Eiopa stress test highlights UK reliance on matching adjustment

Tests reveal how unwelcome any watering down of key measure would be

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Life insurance stress test results released last week make uncomfortable reading for those who fear Solvency II's matching adjustment might be watered down in future.

The results of the European Union-wide tests, published by the European Insurance and Occupational Pensions Authority (Eiopa) on December 15, show the true value of long-term guarantee measures such as the matching adjustment (MA) to UK insurers, while the same matching adjustment yields few benefits to continental insurers.

The solvency capital requirement (SCR) coverage ratio of UK insurers would fall from 142% to 77% without the MA, and 51% without any such adjustments or transitional measures – the lowest of any EU country.

By comparison, the SCR coverage ratio of German insurers would fall from 272% to 145% without adjustments or transitionals, while the ratio of French insurers would fall from 196% to 152%.

"It's possible post-Brexit the European regulators [will] look at the long-term guarantee package and the bits that mainly benefit the UK and say, ‘well I don't really know why we ever had those'," says Andrew Smith, a partner for Deloitte in London.

If the Prudential Regulation Authority is not at the EU negotiating table, continental life insurers might favour tougher rules for UK rivals writing annuities to EU-based policyholders, he thinks.

Several undertakings only pass the legal solvency hurdle thanks to generous relief measures, granted at the insistence of an industry worried about revealing the consequences of a long period of low interest rates on their ability to meet promises to customers
Sven Giegold, Green MEP

"Their competitors might quite like them to feel a bit of heat. I'd be surprised if it hadn't occurred to anybody but, that said, it's enshrined in directives, so it's not the sort of thing you can roll back at the flick of a switch," he says.

The matching adjustment, used most in Spain and the UK, allows insurers to raise the rate at which they discount liabilities by pairing assets and liabilities of similar duration.

Eiopa's stress test assesses the financial health of insurers through two scenarios: a world where yields stay low over the long term, such that the ultimate forward rate (UFR) is 2%; and the same eventuality with an added economic shock amounting to a 33% drop in European stock markets, a 120 basis-point rise in sovereign yields and a 6% fall in property prices, including a 14% drop in UK property prices.

The results reveal that of 236 life insurers, only 38 would lose more than a third of their excess assets over liabilities if yields stayed low, and three would lose all their excess assets.

In the double-hit scenario, 104 insurers would lose more than a third of their excess assets over liabilities and five would lose all their excess assets.

The chairman of Eiopa, Gabriel Bernardino, says: "Our observations are that the implementation of Solvency II has been a success – both in terms of the results from the solvency capital requirements and the preparation period of 2014/2015 that was used by companies in this specific area of the life side to reinforce their capital and provisions. That's why we have these results, which is an adequate capitalisation at the beginning of [Solvency II]."

He added that in most cases, he did not anticipate insurers would raise capital following the results. The Association of British Insurers and Insurance Europe were similarly upbeat, saying the results showed the resilience of European and UK insurers.

Green MEP Sven Giegold says the stress tests were "superficially positive", though, and hide how badly insurers would fare given a stagnant economy, and based on current asset prices and interest rates suggested by markets rather than regulators.

"Several undertakings only pass the legal solvency hurdle thanks to generous relief measures, granted at the insistence of an industry worried about revealing the consequences of a long period of low interest rates on their ability to meet promises to customers," he says.

Without long-term guarantee measures or transitionals boosting rates for liability discounting, 162 European life insurers would lose more than a third of their excess assets and 72 insurers would have liabilities surpassing their assets under the double-hit scenario.

"When you assume regulatory capital requirements, you shouldn't pretend you know better as a regulator what has value than the market. I hope the regulators do not rely on figures that are corrected in a certain arbitrary way from market values, but on the reality," says Giegold.

Gabriel Bernardino

Our observations are that the implementation of Solvency II has been a success – both in terms of the results from the solvency capital requirements and the preparation period of 2014/2015
Gabriel Bernardino, chairman of Eiopa

 

Deloitte's Smith, however, says it is wrong to think certain insurers would be devastated without long-term guarantee measures. "If it wasn't for that, their asset strategy would be different," he says.

He adds that many insurers using internal models are likely to have tested more severe stresses than Eiopa's.

Though Eiopa's Bernardino says the results would have no influence on Eiopa's study into whether to adjust the UFR from its current rate of 4.2%, the stress test may bolster the argument for a lower UFR.

"I suppose some people might look at this and say: ‘what purpose is served by moving the UFR down so slowly at 0.2% per annum? Even 2% is not really a conservative value...' To those arguing the UFR shouldn't fall – Eiopa may use this stress test to say it wouldn't be that bad," says Smith.

Another consequence from the stress test is Eiopa's recommendation that regulators look into lower maximum guarantees and curbs on new guarantees being offered where they judge an insurer's business model to be ill-fated.

"That's interesting, because the guarantees are a contract between an insurer and a policyholder. This seems to be saying that if you're in a jurisdiction where the guarantees are unsustainable, then maybe the lesser of two evils is some sort of industry-wide scaling back of those guarantees," says Smith.

"On one hand, regulators have a consumer protection role that liabilities are paid in full; on the other, they have this solvency role," he says.

"The state should not determine business models, but it should ensure whatever your business model is, you are able to keep your promises so that in the end there will not be pressure on the state," says Giegold.

"We say quite clearly to supervisors you need to analyse the sustainability of the business model, and if your assessment is that the business model is nonviable... then you should [ask] companies to reconsider their dividend distribution," said Bernardino, following the results.

Undercapitalised insurers were not named in the stress tests, but Eiopa says it may be able to publish the names of insurers in its next stress test in 2018.

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