Crunch time for Solvency II

The top European Union institutions are embroiled in trilateral negotiations in Brussels to agree on a draft text of the Solvency II insurance directive before the April 2 deadline.

The European Commission, European Parliament and the Council of Ministers must all agree on the same text for it to become a directive and pass into the national law of member states. At the moment they disagree on two areas: group support and the treatment of equities held by insurance firms.

Group support, often seen as Solvency II's most innovative component, means that subsidiaries of insurance groups need only hold the minimum capital requirement and would rely on the transfer of extra capital from the parent when needed. A group of 12 smaller member states led by Spain and Portugal, whose domestic insurance industries are composed mainly of group subsidiaries, are opposed to group support as they worry it will make them reliant on supervisors in larger nations, and that capital might not be transferred to subsidiaries when needed.

During its presidency of the Council in the latter half of 2008, France struck a deal with the group of 12 that it would exclude group support in exchange for the so-called 'equity dampener', a means of weakening stress tests and reducing capital held against equities in the event of falling markets. The dampener was proposed as a means of reducing procyclicality in the insurance industry.

As it stands, the Commission and the Parliament support a version of the text that includes group support, but the Council has excluded it. They are aiming to reach an agreement in time for the European Parliament to vote on April 2.

Possible resolutions to the deadlock might include an opt-out clause so that some member states can evade the group support obligation, or the exclusion of group support altogether. "An opt-out clause would be a fairly elegant solution to stop the whole process of the directive being derailed," suggested Jim Bichard, a partner at PricewaterhouseCoopers in London.

That would be a severe disappointment for those insurance groups and politicians who have lobbied for its inclusion.

"Group support is something that both the European Commission and the European Parliament want to see remain in the directive," said Peter Skinner, a UK member of the European Parliament and rapporteur (parliamentary sponsor) for Solvency II. "The fundamental question is whether insurance groups are to be appropriately regulated and capitalised according to their liabilities. If that's the case, then some form of group support should be included too."

If a consensus is reached on Solvency II, the development of more detailed implementation measures will begin later this year, with a provisional schedule of full adoption by member states in 2012.