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The consultancy argues that if a narrow approach to the matching adjustment as currently proposed is adopted, then the insurers are likely to reduce the guarantees they offer to consumers and increase the price of guaranteed products.
In addition, the current proposals for the matching adjustment, which is used to protect insurers from credit spread volatility of assets that are held to maturity to match long-term liabilities, could still lead to pro-cyclical effects during times of market stress, Towers Watson argues in a paper due to be published in the next few days.
Instead, Towers Watson argues, policy-makers should widen the scope of the matching adjustment and adopt a test that looks at the reality of the underlying liability cashflows and the assets used to match them, rather than a mechanism that is overly product- and asset-focused.
The consultancy's paper, based on discussions with the CRO Forum, the CFO Forum and Insurance Europe, comes as European law-makers are locked in negotiations over the package of measures to support insurance products with long-term guarantees, of which the matching adjustment forms part.
Under the current proposals for the matching adjustment being discussed by policymakers, its application is limited to certain categories of products, such as annuities. The proposals also place restrictions on the type and quality of assets that insurers can hold to match the liabilities. But Towers Watson says that the matching adjustment should apply where there are cashflows that can be identified as being predictable and stable in the long-term.
For products such as UK annuities, where there is no surrender option, identifying a core of stable cash flows is straightforward. But even where there is a surrender option, the stable cash flows can be identified, the consultancy argues.
The restrictions on assets that would qualify for the matching adjustment should also be eased, Towers Watson argues in its paper, as long as the assets held are consistent with a prudent investment strategy. But the benefits should be limited, it argues, so as not to provide an incentive to invest in lower grade assets.
Towers Watson argues that extending the scope of the matching adjustment would enable Solvency II to reflect better insurers' role as long-term investors and providers of long-term savings products.
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