28 January 2014

Risk.net: Proposals for stable Solvency II credit risk adjustment 'good news' but floor sparks controversy

The Commission has amended the wording used in earlier draft texts in response to concerns that the adjustment would allow artificial volatility to feed through to insurers' balance sheets. But the proposals remain miles away from the demands of the insurance industry, which has lobbied for the adjustment to be fixed or capped at 10 basis points, so that the risk-free rate is closer to the swap rate. The Commission's proposed floor or minimum value of the deduction would lead to a lower risk-free rate.

The latest proposals in the draft delegated acts offer a tentative solution against volatility, according to actuaries. The Commission has taken on board the concept of a formulaic adjustment used in early drafts, but the new wording requires the adjustment to be insensitive to short-term market movements, they say.

Disagreement about the scale and features of the adjustment emerged during the course of last year, after the publication of the long-term guarantees assessment (LTGA) by the EIOPA. A fixed adjustment of 10bp had been used in most exercises until the fifth quantitative impact study (QIS5) in 2010, but in last year's exercise, EIOPA relied on a formula based on the difference between swaps and overnight rates.

Despite addressing insurers' concerns about volatility, however, the Commission's draft makes no concession to the industry's arguments for the need to cap the adjustment. Insurers are set to close ranks to fight the proposed 10bp floor, but for the Commission to yield on this matter it might have to reconsider the factors used in the formula.

The draft proposal, which has been sent to Member States, is to be discussed this week at the commission's expert group on banking, payments and insurance. This is part of the pre-consultation process with Member States. Informal discussions with the industry will follow.

The final version of the text will be finalised before the European elections in May and is expected to be published in August. The European Parliament and the European Council have an individual right to object.

Insurance Risk (subscription) quizzed Rapporteur Balz on the issue: "I understand you sought to bring this issue up to level 1 and a proposal to increase it from 10bp to 35bp was discussed. Why did that not happen?" To which Balz replied: "The CRA to the risk-free rate was actually part of the negotiations. It was discussed in various ways. Generally speaking, the CRA is a valid component for the risk perception and in the development of the risk structure. It can be applied if market data allows for the existence of such an adjustment. It should be applied in a way that ensures both the sustainability and the effectiveness of the long-term guarantee measures."

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