LONDON--(BUSINESS WIRE)--Solvency II (SII) set out to be a consistent, rigorous and market value-based system. In A.M. Best’s view, it has moved the European regulatory regime very significantly toward this objective, but along the way it has become a highly rules-based exercise, according to new research by A.M. Best.
In the Best’s Special Report, “Solvency II - Available Capital Assisted By Unit-Linked and Non-Life”, A.M. Best notes that discounted cash flow reserving means SII Own Funds (SII OF) are created by putting unit-linked life insurance reserves on an insurer’s balance sheet. A.M. Best has examined the 2016 SII data for the 10 European insurers with the largest unit-linked reserves. For these insurers, the benefit to SII OF (net of the risk margin and reinsurance) amounts to around 2.8% of unit-linked funds.
A.M. Best’s research also shows that, for the 10 insurers with the largest non-life best estimate liabilities (BEL), the risk margin is a little over 5% of the BEL. Generally, non-life insurers have been content with the SII regime. This reflects a “trade off” between the costs of the risk margin on the one hand and the benefit to available capital from removing the margins in reserves in financial reporting and, under SII, taking an estimated profit on unearned premium.
Data analysed in the report show that market risk dominates the Solvency Capital Requirement (SCR) under SII. For the 10 EU insurers with the largest SCRs, A.M. Best’s research reveals that market risk amounts to around 49% of their aggregated SCRs. However, the figure varies considerably and is over 60% for pure life insurers in the sample.
SII reporting is described in the report as a patchwork of “textbook” financial mathematics overlaid with adjustments.
Anthony Silverman, associate director, analytics, said: “It can be argued that the target of an economic balance sheet and the use of market values has been compromised by items such as transitional measures and the volatility and matching adjustments. However, an alternative view would contend that these amounts often move the SII balance sheet to better match transaction values, making it more relevant.”
A.M. Best also cautions in the report that the focus in SII, even for illiquid credit-related assets, on estimated market values and their notional variability over a 12-month period, means the process threatens to become remote from an evaluation of actual default costs.
A.M. Best targets its use of SII data to assist with the quantitative component of assessing balance sheet strength through its Best’s Capital Adequacy Ratio (BCAR) model. In addition, A.M. Best recognises the impact regulatory capital levels can have on an insurer’s commercial position, which may influence other rating factors within its credit rating methodology.
To access a complimentary copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=274715 .
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