30 January 2013

Risk.net: Concerns over restrictions in matching adjustment assessment

The versions of the matching adjustment being tested in the long-term guarantees impact assessment are too restrictive and could limit the use of the mechanism by insurers, experts warn.

The European Insurance and Occupational Pensions Authority (EIOPA) launched the assessment on Monday to evaluate the package of measures for dealing with products with long-term guarantees. These measures include the counter-cyclical premium, extrapolation of the risk-free term structure and the matching adjustment.

Despite insurers' efforts to lobby for a broad application of the matching adjustment, which is used to protect insurers from credit spread volatility of assets that are held to maturity, there are concerns that the versions being tested place too many restrictions on the assets insurers can use to match the long-term liabilities in order to reap the advantages of the adjustment.

The assessment, which is part of the process to finalise the Omnibus II Directive, will evaluate five versions of the matching adjustment, ranging from a narrow, 'classic' version to a more permissive 'extended' one.

The two 'classic' adjustments are to be applied to life insurance obligations where no policyholder options can be exercised, such as annuities; while the three variations of the 'extended' adjustment can apply to both life policies where optionality is permitted and non-life annuities.

To be eligible for the matching adjustment, assets generally have to be free from issuer options and of fixed duration. Approved assets include standard or inflation-linked corporate and government bonds, commercial mortgages with ‘make-whole' clauses, and swaps that issue stable cashflows.

Assets that are ineligible for any of the versions of matching adjustment being tested include bank hybrid debt, preference shares, equity release mortgages and derivatives. Convertible bonds and floating rate notes are only permitted under the ‘extended alternative' version of the adjustment.

These restrictions prevent a number of asset classes that insurers currently hold long-term to back annuities from being used for matching adjustment purposes, according to Tamsin Abbey, life insurance partner at Deloitte in London.

The concern is that if these restrictions are reflected in the final Directive, it may force insurers to change their asset allocation strategies if they want to use the matching adjustment, which some may struggle to do. There may be some room for insurers to use certain restricted assets in the assessment of the matching adjustment, as long as they can "demonstrate that the requirements [on changeability and fixity of cashflows] have been met", according to EIOPA's technical specifications.

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