Prudential Regulation Authority (PRA) CEO Andrew Bailey has said insurers in the UK require more time to comply fully with the new Solvency II capital rules, as the January 2016 deadline approaches.

Speaking at the Reuters Financial Regulation Summit, Bailey said a downward shift in the risk-free interest rate curves was affecting capital requirements, and that more insurers were likely to make use of the transitional relief allowed by the EU as a result.

According to Reuters, Bailey, who is also deputy governor for prudential regulation at the Bank of England, said: “As long as the risk-free curves remain where they are, then firms will be making greater use of the transitional capital structure in Solvency II than they thought they would.”

Under EU rules, regulators can allow insurers to apply a transitional adjustment to a risk-free interest rate term structure for up to 16 years to ensure they are compliant with Solvency II.

The deduction is the difference between the current rate and the Solvency II rate, and decreases in linear fashion over a 16-year period.

While the UK has reliable sterling market rate projections extending up to 50 years in advance, the Eurozone can only project 20 years ahead – after which it uses a rate calculated by the regulators.

Because the rate determined by regulators increases sooner than the sterling rate, Eurozone insurers could have an advantage over their UK counterparts.
“I would prefer it if everybody was done on the same basis, frankly,” commented Bailey.

“We can’t have one set of firms benefiting from one set of treatments and another set benefit from a slightly different set of treatments.”

Bailey also said that the PRA was likely to make a statement on the use of the transitional period before January 2016.

The Prudential Regulation Authority (PRA) has warned that many UK insurance companies still have a “considerable amount of work” to do in preparation for the implementation of Solvency II on 1 January 2016.

According to feedback from internal model commitment panels released last week (22 May), the PRA said that firms had to be realistic about their chances of completing further work in time to submit a viable internal model application.

In particular, the UK regulator said that some firms had decided to make changes to models at a late stage, meaning they would now have to carry out further work to demonstrate that the amendments had been properly incorporated into the model.

In order to do this, firms must ensure that any revised approaches are technically sound, and have been reviewed and agreed by internal governance processes.

The PRA noted that it was not likely to have the opportunity to review any late changes, or give further feedback to firms still seeking model approval for 1 January 2016, before they would have to make a formal application.

Because there was limited opportunity for firms to make changes once a formal application had been submitted, the PRA explained that firms had to be confident that any revisions made at this stage would satisfactorily address any previous feedback.

If firms had to make material changes during the application period, the PRA cautioned that a new formal application could be required. Alternatively, firms have a final option to “stop the clock” on their current application.

The PRA also said that all firms should have a viable contingency plan in the event that they either do not gain model approval, or a dependant Solvency II approval is rejected. It added that individual firms had already been notified about any further progress required.

However, it said that it was encouraged to see that in a number of cases firms had made changes to their models to address weaknesses identified in previous feedback.

The European Insurance and Occupational Pensions Authority (Eiopa) has announced a new EU-wide stress test for the insurance sector aimed at assessing its overall resilience.

The test will evaluate the industry’s ability to withstand shocks to the wider financial markets as well as insurance-specific challenges, ahead of Solvency II’s implementation on 1 January 2016.

According to Eiopa, the core part of the test package includes two adverse market scenarios.

These will cover sovereign debt, corporate bonds, interest rates, property and equity stresses, as well as insurance-specific shocks such as mortality, longevity, insufficient reserves and catastrophes.

Charles Garnsworthy, UK Solvency II leader at accountancy giant PwC, said: “Firms will be particularly interested at the addition of a sovereign spread stress, as to date many firms have treated sovereign debt as equivalent to risk-free with their internal models.”

The second aspect of the test will address the impact of a low investment yield environment.

Garnsworthy warned that this exercise could double the workload for firms that are required to complete the stress test at a group level and the low yields assessment at an individual entity level.

Overall, the test is set to cover at least 50 percent of the life and non-life insurance sectors by market share in each country, Eiopa said.

It will be run in co-operation with national supervisory authorities, which will collect data from insurers after 11 July.

Throughout August and September, Eiopa and the national authorities will conduct an EU-wide validation of the data, and results of the stress test analysis will be disclosed in November.

To help insurers through the process, Eiopa said it would hold a workshop in May and launch a Q&A tool throughout May and June.

Eiopa chairman Gabriel Bernardino commented: “I believe that the design and the magnitude of the shocks will properly stress insurance companies’ financial position and that the conclusions of the exercise will allow Eiopa and national supervisory authorities to define areas for further investigation.”

In conjunction with the launch of the stress test, Eiopa also published its Solvency II technical specifications, which provide insurers with a basis for the valuation of assets and liabilities as well as solvency calculations.

They will form the basis for Solvency II interim reporting during 2014 and 2015.

According to Garnsworthy, the technical specifications have not changed significantly from those used in January 2013.

“Whilst this is good news for many insurers who will not need to significantly re-build existing models or alter existing methodologies, it also means that individual firms will be required to develop and apply their own ‘house view’ on remaining key areas of uncertainty,” he explained.