantly strengthen existing policyholder protection. They can be broadly sub-divided into the following themes:

1.4.1. Minimum harmonisation

The harmonised solvency margin (SM) rules are not to be considered strict: Member States are free to establish more stringent rules for the undertakings they authorise. In the past it was not clear whether the existing rules were to be considered strict or minimum. This lack of precision is now clearly removed by Recital (14). This approach reflects differences between existing systems and allows national authorities to further strengthen RSM in line with their national market specificities.

1.4.2. Indexation of MGF and premium/claims thresholds

The MGFs have been strengthened and indexed in line with inflation; so have the thresholds for the application of the split percentage rates for the premiums and claims. The number of MGFs has been simplified and reduced to two (from four). Generous transitional arrangements are foreseen (five plus additional two years from entry into force).

1.4.3. Increased power of early intervention for supervisors

Regulatory supervision has been strengthened by expressly endowing the competent authorities with the power to take remedial action where policyholders interests are threatened. For example, if the financial position of an undertaking is deteriorating rapidly, the supervisory authorities may intervene even though the insurance undertaking may currently satisfy the RSM.

1.4.4. Changes to solvency margin for reinsurance

The existing formula for the reinsurance reduction to the RSM has been slightly improved. It is now based on a three-year average (as opposed to a single year). More significantly, supervisors are now empowered to reduce the amount of the reduction to the RSM where the nature or quality of the primary insurer's reinsurance arrangements is impaired or where there is no real risk transfer. The last item addresses the growing importance of financial reinsurance in today's market place.

1.4.5. Class enhancement

A higher RSM is now established for non-life classes of business that have a particularly volatile risk profile. These are classes 11, 12 and 13 corresponding to marine, aviation and general liability. The proposal is to increase the current RSM by 50%. This proposal seeks to better match the amount of regulatory capital to the risk profile of the business.

1.4.6. Solvency margin requirement for run-off companies

Previously the RSM formula produced an unsatisfactory result for insurance undertakings in run-off. This is now corrected by requiring a proportionate run-down in the RSM.

1.4.7. Miscellaneous improvements

The different items eligible for the ASM have been clarified and categorised into three groups according to their relative financial strength. Generally speaking, items from the first group are acceptable without limitation, items in the second group are subject to some limitation, while items from the third group are only acceptable with the approval of the national supervisor. The eligibility of certain items has been further limited, thus reinforcing the financial quality of the solvency margin. Furthermore, different accounting and actuarial approaches (e.g. book versus market values; discounting versus non-discounting of non-life technical provisions) are now treated in a more coherent and consistent manner.

1.5. Future Commission action

The preparatory work for this draft Directive has clearly demonstrated that the RSM is but one of a series of parameters important to the determination of the overall financial position of an insurance undertaking. A true assessment must have regard not only to the SM of an insurance undertaking but also to other financial aspects:

- the adequacy of technical provisions;

- asset and investment risk;

- asset-liability management;

- reinsurance arrangements; and

- the accounting and actuarial methodologies.

Furthermore, there are other equally important non-financial issues such as the application of fit and proper criteria for management and the ability to make on-site inspections or supervise the operation of the insurance undertaking.

While the analysis has demonstrated the past adequacy of the existing SM regime, the future operating environment for insurance undertakings is likely be much more difficult for a variety of reasons. These include:

- tariff liberalisation as a result of the implementation of the third generation of life and non-life insurance Directives;

- the advent of the euro;

- merger and acquisition activity increasing the business pressure on smaller undertakings;

- shareholder pressure to reduce the free capital of an insurance undertaking to a minimum;

- new distribution channels and methods, such as the internet and direct writing, which will lower distribution costs and market entry barriers;

- reduced investment returns - it seems unlikely that the very favourable investment returns obtained over the last 20 years or so can be maintained at the current level.

These factors all point in the direction of increased competition and reduced free financial resources (i.e. less ASM) for insurance undertakings in the future. For this reason, it is intended to commence a fundamental review (Solvency II) of the overall financial position of an insurance undertaking, embracing all of the above factors as an integral part of the report on the application of this draft Directive as foreseen at Article 3(4).

However, in accordance with the political priority established by the Financial Services Action Plan, it is important to move forward and already implement the improvements described above. The Solvency II exercise will permit a longer term review of the wider picture taking into account all factors of financial stability.

1.6. Concluding remarks

Insurance is a risk business by definition. While no absolute guarantees can be given, every effort must be made to achieve the highest possible level of security. In this context, an adequate and appropriate level of solvency margin is a vital instrument to protect insurance policyholders everywhere. This Directive helps achieve this fundamental objective.

2. Part B - Detailed commentary article by article

(Preliminary comment: references to existing Articles are shown in italics)

2.1. Article 1 - Point (1) - Small mutual associations

This Article sets out the list of amendments to Directive 73/239/EEC

Point (1): The current Directives do not apply to mutual associations where annual contribution income is below EUR 100 000. Point (1) raises this amount to EUR 5 million (idem for life).

There are many, small mutual associations which have a purely local or regional vocation and have no real need to be covered by the insurance Directives. Undertakings falling under the Directives have the benefit of the single passport. This means that they are entitled to market their products freely throughout the EU and that host country supervisors must accept the prudential supervision carried out by the home country authorities.

However, there is an obligation attached to this right and it is that 'passported' undertakings are required to respect all the rules established by the Directives, in particular those applying to the RSM. Nevertheless, in order not to exclude small mutuals satisfying the RSM rules which wish to be covered, a new provision automatically entitles such mutuals to be covered upon simple notification to their competent authorities notwithstanding the fact that their contribution income is below EUR 5 million.

It should be noted that the proposed increase does not mean that such undertakings will be unable to write business in the future, only that they will not fall directly under the Directives. These undertakings will of course be subject to national prudential requirements as determined by the Member State concerned. These undertakings will therefore be able to continue to operate in the future under the direct supervision of their domestic authorities, but will not have a single passport [7]. Given that the vast majority have a purely local or regional vocation, this is in accord with the subsidiarity principle. Furthermore, as described under Article 2 of the proposed Directive, generous transitional arrangements are foreseen.

[7] Unless automatically eligible as foreseen under the proposed amendment.

2.2. Article 1 - Point (2) - Available solvency margin

This inserts a revised Article 16 (ASM)

The revised Article restructures, clarifies and strengthens the existing definition of the items eligible for the ASM for non-life insurance undertakings. Article 16(1) removes the anomaly in the previous definition with regard to the eligibility of certain items and specifically states that the RSM must now be satisfied at all times (merely than at the date of the last balance sheet).

Eligible items are divided into three groups of category: items under Article 16, point 2 are of the highest security and may be accepted without limitation, those under point 3 are subject to some limitations (e.g. preferential share capital, subordinated loans) while items under point 4, may only be accepted with the approval of the competent authorities.

The most significant improvements are:

Article 16(2)(c): The loss carried forward and dividends to be paid in respect of the last financial year are now deducted from the ASM; own shares are excluded (in the event of bankruptcy, their value is likely to be zero). Undertakings will also lose the benefit of discounting non-life technical provisions (cf comments below).

Article 16(3) : No major changes.

Article 16(4)(b): The eligibility of supplementary contributions by members for mutuals will now only be accepted with the approval of the competent authorities (cf comments below). The eligibility of unpaid share capital or initial fund is limited to the lesser of 50% of the available and required solvency and will now only be accepted with the approval of the competent authorities.

The structure of the eligible items for the ASM for non-life is very similar to that for life business. In fact the two lists are identical except for five items as explained below.

The following items are only permitted in life assurance for technical reasons: profit reserves (Article 18(2)(d)), future profits (Article 18(4)(a)) and the adjustment for Zillmerising (Article 18(4)(b)). They are not permitted in non-life insurance and therefore do not appear in the list of eligible items for non-life insurance.

The two eligible items appearing in the non-life list but not in the life list are:

Article 16(2): This concerns the discounting of non-life technical provisions. This is only permitted under special circumstances as described in the Insurance Accounts Directive [8]. Undertakings discounting technical provisions are currently treated more favourably for SM purposes than those undertakings not discounting. The proposed paragraph disallows the benefit of discounting and therefore establishes parity of treatment between undertakings discounting and those not discounting.

[8] Article 60(g), Directive 91/674/EEC.

The practical effect of the proposal is to strengthen the RSM for undertakings discounting technical provisions.

Article 16(4)(b): This concerns the eligibility of supplementary contributions by members for mutuals. This has always been accepted as an eligible item for SM purposes. Under the proposal, supplementary contributions will continue to be eligible, but this will now be subject to the approval of the competent authorities. This will mean that competent authorities will be able to assess the real likelihood of such supplementary contributions being available in the event of difficulty. This measure strengthens the RSM.

2.3. Article 1 - Point (3) - Required solvency margin

The formula for the RSM requirement in non-life business is different to that for life business. Whereas in life business it is based on the amount of the technical provisions, in non-life business it is calculated as the higher of two formulas; one based on premiums, the other based on claims.

A new Article 16a describing the RSM is inserted. There are three improvements to the RSM calculation. These are described below.

2.3.1. Article 16a,(3) first result, first paragraph and (4), first paragraph

This introduces the class enhancement approach which is one of the most important proposals under the draft Directive. Class enhancement retains the simplicity of the existing methodology but for certain, more volatile classes of risk, the solvency margin requirement is increased or enhanced by a factor of 50%. These classes are 11, 12 and 13 corresponding respectively to aviation, marine and general liability. These classes are universally recognised as being more volatile in nature. The 50% enhancement is based on analysis by Member States and other technical input from the European Insurance Committee and the European Association of Actuaries.

2.3.2. Article 16a, (3) fifth paragraph and (4) sixth paragraph

The existing formula is calculated on a split rate basis. On the premium basis, this is 18% on the first EUR 10 million and 16% above; on the claims basis, this is 26% on the first EUR 7 million 23% above. The above paragraphs indexes the breakpoints in line with inflation to respectively EUR 50 and 35 million.

2.3.3. Article 16a, (5)

While the existing RSM has operated satisfactorily, because it is based on premiums and claims, it has a weakness where an undertaking starts to write a significantly lower volume of business. In the most extreme situation, that of an undertaking in 'run-off' where no new business is being written, the formula can produce a zero RSM. This deficiency is corrected by requiring a minimum RSM based on the previous year's RSM reduced by the proportionate reduction in the level of technical provisions.

The advantage of this method is that for undertakings in run-off, the base level of the RSM is determined by the existing method, but that subsequently, the RSM is maintained at a level proportionate to the amount of the technical provisions remaining.

2.4. Article 1 - Point (4) - Guarantee Fund & MGF

This inserts a revised Article 17

Article 17(1): The rules governing the items eligible for the non-life MGF, follow that for life business, i.e. 100% of items must be drawn from the higher quality list subject but, as for non-life insurance, to establish parity between book and market value accounting, hidden reserves on the asset side may be accepted.

Article 17(2): The major difference between life and non-life is that for life business there is a single MGF whereas in non-life business this varies depending upon the class of business written. In the past there were 4 different amounts for the non-life MGF. This has now been simplified and reduced to two.

For classes 10 to 15, the new MGF is EUR 3 million. For all other classes, the MGF is EUR 2 million. This increase is largely justified by inflation in the level of claims and administration expenses incurred over the last 25 years or so. The increase is substantial and in fact goes some way beyond that strictly required by inflation alone. This is to reflect real increases in risk level and is in line with the proposals of the Muller Report.

Lastly, to help ease the capital burden of small mutuals, the Member State option granting a one-quarter reduction to the MGF for mutuals and mutual type associations, has been maintained.

2.5. Article 1 - Point (5) - Update procedure

This inserts a completely new Article 17a.

Article 17a (1) provides for the automatic update of the MGFs and the breakpoint for premium and claims SM percentages in line with EU consumer price inflation. It will strengthen the RSM in the future by maintaining the real level of these amounts. Had such a provision existed in the past, it would have avoided the need for the sharp increase in these amount at the present time.

To avoid needless small adjustments, indexation only takes place when there is at least a 5% increase.

Article 17a (2): This is purely procedural and establishes an annual Commission obligation to communicate the adapted amount to the European Parliament and the Insurance Committee.

2.6. Article 1 - Point (6) - Minor technical amendment

This merely corrects a reference to the RSM to reflect the new Article 16a.

2.7. Article 1 - Point (7) - Power of early intervention by supervisors

This inserts a completely new Article 20a.

This is a completely new Article, expressly confirming the power of supervisors to intervene on a pro-active basis at an early stage. This need was also identified by the Muller Report.

Previously, when the financial position of an insurance undertaking was deteriorating rapidly, it was not clear whether supervisors had to wait until the ASM dipped below the RSM, before they could take action to protect policyholders' interests. This lack of clarity is removed by the present Article.

Article 20a(1): This establishes a general power for the competent authorities to require an undertaking to submit a financial recovery plan where policyholders' rights are threatened. Elements for inclusion in the financial recovery plan are identified.

Article 20a(2): This paragraph gives competent authorities the power to require a higher RSM in such types of situations.

Article 20a(3): Markets are becoming increasingly volatile and significant changes in the market value of assets backing the solvency margin can occur. In order to be certain that the RSM is satisfied at all times, supervisors need power to be able to revalue downwards elements eligible for the ASM. This is vital where an undertaking relies on the full market value of assets and there has been a significant drop in such values since the last balance sheet date. This power is provided by the present paragraph.

Article 20a(4): Reinsurance was an area identified by the Muller Report where supervisors needed to be able to take a more differentiated approach depending upon the quality and nature of the reinsurance programme. In particular, this was the case for financial reinsurance - where little or no real transfer of risk takes place. These issues are addressed by the present paragraph which allows supervisers to reduce the reinsurance reduction for the RSM in such circumstances.

2.8. Article 2 - Transitional period

This Article establishes a generous transition period for undertakings to conform with the new RSM. An initial transition period of five years is permitted which may be extended by a further two years. Given the time required for legislative approval of the present Directive, in all undertakings may have about eight to ten years to adapt to the new requirements.

2.9. Article 3 - Transposition

This Article establishes the usual transposition provisions. Worthy of mention is Article 3(4) which requires the Commission after three years "to submit to the Insurance Committee a report on the application of this Directive and, if necessary, on the need for further harmonisation". It is envisaged that this report will comment on progress achieved with the Solvency II exercise.

2.10. Articles 4 and 5 - Entry into force and addressees

Self explanatory.

2000/0251 (COD)

Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Council Directive 73/239/EEC as regards the solvency margin requirements for non-life insurance undertakings

THE EUROPEAN PARLIAMENT AND THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community, and in particular Articles 47(2) and 55 thereof,

Having regard to the proposal from the Commission [9],

[9] OJ C

Having regard to the opinion of the Economic and Social Committee [10],

[10] OJ C

Acting in accordance with the procedure laid down in Article 251 of the Treaty [11],

[11] OJ C

Whereas:

(1) The Financial Services Action Plan, as endorsed by Heads of State and Government at the European Council meetings in Cologne on 3 and 4 June 1999 and in Lisbon on 23 and 24 March 2000, recognises the importance of the solvency margin for insurance undertakings to protect policyholders in the single market by ensuring that insurance undertakings have adequate capital requirements in relation to the nature of their risks.

(2) First Council Directive 73/239/EEC of 24 July 1973 on the coordination of laws, regulations and administrative provisions relating to the taking up and pursuit of the business of direct insurance other than life assurance [12] requires insurance undertakings to have solvency margins.

[12] OJ L 228, 16.8.1973, p. 3; Directive as last amended by Directive 2000/26/EC of the European Parliament and of the Council (OJ L 181, 20.7.2000, p. 65).

(3) The requirement that insurance undertakings establish, over and above the technical provisions to meet their underwriting liabilities, a solvency margin to act as a buffer against adverse business fluctuations is an important element in the system of prudential supervision for the protection of insured persons and other policyholders.

(4) The existing solvency margin rules as established by Directive 73/239/EEC have been substantially unchanged by subsequent Community legislation and Council Directive 92/49/EEC of 18 June 1992 on the coordination of laws, regulations and administrative provisions relating to direct insurance other than life assurance and amending Directives 73/239/EEC and 88/357/EEC (Third Non-Life Insurance Directive) [13] required the Commission to submit a report to the Insurance Committee set up by Council Directive 91/675/EEC [14], on the need for further harmonisation of the solvency margin.

[13] OJ L 228, 11.8.1992, p. 1; (Article 25) Directive as amended by European Parliament and Council Directive 95/26/EC (OJ L 168, 18.7.1995, p. 7).

[14] OJ L 374, 31.12.1991, p. 32.

(5) The Commission has prepared that report [15] in the light of the recommendations of the Report on the Solvency of Insurance Undertakings prepared by the Conference of the Insurance Supervisory Authorities of the Member States of the European Union.

[15] COM(97) 398 final.

(6) While the report concluded that the simple, robust nature of the current system has operated satisfactorily and is based on sound principles benefiting from wide transparency, certain weaknesses have been identified in specific cases, particularly for sensitive risk profiles.

(7) There is a need to simplify and increase the existing minimum guarantee funds, in particular as a result of inflation in claim levels and operational expenses since their original adoption. The thresholds above which the lower percentage rate applies for the determination of the solvency margin requirement on the premiums and claims basis should also be increased accordingly.

(8) To avoid major and sharp increases in the amount of the minimum guarantee funds and the thresholds in the future, a mechanism should be established providing for their increase in line with the European Index of Consumer Prices.

(9) In specific situations where policyholders' rights are threatened, there is a need for the competent authorities to be empowered to intervene at a sufficiently early stage, but in the exercise of those powers, competent authorities should inform the insurance undertakings of the reasons motivating such supervisory action, in accordance with the principles of sound administration and due process.

(10) In the light of market developments in the nature of reinsurance cover purchased by primary insurers, there is a need for the competent authorities to be empowered to decrease the reduction to the solvency margin requirement in certain circumstances.

(11) Where an insurer substantially reduces or ceases the writing of new business, there is a need to establish an adequate solvency margin in respect of the residual liabilities for existing business as reflected by the level of technical provisions.

(12) For specific classes of non-life business which are subject to a particularly volatile risk profile, the existing solvency margin requirement should be substantially increased so that the required solvency margin is better matched to the true risk profile of the business.

(13) To reflect the impact of differing accounting and actuarial approaches, it is appropriate to make corresponding adjustments to the methodology for the calculation of the solvency margin requirement so that this is calculated in a coherent and consistent manner, thus placing insurance undertakings on an equal footing.

(14) This Directive should lay down minimum standards for the solvency margin requirements and home Member States should be able to lay down stricter rules for insurance undertakings authorised by their own competent authorities.

(15) Directive 73/239/EEC should be amended accordingly,

HAVE ADOPTED THIS DIRECTIVE:

Article 1

Amendments to Directive 73/239/EEC

Directive 73/239/EEC is amended as follows:

(1) In Article 3, paragraph 1 is replaced by the following:

"1. This Directive does not apply to mutual associations in so far as they fulfil all the following conditions:

(a) the articles of association must contain provisions for calling up additional contributions or reducing their benefits;

(b) their business does not cover liability risks or credit and suretyship risks unless these constitute ancillary cover within the meaning of subparagraph (c) of the Annex;

(c) the annual contribution income for the activities covered by this Directive must not exceed EUR 5 million; and

(d) at least half of the contribution income from the activities covered by this Directive must come from persons who are members of the mutual association.

Upon notification by an insurance undertaking to the competent authority of the home Member State, however, and with the agreement of that competent authority, this undertaking shall be concerned by this Directive, once it fulfils the provisions of Articles 16, 16a and 17."

(2) Article 16 is replaced by the following:

"Article 16

1. Each Member State shall require of every insurance undertaking whose head office is situated in its territory an adequate available solvency margin in respect of its entire business at all times.

2. The available solvency margin shall consist of the assets of the insurance undertaking free of any foreseeable liabilities, less any intangible items. In particular the following shall be included:

(a) the paid-up share capital or, in the case of a mutual insurance undertaking, the effective initial fund plus any members' accounts which meet all the following criteria:

(i) the memorandum and articles of association must stipulate that payments may be made from these accounts to members only in so far as this does not cause the available solvency margin to fall below the required level, or, after the dissolution of the undertaking, if all the undertaking's other debts have been settled;

(ii) the memorandum and articles of association must stipulate, with respect to any payments referred to in point (i) for reasons other than the individual termination of membership, that the competent authorities must be notified at least one month in advance and can prohibit the payment within that period;

(iii) the relevant provisions of the memorandum and articles of association may be amended only after the competent authorities have declared that they have no objection to the amendment, without prejudice to the criteria stated in points (i) and (ii);

(b) reserves (statutory reserves and free reserves) not corresponding to underwriting liabilities;

(c) the financial result brought forward after deduction of dividends to be paid in respect of the last financial year.

The available solvency margin shall be reduced by the amount of own shares directly held by the insurance undertaking.

For those insurance undertakings which discount or reduce their technical provisions for claims outstanding to take account of investment income as permitted by Article 60(g) of Directive 91/674/EEC, the available solvency margin shall be reduced by the difference between the undiscounted technical provisions or technical provisions before deductions as disclosed in the notes on the accounts, and the discounted or technical provisions after deductions. This adjustment shall be made for all risks listed in point A of the Annex, except for risks listed under classes 1 and 2. For classes other than 1 and 2, no adjustment need be made in respect of the discounting of annuities included in technical provisions.

3. The solvency margin may consist of:

(a) cumulative preferential share capital and subordinated loan capital up to 50% of the lesser of the available and required solvency margin, no more than 25% of which shall consist of subordinated loans with a fixed maturity, or fixed-term cumulative preferential share capital, provided in the event of the bankruptcy or liquidation of the insurance undertaking, binding agreements exist under which the subordinated loan capital or preferential share capital ranks after the claims of all other creditors and is not to be repaid until all other debts outstanding at the time have been settled.

Subordinated loan capital must also fulfil the following conditions:

(i) only fully paid-up funds may be taken into account;

(ii) for loans with a fixed maturity, the original maturity must be at least five years. No later than one year before the repayment date the insurance undertaking must submit to the competent authorities for their approval a plan showing how the available solvency margin will be kept at or brought to the required level at maturity, unless the extent to which the loan may rank as a component of the available solvency margin is gradually reduced during at least the last five years before the repayment date. The competent authorities may authorise the early repayment of such loans provided application is made by the issuing insurance undertaking and its available solvency margin will not fall below the required level;

(iii) loans the maturity of which is not fixed must be repayable only subject to five years' notice unless the loans are no longer considered as a component of the available solvency margin or unless the prior consent of the competent authorities is specifically required for early repayment. In the latter event the insurance undertaking must notify the competent authorities at least six months before the date of the proposed repayment, specifying the available and required solvency margin both before and after that repayment. The competent authorities shall authorise repayment only if the insurance undertaking's available solvency margin will not fall below the required level;

(iv) the loan agreement must not include any clause providing that in specified circumstances, other than the winding-up of the insurance undertaking, the debt will become repayable before the agreed repayment dates;

(v) the loan agreement may be amended only after the competent authorities have declared that they have no objection to the amendment;

(b) securities with no specified maturity date and other instruments, including cumulative preferential shares other than those mentioned in point (a), up to 50% of the lesser of the available and required solvency margin for the total of such securities and the subordinated loan capital referred to in point (a) provided they fulfil the following:

(i) they may not be repaid on the initiative of the bearer or without the prior consent of the competent authority;

(ii) the contract of issue must enable the insurance undertaking to defer the payment of interest on the loan;

(iii) the lender's claims on the insurance undertaking must rank entirely after those of all non-subordinated creditors;

(iv) the documents governing the issue of the securities must provide for the loss-absorption capacity of the debt and unpaid interest, while enabling the insurance undertaking to continue its business;

(v) only fully paid-up amounts may be taken into account.

4. Upon application, with supporting evidence, by the undertaking to the competent authority of the home Member State and with the agreement of that competent authority, the solvency margin may consist of:

(a) one half of the unpaid share capital or initial fund, once the paid-up part amounts to 25% of that share capital or fund, up to 50% of the lesser of the available and required solvency margin.

(b) in the case of mutual or mutual-type association with variable contributions, any claim which it has against its members by way of a call for supplementary contribution, within the financial year, up to one-half of the difference between the maximum contributions and the contributions actually called in, and subject to a limit of 50% of the lesser of the available solvency margin and the required solvency margin.

(c) any hidden reserves arising out of the under-valuation of assets, in so far as such hidden reserves are not of an exceptional nature.

5. Amendments to paragraphs 2, 3 and 4 to take into account developments that justify a technical adjustment of the elements eligible for the available solvency margin, shall be adopted in accordance with the procedure laid down in Article 2 of Directive 91/675/EEC."

(3) The following Article 16a is inserted:

"Article 16a

1. The minimum required solvency margin shall be determined on the basis either of the annual amount of premiums or contributions, or of the average burden of claims for the past three financial years.

In the case, however, of insurance undertakings which essentially underwrite only one or more of the risks of credit, storm, hail or frost, the last seven financial years shall be taken as the reference period for the average burden of claims.

2. Subject to the provisions of Article 17, the amount of the minimum required solvency margin shall be equal to the higher of the two results as set out in paragraphs 3 and 4:

3. The premium basis shall be calculated using the higher of gross written premiums or contributions, and gross earned premiums or contributions.

Premiums or contributions in respect of the classes 11, 12 and 13 listed in point A of the Annex shall be increased by 50 per cent.

The premiums or contributions (inclusive of charges ancillary to premiums or contributions) due in respect of direct business in the last financial year shall be aggregated.

To this sum there shall be added the amount of premiums accepted for all reinsurance in the last financial year.

From this sum there shall then be deducted the total amount of premiums or contributions cancelled in the last financial year, as well as the total amount of taxes and levies pertaining to the premiums or contributions entering into the aggregate.

The amount so obtained shall be divided into two portions, the first portion extending up to EUR 50 million, the second comprising the excess; 18% and 16% of these portions respectively shall be calculated and added together.

The sum so obtained shall be multiplied by the ratio existing in respect of the sum of the last three financial years between the amount of claims remaining to be borne by the undertaking after deduction of amounts recoverable under reinsurance and the gross amount of claims; this ratio may in no case be less than 50%.

With the approval of the competent authorities, statistical methods may be used to allocate the premiums or contributions in respect of the classes 11, 12 and 13.

4. The claims basis shall be calculated, as follows, using in respect of the classes 11, 12 and 13 listed in point A of the Annex, claims, provisions and recoveries increased by 50 per cent.

The amounts of claims paid in respect of direct business (without any deduction of claims borne by reinsurers and retrocessionaires) in the periods specified in paragraph 1 shall be aggregated.

To this sum there shall be added the amount of claims paid in respect of reinsurances or retrocessions accepted during the same periods.

To this sum there shall be added the amount of provisions for claims outstanding established at the end of the last financial year both for direct business and for reinsurance acceptances.

From this sum there shall be deducted the amount of recoveries effected during the periods specified in paragraph 1.

From the sum then remaining, there shall be deducted the amount of provisions for claims outstanding established at the commencement of the second financial year preceding the last financial year for which there are accounts, both for direct business and for reinsurance acceptances. If the period of reference established in paragraph 1 equals seven years, the amount of provisions for claims outstanding established at the commencement of the sixth financial year preceding the last financial year for which there are accounts shall be deducted.

One-third, or one-seventh, of the amount so obtained, according to the period of reference established in paragraph 1, shall be divided into two portions, the first extending up to EUR 35 million and the second comprising the excess; 26% and 23% of these portions respectively shall be calculated and added together.

The sum so obtained shall be multiplied by the ratio existing in respect of the sum of the last three financial years between the amount of claims remaining to be borne by the undertaking after deduction of amounts recoverable under reinsurance and the gross amount of claims; this ratio may in no case be less than 50%.

With the approval of the competent authorities, statistical methods may be used to allocate the claims, provisions and recoveries in respect of the classes 11, 12 and 13. In the case of the risks listed under class 18 in point A of the Annex, the amount of claims paid used to calculate the claims basis shall be the costs borne by the insurance undertaking in respect of assistance given. Such costs shall be calculated in accordance with the national provisions of the home Member State.

5. If the required solvency margin as calculated in paragraphs 2, 3 and 4 is lower than the required solvency margin of the year before, the required solvency margin shall be at least equal to the required solvency margin of the year before multiplied by the ratio of the amount of the technical provisions for claims outstanding at the end of the last financial year and the amount of the technical provisions for claims outstanding at the beginning of the last financial year.

6. The fractions applicable to the portions referred to in the sixth subparagraph of paragraph 3 and the seventh subparagraph of paragraph 4 shall each be reduced to a third in the case of health insurance practised on a similar technical basis to that of life assurance, if

(a) the premiums paid are calculated on the basis of sickness tables according to the mathematical method applied in insurance;

(b) a provision is set up for increasing age or the business is conducted on a group basis;

(c) an additional premium is collected in order to set up a safety margin of an appropriate amount;

(d) the insurance undertaking may cancel the contract before the end of the third year of insurance at the latest;

(e) the contract provides for the possibility of increasing premiums or reducing payments even for current contracts."

(4) Article 17 is replaced by the following:

"Article 17

1. One third of the minimum required solvency margin as specified in Article 16a shall constitute the guarantee fund. This fund shall consist of the items listed in Article 16(2), (3) and (4)(c).

2. The guarantee fund may not be less than EUR 2 million. Where, however, all or some of the risks included in one of the classes 10 to 15 listed in point A of the Annex are covered, it shall be EUR 3 million.

Any Member State may provide for a one-fourth reduction of the minimum guarantee fund in the case of mutual associations and mutual-type associations."

(5) The following Article 17a is inserted:

"Article 17a

1. The amounts in euro as laid down in Article 16a (3) and (4) and Article 17(2) shall be reviewed annually starting [18 months after the entry into force of this Directive], in order to take account of changes in the European Index of Consumer Prices comprising all Member States as published by Eurostat.

The amounts shall be adapted automatically by increasing the base amount in euro by the percentage change in that Index over the period between the entry into force of this Directive and the review date and rounded up to a multiple of EUR 100 000.

If the percentage change since the last adaptation is less than 5%, no adaptation shall take place.

2. The Commission shall inform annually the European Parliament and the Insurance Committee of the review and the adapted amounts."

(6) In Article 20(2), the term "Article 16(3)" is replaced by the term "Article 16a".

(7) The following Article 20a is inserted:

"Article 20a

1. Member States shall ensure that the competent authorities have the power to require a financial recovery plan for those insurance undertakings where competent authorities consider that policyholders' rights are threatened. The financial recovery plan may include particulars or proof concerning for the next three financial years:

(a) estimates of management expenses, in particular current general expenses and commissions;

(b) a plan setting out detailed estimates of income and expenditure in respect of direct business, reinsurance acceptances and reinsurance cessions;

(c) a forecast balance sheet;

(d) estimates of the financial resources intended to cover underwriting liabilities and the required solvency margin;

(e) the overall reinsurance policy.

2. Where policyholders' rights are threatened, Member States shall ensure that the competent authorities have the power to oblige insurance undertakings to have a higher required solvency margin than provided for under national law, in order to ensure that the insurance undertaking is able to fulfil the solvency requirements in the near future. The level of this higher required solvency margin shall be based on the financial recovery plan referred to in paragraph 1.

3. Member States shall ensure that the competent authorities have the power to revalue downwards all elements eligible for the available solvency margin, in particular, where there has been a significant change in the market value of these elements since the end of the last financial year.

4. Member States shall ensure that the competent authorities have the power to decrease the reduction to the solvency margin as determined in accordance with Article 16a where:

(a) the nature or quality of a reinsurance programme has changed significantly since the last financial year;

(b) there is no or insignificant risk transfer under the reinsurance programme."

Article 2

Transitional period

1. Member States may allow insurance undertakings which at the entry into force of this Directive provide insurance in their territories in one or more of classes referred to in the Annex to Directive 73/239/EEC, a period of five years, commencing with the date of entry into force of the present Directive, in order to comply with the requirements set out in Article 1 of the present Directive.

2. Member States may allow any undertakings referred to in paragraph 1, which upon the expiry of the five-year period have not fully established the required solvency margin, a further period not exceeding two years in which to do so provided that such undertakings have, in accordance with Article 20 of Directive 73/239/EEC, submitted for the approval of the competent authorities the measures which they propose to take for such purpose.

Article 3

Transposition

1. Member States shall adopt by [18 months after the entry into force of this Directive] at the latest the laws, regulations and administrative provisions necessary to comply with this Directive. They shall forthwith inform the Commission thereof.

When Member States adopt those provisions, they shall contain a reference to this Directive or be accompanied by such a reference on the occasion of their official publication. Member States shall determine how such reference is to be made.

2. Member States shall provide that the provisions referred to in paragraph 1 shall first apply to the supervision of accounts for financial years beginning on 1 January [of the year following the date in paragraph 1] or during that calendar year.

3. Member States shall communicate to the Commission the main provisions of national law which they adopt in the field covered by this Directive.

4. Not later than [three years after the date in paragraph 2] the Commission shall submit to the Insurance Committee a report on the application of this Directive and, if necessary, on the need for further harmonisation.

Article 4

Entry into force

This Directive shall enter into force on the twentieth day following that of its publication in the Official Journal of the European Communities.

Article 5

Addressees

This Directive is addressed to the Member States.

Done at Brussels,

For the European Parliament For the Council

The President The President

FINANCIAL STATEMENT

1-9. Non applicable as no financial assistance provided by the Commission

10. Administrative expenditure (Section III, Part A of the budget)

10.1 Effect on the number of posts

No additional posts required. Administration expenditure related to this Directive can be accommodated within existing Commission resources. The only new additional resource demand is the staff resources required to annually update the minimum guarantee funds and premium and claims thresholds in line with inflation, where required. This can be adsorbed within existing resources.

IMPACT ASSESSMENT FORM THE IMPACT OF THE PROPOSAL ON BUSINESS WITH SPECIAL REFERENCE TO SMALL AND MEDIUM-SIZED ENTERPRISES( SMEs)

Title of proposal

Directive to amend the solvency margin requirements for insurance undertakings.

Document reference number

The proposal

1. Taking account of the principle of subsidiarity, why is Community legislation necessary in this area and what are its main aims-

An important element in any system of prudential supervision for the protection of insured persons and other policyholders is the requirement that insurance undertakings establish a solvency margin to act as a buffer against adverse business fluctuations. In an insurance internal market based on the single passport with home country control and mutual recognition of national systems of prudential control, it is necessary to establish a minimum common solvency margin requirement. The proposal identifies improvements to the existing solvency margin rules to strengthen policyholder protection.

In the interest of subsidiarity, the proposal does not apply to mutuals whose contribution income is below EUR 5 million.

The impact on business

2. Who will be affected by the proposal-

- which sectors of business-

Insurance undertakings (life and non-life).

- which sizes of business (what is the concentration of small and medium-sized firms)-

All insurance undertakings established as limited companies and all mutuals whose contribution income exceeds EUR 5 million. The latter is considerably higher than the current minima of 1 million euro. In any event, many of these small mutuals will no longer satisfy the new higher minimum guarantee funds (MGFs) required. The current MGFs are largely unchanged since 1973 and 1979.

The Commission with the assistance of national supervisory authorities has carried out extensive simulations on the impact of various proposals including the increase in the MGF. The distribution of the number of insurance undertakings and their respective premium income is very skew. This is particularly the case in non-life insurance where there are a large number of very small mutuals operating on a purely local or national basis.

Insurers with a premium income below EUR 2 million correspond to 27% of undertakings but write only 0.15% of total non-life business. Insurers with a premium income between EUR 2 and 20 million correspond to a further 31% of undertakings but write only 6.4 % of total non-life business.

The Commission has examined the impact of the proposals on SMEs with a premium income below EUR 40 million. On an aggregate basis, the increase in the required solvency margin would amount to approximately EUR 1.65 billion in nominal terms corresponding to an increase of about 50% compared to the existing requirement. 83% of such undertakings will no longer satisfy the new required solvency margin requirement. In any event many of these undertakings will not satisfy the new EUR 5 million premium income threshold. Such undertakings will no longer be entitled to the single european passport but could still operate on a national basis subject to domestic supervision.

- are there particular geographical areas of the Community where these businesses are found-

Small insurance undertakings exist throughout the Community.

3. What will business have to do to comply with the proposal-

Establish an adequate solvency margin. In practice, the most important aspect for SMEs will be the requirement to establish a minimum guarantee fund of:

- EUR 3 million classes 10-15;

- EUR 2 million for all other classes .

4. What economic effects is the proposal likely to have-

- on employment: broadly neutral;

- on investment and the creation of new businesses: broadly neutral.

To the extent that the proposal increases the solvency margin requirement, insurance undertakings will require greater regulatory capital. The higher minimum guarantee fund may therefore act as a potential entry barrier to the formation of new businesses wishing to benefit from the single passport. In practice, the minimum guarantee fund is unlikely to prove a real barrier to the establishment of insurance businesses wishing to be active on a truly cross-border basis. In particular, it is important to stress that, local or regional mutual SMEs with a turnover below EUR 5 million will still be able to operate on a national basis subject to national rules only.

- on the competitiveness of businesses

The proposals require higher regulatory capital. This does not impose a cost in the sense that it requires an annual outgo of expenditure. However, insurance undertakings will be required to maintain the higher regulatory capital within the business to protect policyholders and will earn investment income on the higher level of regulatory capital.

5. Does the proposal contain measures to take account of the specific situation of small and medium-sized firms (reduced or different requirements etc)-

The proposals foresee a number of measures to take account of the specific situation of SMEs.

In principle, only mutual insurance undertakings whose contribution income exceeds EUR 5 million will now fall under the Directives. Nevertheless, even if a mutual has a turnover below EUR 5 million, provided it satisfies the other solvency margin requirements, it may upon request be automatically covered by this Directive and therefore benefit from the single passport.

The most important aspect of the proposals is the increase in the MGFs. As indicated above, a large number of small non-life mutuals will be affected.

First, these businesses will be able to continue to operate at the local or regional level subject to domestic supervision, but outside the scope of the Directive.

Secondly, the new rules will not come into force overnight. The proposal establishes generous transitional arrangements. A transitional period of five years from the date of entry into force of the rules is foreseen. Furthermore, the competent authorities may allow an additional period of two years for compliance.

Thirdly, the proposal maintains the existing Member State option to allow a one-fourth reduction to the MGF in the case of mutuals and mutual-type associations.

Fourthly, subject to approval by the competent national authorities, small mutuals will be able to take credit for supplementary member contributions up to a maximum of half the solvency margin requirement.

Consultation

6. List the organisations which have been consulted about the proposal and outline their main views.

The Commission has consulted closely with the main European industry associations throughout the review exercise. In general they support the overall thrust of the proposals, but they consider the scale or nature of implementation of a number of specific measures should be circumscribed in a number of cases.

The CEA supports the broad approach but consider that supervisors' power of early intervention should be more tightly defined, that the percentage increase under the class enhancement formula should be only 25% and not 50% as proposed and that the increase in the MGFs and the premium and claim thresholds should be somewhat lower, e.g. the latter should be increased by a factor of 4 and not 5.

These views also broadly shared by ACME, which in particular supports the continued 25% reduction to the MGF for mutuals..

AISAM (a European mutual association with a particular focus on smaller mutuals) was at first very strongly opposed to the substantial increases for the MGFs. However, they could accept a higher level of MGF at the 'European level' under the proposals provided smaller mutuals could continue to operate with lower level MGFs 'at the national level'.

The Groupe Consultatif of European Actuaries also broadly supports the package. The Groupe helped identify the more risky classes of non-life business for the class enhancement approach but provisionally consider it may be better to defer increasing the solvency requirement for such business to the Solvency II exercise.