02 April 2014

Risk.net: Commission takes stricter line on matching adjustment

Recently released draft Solvency II delegated acts from the European Commission propose a treatment of asset portfolios under the matching adjustment that is tougher than expected and would impose increased capital requirements on insurers.

The commission is proposing to impose on matching adjustment portfolios the same tough set of conditions that apply to ring-fenced funds.

Sources familiar with the latest version of the Solvency II delegated acts, dated March 14, say that under the standard formula insurers will be required to stress the assets and liabilities and calculate the regulatory capital of matching adjustment books in isolation from the rest of the business.

Experts say the rules threaten to wipe out the capital relief arising from the diversification of an insurer's asset portfolio, a concept that lies at the heart of Solvency II.

The matching adjustment gives a capital uplift to firms that match the cashflows of a pool of assets and a book of liabilities. It was designed to offset the impact of spread volatility on insurers' Solvency II balance sheets, where assets are marked-to-market but liabilities are discounted based on a risk-free rate.

Because the assets must be held until maturity, a level of ring-fencing was expected to apply to matching adjustment portfolios. But the fine details of the rules have been the subject of controversy and fierce lobbying, in particular by UK and Spanish insurers, which are expected to apply the matching adjustment extensively.

The Omnibus II directive avoided the legal concept of ring-fencing, but states that matching adjustment portfolios must be managed separately from other parts of the business. The latest version of the delegated acts (the second level in the Solvency II legislative process) provides more detail, but not all of it is welcome for insurers.

In the March 14 draft, the commission retains a formal distinction between ring-fenced funds and matching adjustment portfolios, but applies the same rules to both. (Ring-fenced funds are those where policyholders have a greater rights in the fund itself, such as those for with-profits policies.) In both cases there is an explicit requirement for insurers to calculate a notional solvency capital requirement (SCR).

The wording of the draft also implies that these rules apply portfolio-by-portfolio, potentially requiring insurers to create separate matching portfolios for each block of eligible business and preventing them from holding all assets used for the matching adjustment in the same fund. This reduces the diversification benefit to firms that is a central principle of Solvency II whereby their capital requirement is reduced if they can show diversification in their assets.

Full article (subscription)

© Risk.net