Updates to UK Solvency II own funds classification framework
The Bank of England has issued guidelines on the classification of own-fund items under UK Solvency II. The document provides guidance on applying lists of own-fund items and features determining their tier classification, including procedures for supervisory approval.
Navigating own-fund classification under Solvency II
The guidelines aim to clarify the application of own-fund item lists and classification features under Solvency II, particularly Articles 93-95 of Directive 2009/138/EC and Commission Delegated Regulation 2015/35. They detail procedures for classifying own funds, including prior supervisory approval for items not explicitly listed.
Undertakings must assess all capital items against defined features to determine their eligibility as available own funds and their appropriate tier.
The contractual arrangements governing own-fund items must adhere to the substance of Solvency II, not just the form, and be clear and unambiguous.
Paid-in ordinary share capital and similar items are considered the highest quality own funds for loss absorption on a going-concern basis, and their quality must not be undermined.
The guidelines also address the interpretation of share premium accounts, emphasizing economic substance over national legal terminology, and clarify that contractual arrangements should not hinder the raising of new own-fund items.
Ensuring loss absorbency and flexibility
The guidelines specify that own-fund items must possess sufficient maturity, prohibiting call options prior to five years for all tiers under Solvency II. Undertakings must not create an expectation of early redemption, and supervisory approval is always required for repayment or redemption to prevent adverse impacts on solvency.
Own-fund items must also ensure undertakings can maintain adequate funds even in cases of non-compliance with the Solvency Capital Requirement (SCR).
Dividend stoppers, which cap or restrict distributions on Tier 1 items, are explicitly prohibited to avoid discouraging new capital providers and hindering recapitalisation efforts.
The document also clarifies that called-up but not paid-in ordinary share capital can be classified as Tier 2 basic own funds for a limited time, preventing its use solely for classification purposes.
Clarity for capital, not for growth
These guidelines provide much-needed clarity on the intricate classification of own funds under Solvency II, streamlining supervisory expectations.
However, their strict focus on capital quality and loss absorbency, while crucial for stability, offers little direct impetus for insurers to innovate or expand.
The emphasis on regulatory compliance might inadvertently divert resources from growth-oriented investments, a trade-off inherent in robust prudential frameworks.