Own-fund items are classified in three tiers, depending on their value. The criteria for this classification are laid down in the VAG and defined more specifically in the Delegated Regulation (EU) 2015/35. Since the Delegated Regulation is directly applicable law in Germany, its requirements must always be taken into account when determining the value of an undertaking's own funds. In the VAG, the requirements for Tiers 1 to 3 are laid down in sections 91 to 93. In the Delegated Regulation, the requirements for Tier 1 are set out in Articles 69 to 71, for Tier 2 in Articles 72 to 75 and the requirements for Tier 3 are defined in Articles 76 to 78. In addition, the European Insurance and Occupational Pensions Authority (EIOPA) published Guidelines on the Classification of Own Funds (EIOPA-BoS-14/168). BaFin requires all insurance undertakings subject to the Solvency II Directive to comply with these Guidelines.

The Tiers are subject to quantitative limits. Therefore, not all of the own funds available to an issuer are necessarily eligible, i.e. not every own-fund item can be counted towards the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR). The requirements regarding the composition of eligible own funds are set out in sections 94 and 95 of the VAG, which transpose Article 98(1) and (2) of the Solvency II Directive into German law. These requirements are specified in more detail at Level 2, in Article 82 of Delegated Regulation (EU) 2015/35. The limits laid down in the Delegated Regulation are therefore applicable to all insurers subject to Solvency II.

If an undertaking intends to have its subordinated loans recognised as own-fund items, it does not have to apply for supervisory approval. There is, therefore no application procedure for this.

If an undertaking submits a loan agreement to BaFin, requesting an assessment of whether this agreement can be recognised as an eligible own-fund item, it is to be expected that the dialogue with BaFin will take several months, depending on the complexity of the matter. Experience has shown that this process may even exceed a period of three months.

Loans taken out before 18 January 2015 that do not comply with Solvency II may generally be recognised as own funds for a transition period not exceeding ten years after 31 December 2015 if they fulfil the criteria of section 53c (3a) or (3b) of the VAG in the version applicable until 31 December 2015.

Solvency Capital Requirement (SCR)

Pursuant to section 89 of the VAG, all insurers subject to Solvency II must at all times have eligible own funds of at least the level of the Solvency Capital Requirement (SCR).

The calculation of the SCR is governed by sections 96 ff. of the VAG. Pursuant to section 97 of the VAG, the SCR corresponds to the Value at Risk (VAR) of the basic own funds subject to a confidence level of 99.5% over a one-year period. This means that insurers holding eligible own funds equivalent to the SCR will, with a probability of at least 99.5%, be able to cover any unexpected losses they might incur during the year to come.

In the calculation of the SCR, all material quantifiable risks to which insurance or reinsurance undertakings are exposed are to be taken into account. Undertakings may use a standard formula or an internal model to calculate the SCR (section 96 (1) of the VAG).

Standard formula

If the SCR is calculated using the standard formula, it consists pursuant to section 99 of the VAG of the basic SCR, the capital requirement for operational risk and the adjustment for the loss-absorbing capacity of technical provisions and deferred taxes.

In order to calculate the basic SCR, appropriate provisions were stipulated defining which risks must be taken into account. The calculation comprises individual risk modules, which are subsequently aggregated. The basic SCR includes underwriting risks, market risks and credit risk, which are defined in section 7 no. 18, 20 and 32 of the VAG.

For individual underwriting risk modules, undertakings may adjust the parameters of the standard formula using their own parameters. However, these adjustments are subject to prior approval by the supervisory authority (undertaking-specific parameters, section 109 of the VAG).

Internal model

Pursuant to section 111 ff. of the VAG, undertakings may calculate the SCR using an internal model, which must be approved by the supervisory authority. If an internal model is not used to calculate the total SCR but only for individual risk modules or sub-modules of the basic SCR, for the operational risk pursuant to section 107 of the VAG or the adjustment for the loss-absorbing capacity of technical provisions and deferred taxes pursuant to section 108 of the VAG, it is called a partial internal model (section 112 of the VAG). Insurers intending to use an internal model must fulfil extensive requirements (sections 111 ff. of the VAG).

Minimum Capital Requirement (MCR)

Pursuant to section 89 of the VAG, insurers subject to Solvency II must at all times have eligible basic own funds of at least the level of the Minimum Capital Requirement (MCR). For this reason, only basic own funds classified as Tier 1 and Tier 2 are eligible for covering the MCR.

Pursuant to section 122 of the VAG, the MCR corresponds to an amount of eligible basic own funds below which policyholders and beneficiaries would be exposed to an unacceptable level of risk were the insurer allowed to continue its operations. Therefore, authorisation of an insurer is withdrawn when the undertaking's amount of eligible basic own funds falls below the MCR and the undertaking is unable to re-establish the amount of eligible basic own funds at the level of the MCR within a short period of time. The minimum amount of the MCR is governed by the Capital Resources Regulation. The calculation formula is laid down in Delegated Regulation (EU) 2015/35.