The EU Insurance and Occupational Pensions Authority (EIOPA), the European Supervisory Authority responsible for the regulation of the EU insurance sector, has published a consultation paper on its draft opinion (Opinion) on the supervision of remuneration in the insurance and reinsurance sector. The consultation ends on 30 September 2019.
The remuneration rules that apply to insurance and reinsurance firms are found in the Solvency II Delegated Regulation (EU) 2015/35 (Solvency II). Solvency II establishes a range of remuneration requirements that are typically less detailed, and are subject to less detailed guidance, than the remuneration rules impacting other types of financial services firms. The impact of this is that Solvency II firms and supervisory authorities have 'considerable discretion' as to how the remuneration requirements are applied.
EIOPA has identified that this discretion has led to divergent practices across Europe. The Opinion aims to enhance convergence in the supervision of the remuneration policies of EU insurance and reinsurance firms. The Opinion is targeted at supervisory authorities and gives guidance to them on how to challenge the application of the remuneration requirements by firms. EIOPA has, however, stated that it is not their intention to add requirements or to create administrative burden.
The Opinion applies to remuneration for staff in the categories listed below, whose annual variable remuneration exceeds EUR 50,000 and represents more than 1/4 of their total annual remuneration:
- members of the administrative, management and .
- supervisory body;
- other executives who effectively run the firm;
- key governance holders as defined in EIOPA's Guidelines on the system of governance; and
- categories of staff whose professional activities have a material impact on the firm's risk profile.
EIOPA has, however, stated that for staff not covered by the Opinion, supervisory authorities may adopt a proportionate and more flexible approach, including applying the Opinion to staff outside of the scope identified above but in a more flexible manner.
- Balance between fixed and variable remuneration: the proportions of fixed and variable remuneration must be such that employees do not become overly dependent on variable components and, if a firm exceeds the 1:1 ratio, the supervisory authority should investigate whether the remuneration policy is properly balanced. Supervisory authorities should also pay specific attention to very low fixed remuneration.
- Deferral of variable remuneration: firms should use different deferral periods depending upon the risks entered into, as opposed to only applying the 3 year minimum. Supervisory authorities should use their judgement to consider whether a deferral rate higher than 40% and/or a longer deferral period is needed. When deferral is lower than 40% supervisory authorities should engage with the firm to understand the specific situation. The deferral rate is recommended to be higher than 40% in the case of a particularly high variable remuneration e.g. a ratio higher than 1:1.
- Financial and non-financial criteria: supervisory authorities should ensure that firms, when assessing an individual's performance ex ante, set out financial (quantitative) and non-financial (qualitative) criteria and describe the consequences on the pay-out of variable remuneration when the criteria are not met by the individual. The criteria used should be linked to decisions made by the individual and should ensure the remuneration award process has an appropriate impact on the individual's behaviour. When assessing performance in a multi-year framework, the following should be taken into account: (a) financial criteria covering a period long enough to capture the risk taken by staff; and (b) non-financial criteria contributing to creation of value for the firm, e.g. compliance, client service, achievement of strategic goals, staff turnover and reputation. The financial and non-financial criteria should be appropriately balanced and supervisory authorities should challenge where appropriate.
- Downward adjustments: variable remuneration should not only be adjusted downward when staff do not meet their personal objectives, but also when their business units and/or the firm as a whole fail to do so. If a firm is likely to breach. or has breached, the Solvency Capital Requirement its remuneration policy should prescribe that downwards adjustment will be applied. Supervisory authorities should require a clear description of the downwards adjustment(s) from firms, including at least: (a) how short to long-term risks, cost of capital, internal capital requirements and dividends policies have been taken into account; (b) examples of how the downwards adjustment works; (c) rationale for the chosen downwards adjustment and triggers used; and (d) clarification that the downwards adjustments are designed in a way that any unvested portion of variable remuneration may be subject to malus.
- Termination payments: remuneration policies should specify the possible use of termination payments, including maximum payment or criteria for determining the amount. The Opinion identifies payments that should qualify as termination payments. When defining the maximum level of any termination payment, the fixed/variable remuneration ratio should be taken into account. Deferral requirements will apply to termination payments, with some exceptions as outlined in the Opinion. There is also guidance to help firms ensure that termination payments reflect performance achieved over time and are not being made to reward failure or being made in other circumstances where such payments should not be made. Supervisory authorities must ensure firms are able to demonstrate the reasons for the payments, the appropriateness of the amount and criteria, and that the payment is linked to performance achieved over time and does not reward failure.
- Variable remuneration composition: supervisory authorities should ensure firms award 50% of variable remuneration in shares, equivalent ownership or share-linked instruments. The instruments should be subject to an appropriate retention policy.
- Reporting: supervisory authorities should collect qualitative and quantitative data to enable them to perform a supervisory review of the remuneration principles in accordance with the Opinion.
This Opinion follows the UK PRA's recent comments on the application of Solvency II, in which the PRA identified disparities in how the Solvency II remuneration requirements have been implemented. It is notable that a few of the areas of disparity identified by the PRA, such as in relation to downward adjustments and the calculation of performance, are also addressed in the Opinion. This shows that the disparity identified by the PRA for UK firms may also be present throughout the EU generally.
As the Opinion is addressed at supervisory authorities, as opposed to firms directly, it is clear that EIOPA expects supervisory authorities to take action to deal with the divergent supervisory framework, in line with the new guidance, before taking a more direct intervention. If supervisory authorities do not effectively deal with the areas of disparity before EIOPA starts to monitor the application of the Opinion two years after publication, we may see more direct intervention. Any such intervention is unlikely to happen soon and, in the interim, supervisory authorities have time to try and bring firms into line with the expectations outlined in the Opinion.
As the Opinion is only in a draft format, firms should review their existing policies and practices with the draft guidance in mind and consider: (a) whether to engage in the consultation process; and (b) whether, if the Opinion was to come into effect as drafted, the firm's remuneration policy would be compliant with the expectations outlined in the Opinion and, if not, either identify any required remedial action or be prepared to explain and justify any area of divergence.
If you have any questions about this update or in relation to your remuneration regulation compliance generally, please do contact us.