Initial comments on the Proposal for a Solvency II framework Directive (COM (2007) 361 of 10 July

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1 Brussels, 21/12/2007 Version 10 Initial comments on the Proposal for a Solvency II framework Directive (COM (2007) 361 of 10 July This document provides the initial comments of the European mutual and cooperative insurance sector on the Proposal for a Solvency II Directive especially on articles 73 to 146 relating to quantitative requirements. More extensive comments on group supervision (articles 219 to 277), qualitative requirements - including governance from article 27 onwards (Pillar II), supervisory reporting and disclosure (Pillar III) and the scope of application of the Directive will follow in due course. General remarks AISAM and ACME jointly represent the European mutual and cooperative insurance sector. Their members include many small players and account for more than 20% of the European insurance market. ACME and AISAM welcome the proposal for a Solvency II framework Directive in its current drafting and philosophy. Solvency II is a positive development and a major step forward in aligning state-of-the-art risk management with regulatory requirements, while aiming to increase policyholder protection and competitiveness of the European insurance industry. Furthermore, supervision follows different rules in different countries today and solvency limits and eligible elements are very varied. Any step taken to achieve a higher degree of harmonization is a step in the right direction. The quality of this first Lamfalussy directive in the insurance sector is good, and the process which was followed to achieve this result in collaboration with CEIOPS and stakeholders was constructive, although not always easy, given the tight time scale. It is a principle-based directive, which implies that level 2 and level 3 implementing measures will be the test to prove to which extent parties are willing to transpose the level 1 principles into day-to-day business life and are committed to increased harmonization and an improved level-playing field. We support the overall aims of the project and the draft directive in its broad lines but there is room for improvement. One important concern regards the overall calibration (as well in a standard approach as in simplified standard approach), 1 These comments are limited to the Solvency II part and do not touch up the recast Directives part.

2 2 which based on QIS3 results appears to be too high for non-life companies, and which has for life companies been blurred by the KC factor calculations. We will therefore continue to work with CEIOPS, the EU institutions and industry representatives to ensure that the Solvency II framework meets the requirements of large and small insurance undertakings alike, including mutual and cooperative societies. We call on all stakeholders to guarantee the diversity of offer and corporate structures for the benefits of policyholders and fair competition. What we support AISAM and ACME believe that the Proposal for a Directive is a major improvement over the existing solvency framework, because it: - allows for a higher level of harmonization; - allows for the use of a risk-based economic approach including appropriate recognition of risk mitigation schemes; - allows for market-consistent valuation of assets and liabilities (see below); - foresees the potential for principle-based investment policy (prudent person principle); - integrates the option to use a standard formula, a partial model or full internal models to calculate the required solvency capital; - underlines the principle of proportionality as fundamental and essential in all Pillars (see also references to size, scope and complexity), and foresees practical potential for it e.g. simplified methods to calculate technical provisions and simplified calculations for specific sub-modules or risk modules where nature, scale and complexity of the risks they face justifies it and where it would be disproportionate to require all companies to apply the standardized calculation ; - recognizes the value of specialization by allowing for entity specific parameters using company specific experience to calculate underwriting risk modules (both for premium and reserve risks); - defines MCR as an auditable measure with an absolute floor (art 126) to be calculated quarterly; this implies ipso facto a simple computation which should be undisputable (to guarantee its auditability) and that the MCR should not be a percentage of the SCR because a majority of undertakings, in most countries, are not likely to calculate this on a quarterly basis; - lays the foundation for effective, efficient and potentially innovative group supervision; - stimulates the supervisors to think European rather than national ; - restricts capital add-ons to exceptional circumstances; with appropriate disclosure requirements; - increases transparency through Pillar III measures; - -introduces the concept of group supervision.

3 3 Areas which we consider should be given further consideration Recital 12 The new solvency regime should not be too burdensome for small and mediumsized insurance undertakings. We support the addition of the following clarification: One of the tools to achieve this objective is a proper application of the proportionality principle. This principle should apply both to the requirements on the insurance and reinsurance undertakings and on the exercise of supervisory powers. Recital 17a We support the addition of the following clarification: The expression exceptional should be understood in the context of the specific situation of each undertaking rather than in relation to the number of capital add-ons imposed in a specific market. With regard to the following sentence: It is understood that, in the first years of application of the new solvency regime, there may be a more frequent imposition of capital add-ons in the context of the approval of internal models, we request a further clarification as to the number of years that are referred to. Art 38, 48(2) and (48(3) We request the deletion of these articles which we consider superfluous and unduly interfering with the management decisions of the undertaking. Article 48(1) clarifies sufficiently that the undertakings remain fully responsible for discharging all of their obligations under the Directive. Art 50 The disclosure of capital add-on provided for in article 50 (despite a 5 year opt-out option) could be a problem vis-à-vis the market, reinsurers and policyholders and in addition is pro-cyclical. Art 74 - Technical provisions should no longer be required to be calculated in a prudent manner as this may give rise to double counting. - Technical provisions shall be based on exit values : it should not be overlooked that the majority of the European insurance industry will not be subject to IFRS accounting; the final opinion of the EU is therefore important Art 75 - Risk margins shall be calculated using the CoC approach: the proper calibration of the standard formula (e.g. reserve risk for non-life insurers) is essential for the acceptability of this method especially for long tail insurers. Art 76 - We would seek clarification as to whether inflation, which is to be included as element to calculate technical provisions, is a company specific parameter.

4 4 Art 87 - Ancillary own funds may also comprise any future claims within the year concerned: if conditions are fulfilled, there should not be a may also. Art 88 - Any information on the outcome of past calls: please add if any as the preexistence of past calls should not be a condition for accepting the potential to call as contingent own funds; Art 89 - Not made available for distribution may need some clarification so as to avoid confusion between the right of policyholders to these funds, whether now or in the future, and the effective freeing up for distribution. For example, in Sweden, Konsolideringsfonden is a surplus fund and in reality the only own capital in a mutual life company. All capital in the Konsolideringsfonden can be used for losses and the customer has no legal right to the money until it is paid (or been ordered for payment). The Konsolideringsfond is therefore not available for distribution. Art 91 - The treatment of participations in insurance companies held by insurance groups is subject to neutralisation in the evaluation of the SCR which is not compatible with the governing principles of the Solvency II project. Insurance companies which will have to apply Solvency II in the future will have to invest heavily in order to fulfil the new requirements which have a much wider field of application than those of Basle 2. Consequently, penalizing the industry via the concentration risk as in QIS3 and not taking into account the evaluation of risks in their subsidiaries is a negative incentive as regards the transparency of insurance groups. Art 93 - Main criteria for classification into tiers: Treatment of own funds in tiers, with additional restrictions; the arbitrary percentages seem especially hard to reconcile with an economic approach; further work is required on this point. Art 99 - SCR should not be a hard target inducing insurers to avoid volatility in asset management or liabilities underwritten thus fundamentally but slowly changing the nature of the insurance business not only in the nature of their institutional investments but also concerning the business lines in which they engage. Art annex I and annex IV (art 5) - Given the nature and the social and economic importance of health insurance, and the interactions of this activity with public social security schemes, the SCR should be structured in such a way as to allow each Member State to apply an appropriate treatment of all types of private health insurance. To achieve this goal, we believe that, as demonstrated in the study of Mutualité Française 2, a general health underwriting risk should be introduced (the special health 2 Solvabilité 2 et la Santé La Tribune de l Assurance Conference JL.Davet Mutualité Française 25 october For copies of the document, please contact jeanlouis.davet@mutualite.fr.

5 5 insurance module described in articles 104 and 213 then being a subdivision of this risk). Art Need for on-going monitoring: frequent monitoring and recalculation when the risk profile deviates significantly needs be clarified and implemented in a proportionate way. Art 106: - Adjustment for the loss-absorbing capacity of technical provisions and deferred taxes: The adjustment referred to in point (c) paragraph 1 of Article 102 for the loss-absorbing capacity of technical provisions and deferred taxes shall reflect potential compensation of unexpected losses through a simultaneous decrease in technical provisions and deferred taxes. We would welcome a clarification that confirms that the loss-absorbing capacity relates to both the technical provisions and the deferred taxes. Or, in other words, that if national legislation gives the possibility to build up untaxed reserves for loss-absorbing purposes those reserves should not be burdened with taxes if the reserve can only be used for loss-absorbing purposes. In such a system no tax will be levied, as the loss will be a deductible cost (see the Swedish säkerhetsreserven ). Art The concurrent calculation of approved internal model or partial internal model (PIM) and standard formula for 2 years after approval is unduly costly and uncompetitive. Art A partial internal model (PIM) should be a long term viable solution without supervisory requirements and not a roadmap for full transition to internal models neither formally NOR INFORMALLY. In line with the proportionality principle, we would like to underline that a PIM could be a long term viable solution e.g. if the risks not covered by the PIM are not material enough. - In the case of a PIM, the same supervisory approval principles/procedure as IM should be applied (use test, statistical test, ). - Minor LOB suppliers risk withdrawing from the market if having to go to FIM. - Operational risks: part of IM: not able to model this. Art Supervisors can ask for IM development: this should be an exception and should be worded as such since an IM should remain an option. Art Different time period or risk measure: even for PIM we should be able to change time horizon if accepted by supervisor. Art Transitory period of one year for all companies which breach MCR on (i.e. one year after entry into force): We are waiting for additional information on the MCR result; for us, the deadline for compliance would depend on the final design of MCR.

6 6 Art 131 Technical provisions to be covered by assets localised in the EU: implies EU custodian or EU originated issuer or listing? All insurers should be able to invest worldwide. This localisation requirement is not in line with an economic approach. It may also result in increasing concentration in risks. Art months to redress a financial situation may be too short; need for timing on turn-around plan with encouraging results after 6 months and a timing horizon of not more than 2-3 years. The Directive should allow companies to make turnaround and not declare them immediately out of business (see also art 141). Additionally, an insurer has contracts with suppliers, brokers, reinsurers, coinsurers which may well need 6 month cancellation periods. - Any strict limit to redress procedures implies that SCR is a hard target. Art Supervisory powers have been increasing within Solvency I compared to the first and third directives, and again now compared to Solvency I; while we understand the need for appropriate powers, we are concerned about the open formulation of this article and the lack of harmonization potential. - Pillar II should not replace Pillar I. A case in point is the own risk and solvency assessment requirement. Art Definition and scope of group supervision Art 219, 1 is worded principally to refer to groups created through the exchange of capital. However, there are insurance groups and/or mixed-activity insurance (holding) companies created based on contractual relations, where the concepts of parent, dominant influence and control are not relevant. Group supervision should also benefit these groups created through a contract which is the material recognition of the existence of strong and sustainable financial links among the members, such as the mutual societies group, in casu the mutual insurance group. We suggest rewording art 219, 2 so as to reflect also this reality, potentially even de lege ferenda on a European level. Areas we dislike - Exclusion of all insurance undertakings below a fixed threshold: the mutual and cooperative insurance sector has requested an exemption for very small, variable premium or equivalent mutual insurers operating only domestically. - The Proposal for a Directive as currently worded does not foresee any appeal procedure for decisions of supervisors, e.g. regarding any refusal to approve internal models, any request to develop an internal model, redress timing, This should be provided.