Unlocking opportunities

The upcoming changes to the Solvency II regulations, which are set to take effect from 2027, offer a seemingly attractive opportunity for EU-regulated (re)insurers to potentially unlock around 70 billion EUR in capital. These estimated amounts are remarkable and raise the question of whether the deployment of excess capital will create a golden opportunity for (shareholders of) EU-supervised insurers. Instead, insurers may rethink their strategy with respect to, for instance, underwriting, asset allocation or operations to also benefit in the long term from greater degrees of freedom due to updated solvency regulations.

To illustrate the possible range of capital relief resulting from the proposed changes to the Solvency II regulations, as well as to analyse potential management actions, a case study has been conducted on a hypothetical European life insurer called EU Insurance AG. In our study, we focus on simple life insurance products and analyse the quantitative key elements of the revised Solvency II regulations, which are:

Volatility Adjustment (‘VA’)
Risk Margin (‘RM’)
Long-Term Equity (‘LTE’).

For our analysis, a quantitative model is used to estimate cash flows and potential impacts on the solvency ratio when using the Solvency II standard formula. Inherent secondary effects of the suggested changes on other regulatory and financial reporting requirements, such as ORSA, IFRS 17 and the Swiss Solvency Test (SST), are briefly outlined.

For example, if a group insurance undertaking is subject to Solvency II reporting and an entity is subject to Swiss Solvency Test or vice versa.

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The revisions to the Solvency II, Directive (Level 1) entered into force from 8 January 2025, with member states having a transition period of up to 24 months to adopt them by earliest from January 2027. The detailed rules in the Level 2 Delegated Regulation, as well as the underlying Technical Standards (Level 2.5) and Guidelines (Level 3), will be developed in parallel and be directly applicable to firms.

Three key observations are made. Firstly, the proposed modifications to the underlying mechanics for determination of the Volatility Adjustment are likely to offer benefits to European insurers. Accordingly, for our illustrative EU Insurance AG, an increase in the solvency ratio of about 4 percentage points is expected. Secondly, the Risk Margin is expected to be lower, mainly due to the reduction of the Cost of Capital rate and the introduction of a new ‘lambda’ factor. This factor mainly aims to reduce the sensitivity of the projected capital requirements to volatile interest rates. The reduction of the Cost of Capital rate is expected to enhance the solvency ratio of EU Insurance AG by an additional 20 percentage points. Thirdly, the revision of the eligibility criteria for Long-Term Equity investments is expected to boost the solvency ratio by an additional 5 percentage points for our considered insurer.

The solvency ratio of EU Insurance AG is expected to increase by nearly 30%

There is no unique strategy to optimise the resulting benefits of the updated Solvency regulation in the EU, but (re)insurers may have several management options. In the short term, the available but no longer required capital could be distributed to shareholders in the form of dividend payouts or share buy-back programmes. However, it could be more effectively used to optimise the business strategy, such as allocating free capital to the underwriting of new products that cover emerging risks and may improve operational results. Another option is to refine the asset allo cation strategy to achieve improved financial results in the coming years. Whatever action is taken by management, (re)insurers may also consider certain second order effects on other regulatory and financial reporting frameworks, such as ORSA, IFRS 17, and even the Swiss Solvency Test (SST).

By understanding the changes to the revised Solvency II and their potential impacts, (re)insurers will be better equipped to navigate the revised Solvency II regulations and capitalise on a range of opportunities over the coming years.

There is no unique strategy to optimise the resulting benefits of the updated Solvency regulation in the EU, but (re)insurers may have several management options while carefully considering the regulator’s, customers, and investors’ perspective.