26 June 2013

Risk.net: Solvency II volatility balancer 'will fail to immunise insurers'

In its long-awaited report on the long-term guarantees assessment (LTGA), the European Insurance and Occupational Pensions Authority (EIOPA) recommends replacing the countercyclical premium (CCP) with a new adjustment mechanism that enables insurers to take some credit for spreads flying high above the risk-free rate.

The volatility balancer is intended to mitigate the artificial impact of spread volatility by giving an adjustment to insurers' own funds. But there are concerns that its proposed calibration is flawed, and that the tool will hardly protect insurers.

Italy's insurance supervisor, IVASS, was the first to cast doubt on EIOPA's assumptions. On the eve of the publication of the LTGA report, it released its own report, saying its internal analysis showed EIOPA had overestimated the mechanism's effectiveness. "Compared to IVASS's internal analysis of Italian data, EIOPA's report shows much better results in terms of solvency capital requirement (SCR) ratio for the volatility balancer both in the form of the currency level and in the form of the national level", IVASS said in its report.

Insurers in other European countries are also calling for a review of the volatility balancer's calibrations, in particular the proposed cap on the allowance to the firm's own funds.

Under EIOPA's proposals, the benefit accrued would be based on the spread between the risk-free rate and a European average bond portfolio. But insurers would only be able to benefit from 20 per cent of that spread, after removal of default and downgrade risk.

Doug Caldwell, chief risk officer and member of the management board insurance EurAsia at ING, says: "We think the initial calibration of the volatility balancer and, in particular, the 20 per cent cap's application to long-term life insurance products, is disappointing, as these products often have a much more illiquid nature that should be reflected".

EIOPA argues in the report that the cap takes into consideration the risks of implementing the volatility balancer. It says the cap is set at a level that would ensure the mechanism would have the same effect as the countercyclical premium.

But actuaries and consultants warn that the proposals will not fully insulate insurers against short-term volatility, although they accept the precise workings of the volatility balancer have yet to be made clear.

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IVASS-LTGA-report, 17.6.13 (Italian)

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