 By Tamsin Abbey, insurance partner at Deloitte
The date for implementing Solvency II is moving further away. Over the last few years, the date has slipped from November 2010, to November 2012, January 2013 and now is not likely to be earlier than January 2016. Although several years in the making, Solvency II brings many benefits, particularly in the way insurance companies manage their risks and hold capital against them.
The majority of the Solvency II text and its implications are known and for most products, any changes in the capital requirements should not change prices significantly.
Solvency II capital requirements tend to have more impact on products where the insurer takes on significant risk from policyholders over a long period of time. This is exacerbated if long term investment guarantees are given and the insurer needs to hold assets to back these guarantees.
Prices are potentially increased by the need to lock in more money within an insurance firm because of need to hold higher reserves and greater capital requirements. In this situation, while the outcome of the actual payments to policyholders will be the same as they emerge over time, the additional money held back costs the firm. This is likely to be, at least partly, allocated back to the policies that generated the need for the capital, soresulting in an increase in prices.
In the UK life insurance market, annuities meet all of these criteria of high impact by taking on the liability for making payments, normally for the remainder of life. These payments are backed by holding assets, and the insurer takes the risk that they might not be sufficient.
Insurers and regulators want to ensure that there will be sufficient money to pay people their pensions over potentially a long period. Pension provision is also a political issue as any reduction in private pension savings will impact the welfare state budget further down the line. This gives you some idea of why one of the key stumbling blocks in the negotiations has been the treatment of annuity liabilities impacting both legacy books of business and customers at retirement.
Regulators across Europe have started to assess the impact of the potential rules on annuities in further detail as part of aligning the treatment of insurance. The European Commission’s Long Term Guarantee Assessment – part of this development process for setting the Solvency II rules – will test the impact of different approaches to how insurers set reserves and capital for products like annuities.
This initiative by the Commission and EIOPA to test potential approaches is welcome, but it does place a burden on annuity providers at a busy time. The findings will prove important in helping to finalise this aspect of the Solvency II regime and reduce uncertainty.
The Matching Adjustment is an extremely important issue for life insurance companies and pensions savers as it plays a key role in determining the levels of reserves which insurers need to hold. Depending on what the final regulations say, annuity providers might need to hold larger reserves, which could lead to them either reducing dividend payments or raising more capital. Insurers must ensure senior management understand and manage their company’s risks properly. However, the size of reserves is only one part of the equation.
Consumers could also be affected because annuity rates for new policies could fall by between 5-20%, and that will effectively make retirement a lot more expensive.
The current assessment tests several approaches but does not deal with some of the key issues that are concerning the UK life insurance industry. For example, subordinated and hybrid debt are not allowable in determining the matching adjustment nor are bond assets with any kind of prepayment option.
Fortunately, in addition to the quantitative tests there is a qualitative survey. Thissets out a series of questions giving respondents an opportunity to provide detailed feedback on the products that will be most affected by the current approaches proposed. This is very welcome and should shape further proposals.
It is interesting to note that the impact of the current proposals is worse in the UK than in other European markets. The UK has been at the forefront of providing innovative annuities as private pension provision is an important part of the UK’s retirement provision. The market is very competitive and when insurers moved to back annuities with not just government bonds, but also assets such as corporate bonds, equity release mortgages and commercial mortgages, part of the additional income assumed to be earned over the term of the contract was passed to the policyholder, thus lowering prices. These assets create a need for relatively higher reserves and capital requirements under Solvency II, thus worsening the position for policyholders.
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