Contrary to initial expectations, the recent update of the EU Solvency II regulatory framework is intended to loosen insurance capital requirements, rather than exacerbating them. In 2020, the European Insurance and Occupational Pensions Authority (EIOPA) estimated that Solvency II ratios could decrease by around 20 percentage points (ppts) after the implementation of the review; following the update approved by the European Parliament in April, S&P Global Ratings now predicts that the insurance sector will benefit up to 25 percentage points on an aggregate basis.
How much you save
S&P's baseline estimate is that the sector could see a total capital relief of up to 80 billion euros in 2026-2027, once EU Member States implement the update.
It is pointed out that the increase in interest rates is the basis of this positive result. The Solvency II update includes several measures to ease capital requirements, but the gap between initial estimates and the final outcome is largely due to sensitivity of Solvency II coefficients to very low interest rates. If interest rates repeat the “lower for longer” pattern seen between 2015 and 2021, much of the potential capital relief could dissipate.
“As regulatory relationships become more sensitive to low interest rate scenarios, capital relief could dissipate if interest rates fall below 1%“said Taos Fudji, credit analyst at S&P Global Ratings.
“If insurers took advantage of the capital relief for substantially increase shareholder payouts and invest more in stocks, their capital buffers under our capital model could shrink,” Fudji added. “That said, we do not currently expect the effect to be sufficient to induce negative rating actions.”
The distribution of the benefit
EIOPA data shows that, as of the end of 2022, the available aggregate regulatory capital in the European insurance sector it exceeded 1,000 billion of Euro. This figure excludes the UK and Swiss insurance sectors, which operate under different regulatory frameworks. On this scale, it capital relief estimated at up to 80 billion euros on an aggregate basis “considerable, but not critical”, we read in the S&P report. However, the lion's share of the benefits deriving from the easing measures could, however, be reserved for insurers with long-tail lines, in particular for life insurers.
Timings
According to the rating agency, the solvency ratio of insurers unlikely to be affected until 2026. Over the next two years, EU Member States will implement the revised Solvency II Directive into their national legislation. The estimate that insurers could see €80 billion in capital relief by 2026-2027 is the baseline scenario. In the long termhowever, this Capital relief is uncertain: Structurally low growth prospects in most European countries could create a downward trend in long-term interest rates, as occurred before the pandemic.
