12 February 2014

Risk.net: Insurers claim draft level 2 proposals could water down volatility adjustment

Insurers are also arguing for greater consistency with the matching adjustment's treatment of fixed income spreads.

Industry sources say the unofficial draft of the level 2 delegated acts, circulated last month, falls short of the insurance industry's expectations, putting it at odds with the EC. The composition of the reference portfolio used for calculating the volatility adjustment is one of the contentious issues. The delegated acts specify that the portfolio is to include not only bonds and loans, but also equity and property.

Insurers say that since the volatility adjustment is based on fixed-income spreads, the addition of equity and property will reduce the benefit firms can derive from the mechanism. The inclusion of non-fixed-income assets in the reference portfolio is unjustified because Omnibus II has already set an application ratio of 65 per cent, they argue.

The formula for calculating the volatility adjustment's risk-corrected spread is also raising concerns, with insurers calling for consistency with the matching adjustment – another tool for countering short-term volatility.

The risk-corrected spread is the spread of the reference portfolio discounting the portion of the spread that can be attributed to expected defaults and unexpected credit risk and other risks. The industry wants the commission to link this formula to that used to calculate the fundamental spread of the matching adjustment – a complementary measure that was introduced in Omnibus II to protect firms with matched portfolios from unduly volatility.

But the draft level 2 text does not make that link and provides little detail on how the risk-corrected spread will be calculated, giving considerable leeway to the European Insurance and Occupational Pensions Authority (EIOPA) to define it in the level 3 texts.

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