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The transitional measures, outlined in the technical specifications for the long-term guarantees impact assessment (LTGA), propose gradually introducing the full effects of Solvency II over a seven-year time period for liabilities that do not qualify for the matching adjustment.
There are concerns that the application of these measures are too complex and will cause firms significant problems if they are included in the final version of Solvency II.
The transitional arrangements would only apply to existing liabilities upon implementation of Solvency II, not to new business. These would be valued on a discount curve calculated from a weighted average of Solvency I and Solvency II rates, with the weighting shifting gradually towards the full Solvency II rate over the seven-year period.
The requirement will test insurers' modelling capabilities, actuaries warn. Theresa Chew, London-based senior consultant at Towers Watson, says: "Models were built in specific ways, and they weren't built to move from one year to the next, which is what [the transitional measures] are effectively asking you to do".
The criteria for identifying liabilities eligible for the transitional measures are excessively onerous, says Chew. "At the moment, the level 1 text says you [add the measure] to all existing business but not to new business. So you could have the same business that was just written one day on either side of [the cut-off] valued according to different rates."
Even for existing policies the transitional measures would only apply to premiums that have already been paid, adds Chew. "Even within the same policy, you need to do two different things, and that is a very complicated thing to do", she adds.
The amount of additional work required of insurers to benefit from the transitional rates may drive a number of firms to opt out of the measures.
Tim Ford, London-based executive director in the insurance team at Ernst & Young, says: "Those firms that achieve sufficient capital adequacy without applying transitional measures may choose to ignore them as it is a change to the system that's of limited duration. If there's no compelling reason to apply it, then why would you do it?"
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