14 January 2013

The impact of LCR easing on Solvency II

The direct links between the amendments to the rules and economic recovery may have some clear implications for insurance regulation. According to Paul Fulcher, Managing Director, ALM Structuring, Nomura: “The obvious read-over for insurance is that regulation should be designed so it doesn’t hinder the ability of insurers to provide affordable long-term guarantees to their customers and stable long-term finance to the wider economy. So the international agreement on the LCR should give new impetus to regulators and insurers to agree on the long-term guarantees package and get Solvency II back on track”.

Mr Fulcher also noted that the flexibility to suspend the LCR suggests that the regulators accept that liquidity shocks can be endogenous events, and that the key focus for individual banks in the coming years should be to strengthen their capital base.

This focus on individual firms is echoed, to a certain degree, in EIOPA’s decision to press on with implementing the risk management aspects of Solvency II ahead of full implementation. “Similarly, EIOPA are focusing individual insurers, and national regulators, on the Pillar II aspects of Solvency II, such as governance, proper risk-management systems and a forward looking-assessment of risk”, Mr Fulcher said.

However, potentially the most significant implication for Solvency II may be the decision to allow riskier assets, such as BBB–rated corporate bonds and some MBS, to be counted towards the HQLA. Kuni Kawasaki, London Liaison for Industry and Government affairs at Mitsui Sumitomo Insurance, said that even though the discussion around liquidity risk in banking is totally different from that in insurance it might still be significant. “If one interprets the allowance of a wider range of assets under Basel III as a sign of supervisors’ willingness to revisit and adapt some of their initial thinking, then such a move should at least encourage insurers who are arguing for a more flexible approach for LTG products under Solvency II.”

Potential impact on Solvency II

While the direct impact of the changes to the LCR on Solvency II capital requirements may not be immediately clear, the need for rulemakers to consider economic growth – or at least not impede it – is more relevant than ever. The Commission has already made this explicit.

Officially at least, the financial crisis has provided impetus to increase coordination and awareness between international regulators of insurance and banking... But it does not appear that coordination takes place in practice. One official familiar with the European regulatory framework said that in general very little attention is given to the interplay between banking and insurance regulation. Another person familiar with discussions of insurance regulation at international level stressed the independence of international standard setting bodies and noted that each was still very focused on its own area of expertise.

So it is possible that the direct impact of the LCR rules on Solvency II will be minimal. The Solvency II rules are very well developed and although an impact assessment of the LTG is to be launched shortly, it is unlikely there will be any political will to make significant changes to the capital requirements as currently defined.

On the other hand, the results of the impact assessment are far from a foregone conclusion and the level of uncertainty surrounding the implementation date is so high that almost anything is possible. At the time of writing, 2016 is the favourite in the ‘Solvency II implementation date lottery’ – and it does feel like a lottery.

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