Recent months have seen the first releases of data from the European Insurance and Occupational Pensions Authority (Eiopa) for the Solvency II risk-free rate curve, which forms the basis on which insurers will discount liabilities under the directive.
It is late to pick fault with methodologies that have been developed over several years and through multiple consultations, but that is not holding back a groundswell of opinion that the final outcome is over-engineered.
Points that seemed minor when the rules were being set, now feel to some like marks of a wider failing – the dislocation of the directive from reality. The credit risk adjustment, to take a single case, is expected to have limited impact on insurers’ balance sheets. But as an element of the discount curve that firms say is unhedgeable, it means they are stuck with some volatility in their regulatory balance sheet whether they like it or not.
Meanwhile, the ultimate forward rates set under the directive bear little relation to current long-term yields, contributing to a view that this core element of the Solvency II project is more the product of theoreticians in Frankfurt than anything to do with markets.
“Our capital requirements are based on a fictitious curve,” says one insurer. Meanwhile, experts are starting to talk of ‘regulatory risk’ in the form of Eiopa changing the calibration of key metrics for calculating solvency positions.
Elsewhere, regulatory risk comes up again in relation to implementing the directive at national level. Here the spirit of the rules seems in danger of being pushed aside by political considerations.
Solvency II is meant to be a maximum harmonisation directive, but gaps are clear in how regulators are interpreting the rules. The softening of the UK regulator’s line on equity-release mortgages and the matching adjustment adds to the impression that political influence plays a role at times.
The point is underlined by the confirmation in March that the PRA will have right of veto over the use of the volatility adjustment. The legal text on this cites the encouragement of pro-cyclical investment behaviour as a possible reason to block its use.
That makes little sense to many in the industry because the volatility adjustment is intended to be counter-cyclical. But an interest in the pro-cyclical effects of regulation has been raised in the UK by the Bank of England before, so perhaps it should come as less of a surprise.
Several practitioners that spoke to Insurance Risk, however, were clear on what this sort of change represents. It is regulatory gold-plating, they said, and they were less than pleased about it.