Liquidity Risk Management Planning Under the Solvency II Amendments: Key Actions for Compliance

Topics

Quantitative requirements

Qualitative requirements

Criteria for covering liquidity analysis over the medium and long term

• A medium- and long-term liquidity analysis is required, in addition to the short-term analysis, for companies with assets exceeding €12 billion.
• Forced asset sales are considered to potentially impact financial stability beyond this threshold.
• Based on the nature, scale, and complexity of risks, supervisory authorities may require this analysis for smaller companies, particularly if their liquidity risk exposure arises from:
  • Policyholder behavior,
  • Insurable events,
  • Counterparty risks,
  • Economic and market developments.

Time Horizon for Liquidity Analysis

• The liquidity analysis is split into two-time horizons:
  • Short-term: Cash flow projections (inflows and outflows) cover a three-month period from the start date of the projections.
  • Medium and long-term: This analysis spans at least one year, extending until liquidity risks become immaterial. This flexible approach allows the duration to be tailored to the risk profile and business model of each company. Insurers must also include additional horizons (e.g., daily, weekly) if necessary to address specific risks such as margin calls or early lapse.

Structure of the Liquidity Risk Management Plan and Updates

• EIOPA proposes a common structure to enhance the readability and comparability of LRMPs across companies and to facilitate understanding by supervisory authorities. Each plan should include:
  • A summary at the beginning of the document, presenting the main conclusions of the liquidity analysis,
  • The assumptions underlying the calculations,
  • Information on projected cash flows,
  • Buffer of liquid asset,
  • Liquidity risk indicators across different time horizons,
  • Any other relevantinformation.

• Update Frequency: The LRMP must be updated regularly to reflect changing risks:
  • Short-term liquidity projections: Updated quarterly.
  • Medium- and long-term analyses: Updated annually.
  • Immediate updates: Triggered by significant changes, such as large asset sales or macroeconomic shocks.
  • Establishing internal triggers for LRMP reviews ensures responsiveness to market and operational changes.

Overall assessment of liquidity risk

This section should include the following key elements:

• Summary of Liquidity Position: Start with a concise summary of the company’s current liquidity position. Evaluate whether liquid assets are sufficient to meet financial obligations under normal and stressed conditions. Highlight key findings, such as liquidity coverage metrics and other relevant indicators.
• Assessment of changes and vulnerabilities: Identify material changes in the liquidity risk profile since the last LRMP update. Summarize key vulnerabilities, such as reliance on short-term funding or other liquidity risks.
• Evaluation of Liquidity Risk Tolerance: Verify adherence to the company’s liquidity risk tolerance limits.
• Corrective Actions: Document corrective measures to address any weaknesses or vulnerabilities identified in the analysis. Outline specific steps to strengthen the company’s liquidity risk management system.

Assumptions underlyings the projections

• Insurers must present quantitative data on assumptions underlying cash flow projections in both normal and stressed conditions.
• In line with Article 259(3) of the Delegated Acts, this should include stress tests and relevant scenario analysis addressing material sources of liquidity risk, such as:
  • Policyholder lapse (e.g., structural and cyclical lapse assumptions) and mortality (e.g., mortality tables used),
  • Natural or man-made catastrophes,
  • Deterioration in credit quality, making it more difficult for the company to access financing,
  • Shocks applied to these risk sources (e.g 150-bps interest rate hike effect on cash flow, 40% mass lapse, increases of costs).
• Entities may build their stressed scenarios using the adverse scenarios proposed by EIOPA as part of the 2024 Stress Tests.

Companies must provide qualitative information to explain and justify the assumptions used in their cash flow projections.

Example: What assumptions should be retained to project future premiums, Lapse, or mortality?

Buffer of liquid asset

• The Buffer of Liquid Assets serves as a vital safeguard during stress scenarios, ensuring that insurers can meet obligations without resorting to distressed asset sales. EIOPA requires companies to maintain adequate liquidity buffers, factoring in haircuts and operational readiness, to address potential shortfalls under adverse market conditions.
• Thus, companies must provide quantitative information on their liquid asset reserves (buffers) tailored to their needs and time horizon.
• These buffers must be broken down by:
  • Asset class:  Government bonds, corporate securities, or cash equivalents) among assets classified as HQLA (see section 1),
  • Initial market value: Pre-haircut valuation of assets.
  • Haircuts applied (potential losses under stressed conditions),
  • Value after adjustment.

• The RTS does not propose a specific template for breaking down buffer assets but refers to the template provided by the IAIS on page 54[2]

• Companies may also leverage the liquidity templates provided by EIOPA as part of the 2024 Stress Tests[3] for detailing buffer asset classes

Buffer assets must require qualitative information to demonstrate:

• Their reliability in covering liquidity shortfalls under stressed conditions (credit quality, absence of encumbrances, market liquidity),
• The company's operational capacity to convert them into liquidity within the required timeframes,
• The continuity of arrangements with counterparties to secure unsecured funding or transform assets into liquidity.

Cash-Flow Projected

• EIOPA proposes in the RTS to detail the following Cash-Flow projections in the LRMP, under both normal and stressed conditions
  • Incoming Cash Flows: Gross premiums, reinsurance recoverable, intragroup inflows, investment income, asset sales, and unsecured funding, excluding intragroup loans.
  • Outgoing Cash Flows: It is at least proposed to distinguish between:
    • Payments such as claims (e.g., deaths, maturities, ceded premiums to reinsurer), ands expenses,
    • Payments for which the supervisory authority may restrict payments during a crisis under Article 144c, such as Lapses, dividends, subordinated debt, and bonuses.
• Incoming cash flows must be reported gross, without transforming liquid assets into available cash. The difference between gross and net flows will represent, at a minimum, asset sales, secured funding, and collateralized transactions.
• The objective is to verify whether the company has sufficient liquid asset reserves, without the net balance hiding a deficit covered by asset sales.

Cash flow projections must be presented separately for portfolios with profit participation (e.g. euro savings, ) and unit-linked portfolios.

This is not explicitly stated in the RTS, but it appears that cash flow projections should be performed in a real-world framework to best align with observed flows. Indeed, cash shortfalls measured in a risk-neutral framework do not reflect economic reality.

Liquidity Risk Indicators

• To effectively monitor and manage liquidity alerts, companies must establish specificindicators to identify, track, and address potential stress situations across different time horizons.
• Among these tools, the Liquidity Coverage Indicator (LCI) (see formula in section 3.1) is recommended by EIOPA and measures the ability of liquid assets to cover projected cash flow deficits under stressed conditions.

As the LRMP is principle-based, companies can adapt their indicators to their needs and profiles, but they must justify any deviation from the LCI if it is not implemented.

Group-Level Liquidity Considerations

• A LRMP must also be produced at the group level, with the same frequency and information as a solo report
• Nevertheless, intragroup liquidity flows must be analysed. Include
  • Liquidity Transfer Mechanisms: Shared liquidity pools or intercompany loans.
  • Transferability Restrictions: Regulatory constraints or operational barriers affecting liquidity movement.
    For example, shared liquidity pools can provide flexibility during stress events, but regulatory restrictions on subsidiary-level buffers may limit transfers. Regular reviews ensure these mechanisms remain effective

Current Requirements (Delegated Acts):

New Requirements for LRMP (RTS):

• Liquidity risk included in the written risk management policy.
• Cash flow projections (Article 260(1)(d)), including under stressed conditions (Article 259(3)).
• Liquidity analysis across short-, medium-, and long-term horizons.
• Stress tests and scenario analyses integrated into the risk management system.

• Formalisation of liquidity risk management through a separate document.
• Liquidity risk indicators to be produced for various time horizons (short, medium, long term).
• Underlying assumptions for liquidity analyses to be disclosed.