Proportionality on Paper
Proportionality has always been part of the Solvency II framework, at least on paper. When the Solvency II Directive 2009/138/EC was introduced in 2016, the principle was clearly embedded both in the recitals and in the operative provisions of the Directive.
Recital 19 makes this explicit: the framework should not be too burdensome for small and medium-sized undertakings, and proportionality should apply both to regulatory requirements and to supervisory powers. Recital 21 further recognises the specific nature of captives, calling for approaches that reflect the nature, scale and complexity of their business. This is reinforced in the core provisions, including Article 29, which requires Member States to apply requirements in a proportionate manner, and Article 41(2), which links governance systems directly to the nature, scale and complexity of operations.
The objective was clear and remains valid. Avoiding unnecessary complexity and excessive compliance costs is essential, not only to reduce the burden on firms, but also to protect policyholders, who ultimately bear these costs, and to preserve a diverse and competitive insurance market.
The Gap Between Principle and Practice
Despite this, the high-level nature of the proportionality principle meant that, in practice, it did not always deliver the intended results. There has been broad recognition across the industry and among regulators that proportionality was not being applied consistently or effectively. This led to higher compliance costs, particularly for smaller and less complex undertakings, and diverted supervisory attention away from firms with more significant risk profiles.
This concern is also reflected in the technical work carried out at EU level. In its Technical Advice on the implementation of the new proportionality framework under Solvency II, EIOPA noted that the new framework “represents a shift towards a more robust and transparent application of the proportionality principle,” introducing objective criteria to identify small and non-complex undertakings and enabling the use of specific proportionality measures.
Resetting the Framework
The Solvency II Review seeks to address this through a more structured approach. The solution is largely twofold. First, the thresholds for exclusion from the scope of Solvency II have been increased, allowing more small undertakings to fall outside the regime altogether. Second, and more importantly, a new category of undertakings has been introduced: Small and Non-Complex Undertakings (SNCUs).
SNCUs: A Practical Solution
An SNCU is defined as an (re)insurance undertaking, including captives, that meets the conditions set out in Article 29a and has been classified as such for two consecutive financial years. Certain undertakings are automatically excluded from this classification, including those using approved internal models and parent undertakings of large groups or financial conglomerates.
Once classified as an SNCU, an undertaking should, in principle, benefit automatically from a range of proportionality measures. These cover key areas such as reporting, disclosure, governance, the review of written policies, the calculation of technical provisions, the own-risk and solvency assessment, and liquidity risk management. The only exception is where the supervisory authority has serious concerns about the undertaking’s risk profile.
Captives: A Natural Fit for Proportionality
Captives deserve particular attention, not only because they are expressly recognised in the amended framework, but also because of their distinct role within the insurance ecosystem.
Captives are fundamentally different from commercial insurers. They exist to serve the risk management needs of their parent group, rather than to compete in the open market. Their risk profile is typically more stable and predictable, their underwriting is closely aligned with the group’s operations, and they have a direct line of sight over the risks they assume. This often results in a simpler business model, limited distribution complexity, and a clearer governance structure.
At the same time, captives play an important role. They support risk retention within groups, provide flexibility in managing unconventional risks, and can enhance overall risk awareness and discipline at group level. For many international groups, captives are a key tool for managing volatility and accessing reinsurance markets efficiently.
It is therefore logical that the revised framework treats captives differently. Under the amended Directive, captives can be classified as SNCUs even if they do not meet all the standard criteria, provided certain conditions are met.
In particular, all insured persons and beneficiaries must be linked to the group to which the captive belongs, with only a limited allowance, below 5% of technical provisions, for natural persons covered under group policies. In addition, the business must not include compulsory third-party liability insurance.
This tailored approach reflects a practical reality: captives are generally less complex not just because of their size, but because of the nature of their activities. Applying proportionality more systematically to captives is therefore not a relaxation of standards, but a better alignment of the rules with the actual risks involved.
Non-SNCUs: Proportionality beyond SNCUs
Proportionality is not limited to undertakings classified as SNCUs. While the new framework introduces clearer and more structured access to proportionality through the SNCU category, the underlying principle is broader and applies across the entire Solvency II regime. This is explicitly recognised in the revised framework, which allows non-SNCUs to benefit from certain proportionality measures subject to supervisory approval.
For non-SNCUs, this means that proportionality becomes a supervisory engagement rather than a classification. Undertakings must demonstrate that their business model, governance and risk exposure justify a more proportionate application of certain requirements. Supervisors, in turn, must be willing to engage with that assessment and exercise judgement.
Notification or Approval: How It Works
The starting point for SNCU classification is a self-assessment carried out by the undertaking against the criteria set out in Article 29a – refer to decision-making tree.
In Malta, as outlined by the Malta Financial Services Authority (MFSA), undertakings that meet the conditions must formally notify the Authority of their intention to be classified as SNCUs. This is a notification process rather than an approval process, which marks an important distinction from the approach taken for non-SNCUs.
The notification will require undertakings to provide key information, including the type of business (life, non-life or mixed) and an explanation of how the relevant quantitative and qualitative criteria are met.
The MFSA has two months to object to the classification, or four months for notifications submitted between January and July 2027. The Authority may oppose the classification if the legal criteria are not met or if the undertaking’s risk profile is considered too complex.
For undertakings seeking proportionality measures outside the SNCU framework, a formal application and approval process applies. The MFSA will assess the evidence submitted and may grant full or partial permission to apply the requested measures.
Turning Proportionality into Reality
The framework for stronger proportionality is now in place, and Member States will have until January 2027 to transpose these provisions into national law. This provides a clear timeline, but also a limited window to ensure that the changes are implemented in a meaningful way.
These reforms should not be seen as an end in themselves. They are a means to achieve a more consistent, practical and predictable application of proportionality, one that reduces unnecessary costs while maintaining appropriate standards.
At its core, proportionality is not a status, it is a way of applying the rules. The principle requires a holistic assessment of an undertaking’s risk profile, rather than a purely mechanical approach. In other words, proportionality should not be confined to a predefined group of undertakings, but should guide how all requirements are interpreted and applied.
More importantly, proportionality is as much about supervisory judgement and regulatory culture as it is about legal provisions. The challenge under Solvency II has not been the absence of the principle, but its inconsistent application. The principle is inherently flexible, but that flexibility requires regulators to actively interpret and apply it, rather than default to a uniform or conservative approach.
In this sense, the new framework can be seen as moving from a more rules-based approach to a more principle-based one, where undertakings are expected to justify why a simplified or tailored approach is appropriate to their risk profile, and supervisors are expected to assess that justification.
Proportionality does not mean lowering standards. It means applying them in a way that reflects the actual risks involved. For this to work in practice, there needs to be a shift in approach. Regulators will need to place greater trust in simpler structures and accept that a lighter touch can be appropriate in certain cases. This may not always come naturally, but it is essential if the reforms are to have real impact.
If proportionality is treated only as a label attached to SNCUs, its impact will remain limited. If, however, it is applied as a guiding principle across the framework, it can deliver a more balanced and risk-sensitive supervisory approach for all undertakings. The challenge now is to turn that principle into consistent practice, and to ensure that proportionality becomes part of day-to-day supervision rather than an exception.
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