Generali’s solvency ratio falls on risk-free rate changes

Regulatory changes increased present value of liabilities

Italian insurance giant Generali posted a 10-percentage point decline to its Solvency II ratio over the first quarter, as regulatory changes eroded its eligible own funds. 

The firms’ preliminary Solvency II ratio was 207% at end-March, down from 217% at end-2018 and 211% the same quarter a year ago.

Changes made by Europe's insurance watchdog to the risk-free rate used to discount long-term liabilities, known as the ultimate forward rate (UFR), shaved off one percentage point, and a shake-up of the representative portfolio used to calculate the volatility adjustment to the risk-free rate took off another three. 

A further three-percentage point deduction followed a shift in the regulatory treatment of Generali's occupational pensions business in France. The French regulator has steadily increased the haircut applied on the amount of unrealised gains generated by the business that the insurer can count in its own funds. Only 25% of these gains are now factored in, compared with 50% in 2018. 

Widening Italian government bond spreads and falling interest rates contributed to the remaining three-percentage point net reduction to the ratio. 

Generali’s finance chief said that the insurer’s Solvency II ratio had climbed back up to 212% by end-April. 

What is it?

Under Solvency II, an insurer’s solvency ratio is the ratio of eligible own funds to its solvency capital requirement. The latter is calculated as the amount of own funds needed for the insurer to honour policyholder obligations after a one-in-200-year stress event. The SCR is calibrated to each insurer’s risk profile, either through the application of a regulator-set standard formula or the use of a firm’s own internal model.

The ultimate forward rate is used by insurers subject to Solvency II to calculate the long end of the liability discount curve, where market rates are no longer deemed reliable. Beyond a ‘last liquid point’ – 20 years for the euro and 50 years for sterling – the discount curve is extrapolated from that point to the UFR.

The European Insurance and Occupational Pensions Authority (Eiopa) updates the UFR yearly by combining an expected inflation rate and real interest rate. The annual change to the UFR is limited to 15 basis points under the adopted methodology. The UFR was changed to 4.05% from 4.2% in 2018, and to 3.9% in 2019. 

Why it matters 

Generali's solvency ratio is hostage to a series of forces outside of its control. European regulators determine the level of the UFR and the make-up of the reference portfolio used to set the volatility adjustment. This means a significant fraction of the risk-free rate the firm uses to discount its liabilities does not reflect market prices, making it difficult to hedge. 

This injects volatility into insurers' capital requirements from quarter to quarter. To counter this, Generali can continue to address the sensitivity of its solvency capital requirement to interest rate, equity, and bond movements by shaking up its asset allocation, for example by diversifying away from Italian government bonds.

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Insurers were braced for the UFR change, but is the cut influencing firms’ asset-allocation decisions? Share your observations by emailing louie.woodall@infopro-digital.com, sending a tweet to @LouieWoodall or messaging on LinkedIn.

You can keep up with the Risk Quantum team by following @RiskQuantum.

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