Investment - Articles - EIOPAs proposal for changes to the Standard Model

Chris Price, Insurance Solutions Strategist at AXA IM comments on EIOPA’S (European Insurance and Occupational Pensions Authority) Insurers’ Investment Behaviour report and proposed changes to the Standard Model For the Solvency Capital Ratio.

 “On the asset side, two important proposed changes to the Standard Model are notable that insurers should take note of:

 A review of how interest rate shocks are modelled. EIOPA has suggested using a symmetrical stress test that models the impact of a 1% increase and a 1% decrease, instead of the current method, which uses an asymmetrical shock scenario of +33 bps but at least 1%-point on the upside and a fall of 25bps to the downside1 and no rate decrease in case of negative rates currently. If applied, the wider boundaries, in particular the downside-adjustment, could give rise to significant duration adjustments.
 If insurers do nothing they risk a mismatch of their assets and liabilities will have to put up more capital. We would encourage clients to review the duration match between assets and liabilities.

 EIOPA has proposed making instruments with partial government guarantees eligible for favourable capital treatment, rather than requiring a full guarantee as they do at present. We would view such a move as a positive for insurance companies . Various assets or strategies such as Dutch residential mortgages or infrastructure bonds that are guaranteed by the European Investment Bank might benefit from the underlying guarantee, at least pro rata.

 Essentially this makes some asset classes more attractive to insurers or could potentially reduce the capital they have to post.

 “Adjustments to the calculations of the SCR ratio will be scrutinised very closely and the Consultation ends on the 28th February 2018.

 “In terms of the recently released Insurers’ Investor Behaviour report, EIOPA has noted a considerable change in how insurers’ fixed income allocations have changed in response to low yield environment and changing regulation. Allocations to lower rated credit (BBB+ to BBB-) have increased from 11% to 27% since 2011, which requires a heightened monitoring as we will pass the economic and liquidity peak in 2018. In particular idiosyncratic risks should not be neglected. Equally remarkable, the body reports that there has been a €1.2tn to €2.3tn increase in unit-linked business assets in the region, with the lion’s share taken-up by the UK while continental Europe will most likely catch-up given the low starting point.

 “We believe insurers will continue to review their asset allocations, seeking the benefits of diversification, working with their asset managers to look at new asset classes and manage risk.”

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