Re/insurers would find it hard to change their business to avoid or reduce the burden of Solvency II, lawyers have said, because of the difficulty of meeting the proposed qualifying criteria under the proportionality principle in the EU-wide review. 

While the UK published its decision on Solvency II reforms earlier this month, the EU is currently undergoing a massive review of the directive, six years after it first took effect. 

Proportionality is currently being examined by the block to reduce operational complexity and burden for smaller or monoline insurers. The EU is considering exempting smaller firms from Solvency II by raising certain thresholds. Separately, it also proposed the concept of ‘low-risk profile undertakings’, subject to meeting a list of stringent requirements. 

Asked about the likelihood of an insurer changing its business structure to avoid Solvency II or secure more relaxed requirements of the directive, Christoph Küppers, a partner at Hogan Lovells’s Düsseldorf office, said it would not be easy for firms to do so. 

Pablo Muelas, a partner at the law firm’s Madrid office, explained that the requirements to be a low-risk profile undertaking were rather rigid.

Speaking at a webinar organised by Hogan Lovells last Thursday, Muelas said: “The supervisory authorities will be very vigilant to make sure that the companies applying for that regime are fully complying with all the qualifying criteria.”

Currently, the minimum threshold for an insurer to be subject to Solvency II is €5m (£4.3m) in premiums and €25m in technical provisions, but the EU is considering tripling the figure to €15m in premiums and doubling the threshold to €50m in gross technical provisions. 

In order to become a low-risk profile undertaking, for life insurers, the interest rate risk sub-module should not be higher than 5% of technical provisions. Business underwritten in member states other than the home country should not be higher than 5% of the company’s global annual gross written premium. 

The size criterion proposed for life firms is no more than €1bn in technical provisions. Non-traditional investments should not represent more than 20% of total investments, while reinsurance business should be below 50% of the firm’s annual GWP.

For non-life insurers, the same requirements for reinsurance business, business written in other member states and non-traditional investments also apply, but annual GWP should be below €100m while the average combined ratio of the last three years should be below 100%.

In addition, the sum of the annual premiums of classes related to vehicles, credit and surety risks must not exceed 30% of the total premiums of the non-life business.

Certain re/insurers, such as those using partial or full internal models to calculate solvency capital requirement and parent companies of an insurance group would never be classified as a low risk profile undertaking, Muelas said. 

Citing estimates from the European Commission, at least 249 insurers within scope of Solvency II would benefit from such a classification, according to Siegbert Baldauf, chair of the Solvency II Working Group of the Actuarial Association of Europe, who spoke at a separate webinar last week.

The changes to the principle of proportionality are welcome, Muelas noted, but increasing the thresholds for the application of Solvency II “raises some concerns”. 

“Our experience shows that it is preferable for all insurers to be governed by the same rules, applying the proportionality principle when needed,” he said. 

According to Steven McEwan, a partner in Hogan Lovells’s London office, the same process in the UK is called “mobilisation” as opposed to proportionality. This is to ease the entry for smaller firms, such as insurtech startups, to the market, so “we don't cripple them with all of the burden of Solvency II right from the start”.

The EU’s exclusion threshold is similar to that in the UK. Instead of €5m in premiums and €25m in technical provisions, the Treasury decided to increase the thresholds to £15m in premiums (triple the previous threshold) and to £50m in gross technical provisions, double the previous threshold.

“It's a remarkable coincidence,” McEwan argued, as the UK is no longer expected to follow the EU.

“What it does show I think, is that both jurisdictions see the importance of allowing small entities and new entities to be able to come in and operate without suddenly having a huge burden imposed on them, and that's going to be a good thing for both markets.”

The company would need confirmation from its supervisory authority about its status and submit a declaration to say it does not plan any strategic change that would lead to non-compliance with the criteria within the next three years.

Regular supervisory reporting with information on the business and performance, system of governance, risk profile valuation for solvency purposes, and capital management would need to be submitted to the supervisor every three years instead of at “least every three years” for non-qualifying firms.

Muelas also explained the firm’s key function holder may also perform other key functions.  

“[The person] who is responsible for the key functions, risk management, actuarial and compliance function may also perform any other key functions different from internal audit, any other non-key function or be a member of the administrative management or supervisory body provided that potential conflicts of interest are properly managed and the combination of functions does not compromise the person's ability to carry out her or his responsibilities,” he said. “This possibility is not allowed for non-low risk profile undertakings, by the way.”

In addition, these firms are not obliged to conduct analysis of climate change, pandemic and other mass scale events in their own-risk and solvency assessment - an internal risk management process for insurers.

Muelas said: “Instead of performing the Orsa annually, these undertakings may perform this assessment at least every two years. They do not need to specify in the Orsa climate change scenarios nor to assess their impact on their business.”

In the solvency and financial condition report, which contains information produced annually by re/insurers about their solvency position, the low-risk profile undertaking may disclose only the quantitative data as long as it discloses a full report containing all the information every three years.

In addition, the balance sheet disclosed in the SFCR does not need to be subject to audit. Those firms are not obliged to draw up a liquidity risk management plan. 

“Of course, low risk profile undertakings are not obliged to apply all these measures. It is up to them to decide,” Muelas said.