08 January 2014

Risk.net: Commission urged to curb supervisors' leeway on volatility adjustment

European insurers are lobbying for the commission to set conditions on the reference portfolio and calculating an allowance for the risk inherent in the assets, two basic elements of the volatility adjustment formula that was agreed in the Omnibus II compromise text last November.

The volatility adjustment is designed to protect insurers with long-term liabilities from the impact of short-term volatility and was one of the controversial issues that held up agreement on the Omnibus II Directive, which amends the Solvency II Directive.

The adjustment is an allowance to the discount rate based on the spread between a reference portfolio and the basic risk-free rate. That spread is adjusted to exclude a compensation for expected defaults, unexpected credit risk and other risks. The resulting figure, the so-called fundamental spread, is then capped at a pre-determined level.

But in a concession to the industry, policy-makers agreed to increase the cap to 65 per cent, up from the 20 per cent proposed in a technical report published by the European Insurance and Occupational Pensions Authority (EIOPA).

While the higher cap was explicitly stated in the Omnibus II compromise text – and therefore set in Solvency II's level 1 text, the remaining elements of the formula were left to be defined at a later date.

Insurers, while recognising not all the details can be fixed in Solvency II's level 1 texts, are calling for Solvency II's level 2 text, which will be published in the third quarter of 2014, to provide clear guidance on these issues.

"The commission may not hard-code indices or the reference assets at level 2, but they can give quite strict and clear guidance about what they should be", says Jim Rasqué, Brussels-based policy adviser on prudential regulation at Insurance Europe.

One possible solution, Rasqué says, would be for the delegated acts to state that the reference portfolio must closely reflect a company's holdings and that the allowance for default must be consistent with that same portfolio.

Insurers say guidance on the reference portfolios is justified due to the crucial role national supervisors may come to play in deciding its composition.

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