Italian insurers question benefit of Solvency II long-term guarantees package

Matching adjustment and countercyclical premium inadequate for Italian insurers’ needs

Italian insurers claim the package of measures being tested in the long-term guarantees impact assessment (LTGA) may not go far enough to address the issue of asset price volatility.

The Italian insurance market has experienced huge swings in companies' balance sheets as a result of volatile bond prices. Yields on government securities over the last 15 months have been highly unstable, varying between 7.12% and 4.45% for 10-year BTPs (Italian Treasury bonds).

The Italian regulator, Isvap (renamed Ivass in July 2012), put in place measures to limit the impact on insurers' solvency ratios from unrealised losses on eurozone government bonds. However, insurers warn that measures being discussed to control volatility at the European level are not yet fit to task.

The Italian industry is particularly concerned about the final definition of the countercyclical premium (CCP), which allows insurers to use a higher discount rate for valuing their liabilities at times of extreme market stress.

Gianluca De Marchi, head of the financial and credit risk unit at Unipol Gruppo Finanziario in Bologna, says: "From our point of view, the only measure that could really help with this to reduce volatility is a countercyclical premium formula specific to real events. Unfortunately, the solution the European market has proposed – the matching adjustment – is not completely applicable to the Italian profit-sharing products."

In addition, De Marchi says, the requirement to hold assets backing liabilities in ring-fenced funds to qualify for all types of the matching adjustment – including the more loosely defined extended alternative version – does not suit the type of profit-sharing business popular in Italy.

"These products are not ring-fenced funds, so looking at the technical specifications of the LTGA we have seen that if you apply the matching adjustment you have to [ring fence and] lose diversification benefits and lose the possibility to use surplus in your own funds," he adds.

A report by Fitch Ratings suggest only 10% of a typical Italian insurer's life book is made up of interest-guaranteed annuities or fixed-term savings products, meaning a smaller proportion of their liabilities than insurers in other European countries could reap the benefit of the classic matching adjustment being tested.

The current CCP being tested under the LTGA is applied at fixed rates of 50, 100, and 250 basis points depending on the scenarios defined by the European Insurance and Occupational Pensions Authority (Eiopa). It remains uncertain at the European level how the CCP will be calculated, and how much discretion Eiopa will have to define when it can be applied.

Italian insurers have put forward a version of the CCP whereby the risk-free rate is adjusted by a ‘government spread premium' – an amount equal to the difference between the yields on a basket of European government bonds at 10-year maturity and the swap curve. Italian life insurer Generali said that at the end of 2012 this difference amounted to 134bp.

The Italian industry's approach, De Marchi says, would be more responsive to local market conditions. "In this case you will have a higher control over the possible impact determined by a specific stress situation in the market, both in terms of liquidity and the valuation of the balance sheet at the market value," he says.

A rating agency source adds: "What the Italian insurance industry does not want is an approach that gives no flexibility to firms or national regulators. They do not want something that is predetermined by Eiopa; they want some flexibility to apply the CCP depending on local market conditions generally."

The Italian regulator is hoping the LTGA will provide some clarity on the extent to which the matching adjustment and the CCP will benefit Italian insurers. A spokesman for Ivass says: "We have always said in the official forums at Eiopa and at the European Commission there is an issue of volatility. We want to understand from the impact assessment how much we can use and rely of the matching adjustment, because the combination of the two measures could be adequate or not. We still do not know."