By Barney Wanstall, Director, Insurance PwC and Anna Bender Senior Manager
Well, it turns out a fair amount – in fact there is only room here to talk about Pillar I.
First of all, Pillar I requirements have prompted (re)insurance companies to rethink their overall capital positions. And that’s been a good thing. While most companies across Europe have been using internal capital models and various capital measures for many years mostly for internal capital management purposes, the introduction of a new, risk-based capital regime has led to many firms revisiting and ultimately reconsidering the risks they are exposed to across both assets and liabilities.
However, there is the challenge of comparability. A rating agency’s opinion of a (re)insurers risk-based capital adequacy is a major input into the overall rating, if not one of the most important inputs for a large number of rated entities. In order to form that opinion and establish the appropriate rating, it is essential for the rating agency to be able to compare levels of capitalisation across a number of (re)insurers. Where a company sits on the rating scale very much depends on how this rating compares relative to peers.
This is why most rating agencies have publicly stated that they will continue to focus on their own propriety capital models and metrics for assessing an insurer’s capital adequacy instead of relying on results from Solvency II-based calculations. Because, even though Solvency II was created to harmonise legislation, it’s a long way from providing the level of comparability that rating agencies would find useful.
Standard formula or internal model, the challenges presented to the rating agencies are the following:
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Inconsistencies between results, for instance, many insurers are applying different transitional measures which significantly distort their comparability.
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Standard formula appropriateness – results have shown that the standard formula results can be both overly prudent and optimistic for different firms.
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Some European regulators have interpreted rules slightly differently than others or have been more severe, again making it difficult to compare internal model and standard formula results across European (re)insurers – for instance, the equivalent territory calibrations under Method 2.
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For life insurers in particular - The ultimate forward rate (“UFR”) used under Solvency II seems too high at 4.2% compared to current long-term yields. This creates fears that balance sheet and the resulting capital requirements calculated using the Solvency II forward rate could potentially be overstating a (re)insurers economic balance sheet and the resulting capital position under Solvency II. The high UFR combined with different “last liquid points” between the Euro and other currencies (such as Sterling) further distorts the resulting discount curves and so therefore cross-European comparability.
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Regulators are planning a further review of Solvency II in 2018. This means that internal models and the standard formula are still subject to potentially significant changes
This has led to rating agencies putting a bigger emphasis on their own, usually factor-based models, ensuring comparability between the (re)insurers they rate. With the exception of Moody’s, who do map Solvency II capital scores of reinsurance companies directly to a given rating level as one input into their capital analysis, other rating agencies do not pay a lot of attention to the (re)insurers’ Solvency II capital score. They might look at the results to make sure they haven’t missed anything - but that’s about it.
However, credit rating agencies continue to view a lot of value in Solvency II. The main reasons for this are:
The overall level of sophistication of (re)insurers’ risk management frameworks has significantly improved and has somewhat become more formalised and holistic. For instance, the review of a (re)insurer’s ORSA can be a highly valuable input into a rating agency’s evaluation.
More standardised reporting requirements under Pillar III are expected to increase availability and comparability of reported financial information. A harmonised balance sheet will be greatly beneficial to rating agencies, as they will no longer be required to make sometimes substantial adjustments to various European local GAAP numbers in an effort to make them comparable.
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