European life insurers and their regulators are “in denial” over the impact of current market turmoil on firms’ Solvency II-consistent balance sheets, according to Tom Wilson, chief risk officer of Allianz. They would be facing 2008-style hits if not for the use of a liquidity premium in discount rates, which is reducing liability values.
Speaking on the sidelines of Life & Pension Risk’s Solvency II conference in London, Wilson said market volatility witnessed over the past couple of months has been comparable to the peak of the crisis in September 2008, and claimed regulators were already seeking to paint a more favourable picture of the industry before markets began to slide in August.
The industry’s July stress test, run by the European Insurance and Occupational Pensions Authority (Eiopa), focused on meeting the Solvency II minimum capital requirement (MCR), rather than the higher solvency capital requirement (SCR), because there was a desire to show more firms had passed, Wilson claimed.
“It was especially telling that Eiopa communicated in MCRs, rather than SCRs. The current framework is just too volatile – one easy solution is to begin communicating and focusing on MCR ratios instead of SCR, which gives everybody more breathing room, both regulators and the industry. They are both in denial,” he said.
In a presentation at the conference, Wilson painted an alarming picture of European insurers’ solvency levels as markets have become increasingly driven by fears about European sovereigns and banks. He cited the controversial liquidity premium – which is added to the discount rates used to value liabilities as a way of reflecting the illiquidity of assets backing them – as the crucial mitigant preventing losses under certain valuation metrics.
As an example, Wilson pointed to market-consistent embedded value – which closely tracks share valuation, according to industry participants – and said insurance industry losses under the measure would have been comparable to those suffered in 2008 without the liquidity premium.
“We have created an incredibly volatile solvency regime. If we had naively walked into 2008 thinking we are all market-consistent and everything’s fine, we would have had regulatory fire drills every day. Now it’s the same environment in several areas – credit spreads, rates, equities. If it weren’t partially mitigated by the liquidity premium, we would be looking at comparable implications for Solvency II,” he said.
The inclusion of the liquidity premium in the Omnibus II directive amending Solvency II remains controversial, prompting different countries’ industries to lobby for their preferred design.
Having begun as an idea from the UK industry aimed at preventing the collapse of its annuity business, it now appears the latest proposal – due to be announced by the European Commission – will apply uniformly across all assets and currencies, according to a source close to European regulators.