COMMENT: €90bn, €120bn... what's the reality of the Solvency II capital savings?

Published in: Capital, Solvency II, UK, Rest of Europe

Companies: European Commission, Bank of England

Reporting of yesterday’s announcement from the European Commission about Solvency II reforms naturally focused on the billions of euros capital relief the proposed package was offering. 

InsuranceERM reported €90bn ($106bn) in short-term gain, so I was a bit surprised when I saw other headlines mentioned €120bn. 

I delved deeper, but I couldn’t work out where the €120bn figure comes from.

The Commission estimates €90bn in the short term, but as the changes are phased in (to 2032) the amount of freed up capital will drop to €30bn in the long term. Nowhere in the hundreds of pages of impact assessment is a figure of €120bn mentioned. I can only think other journalist(s) have seen the €90bn, added the €30bn and came up with… a mistake.

The reason why the figure is high to start with, but reduces over time, is that all the positive benefits (e.g. risk margin, equity risk) will come into effect immediately, while the main negative one – the new extrapolation of the risk-free rate curve – will be phased in. 

Note my use of “positive” and “negative” here refer to the size of freed-up capital. A revised (i.e. lowered) extrapolation is a good thing, if you believe in market consistency.

How you judge the level of capital release depends on the market conditions at the time. The figure is especially sensitive to interest rates. The Commission was helpful enough to provide a table (below) showing the impact of changing the reference date on the long-term capital release. 

Source: European Commission

Pick the most recent period of market “normality” (end of 2019) and it’s €30bn. It’s almost half that if interest rates are lower, as we saw during mid-2020.

Incidentally, the Commission sees these numbers as a floor. As older life insurance contracts with high guaranteed returns – and high capital requirements – expire, life insurers will feel less of the impact from the reduction in the risk-free rate curve. This assumption is not factored into their sums here. 

The other outstanding question is what will insurers actually do with this freed-up capital? Will they actually invest it in the real (and green) economy, as EU politicians want? Or will they return it to shareholders?

Regulators in the UK, where a parallel review of its version of Solvency II is underway, are not entirely sure of it being the former.

As the Commission was revealing its plans on Wednesday, Gareth Truran, director for cross-cutting and insurance policy at the Bank of England, was delivering a speech at Bank of America’s Financials CEO conference where he warned of “a number of reasons why it is not obvious that loosening of capital requirements per se would necessarily increase productive investment.”

That is the big downside of such a headline-grabbing figure. Insurers will now be expected to fulfil politicians’ promises, when they might have a limited ability — and desire — to do so.

Christopher Cundy
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