QIS 5 - A welcome relief for insurers

Stereotypes are dangerous things but it is a fair generalisation that Britons are less enthused about the European Union (EU) than the citizens of its other 26 member states. So it is no surprise that protestations from UK annuity providers over the absence of a liquidity premium were translated into a big stick for the country’s right-wing press to beat “interfering Brussels technocrats” with.

“Millions of British workers could see their pensions slashed by up to 20% in a devastating new round of meddling by Brussels,” was the interpretation by the UK’s Daily Express of the Committee of European Insurance and Occupational Pensions Supervisors’ (Ceiops) July round of consultation papers.

So the release of the European Commission’s (EC) calibration advice last month, which brought in a premium to be added to all liabilities of more than one year and double for retirement annuities, came as a welcome relief to the UK industry, if a disappointment to right-wing tabloid leader writers.

The actual figures are still a matter for conjecture, but it is undeniable that the imposition of a risk-free rate on annuity providers would have led to the annuity rates plummeting, a scenario that makes little sense in a world in which all governments are desperate to encourage people to save for their retirement.

What is less obvious is why the EC included a premium in all liabilities of more than one year. The suspicion among the UK industry is that it is a sop to gain the support of the continental industry, where annuity provision is less widespread. The whole point of annuities is they can only be lapsed at death, meaning the provider has a high degree of certainty over the payments it will need to make – an attribute not present in other life products.

Even in this context, reinvestment risk still poses a potential threat as higher-than-expected longevity will require insurers to cashflow match at a time which cannot be predicted. But the liquidity issue is clearly not the same for shorter-dated products. Indeed, even Karel Van Hulle, head of insurance and pensions, internal market and services at the EC and an advocate of the liquidity premium’s inclusion in Solvency II, appeared perplexed at its wider use in the calibration advice.

When Life & Pension Risk spoke to Van Hulle about this issue, he said his initial assumption was that only retirement annuity providers would be beneficiaries of the liquidity premium. But if nothing else, the whole episode does make one thing clear: developing Solvency II is an organic process. Items that were sacred cows of the larger insurers, such as group support, have been discarded and ones that definitely were not, such as the equity risk dampener, have been included.

With the process of the fifth quantitative impact study not starting until later this year and the continuing sovereign debt problems of EU member states such as Ireland and Greece, it would be bold to make firm predictions over what will, and won’t, make it in the final draft. But the liquidity premium should only be applied to annuities; if it is tacked onto other products the economic basis on which Solvency II is based would be undermined and that cannot be good for the industry.