Solvency II may bring unwelcome surprises
There is potential for unwelcome surprises in the short time before Solvency II goes live, given the challenges facing insurers in relation to the capital model and, in the UK, matching adjustment approvals.
That is according to a research note by Morgan Stanley, based partly on a conference held in the UK last week by the Prudential Regulation Authority (PRA) which focused on the implementation Solvency II. The event brought regulators and insurance firms together to examine the challenges both sides face to ensure they are prepared for the introduction of the new regime.
Morgan Stanley warned there could be some tricky challenges ahead for both sides.
“We think it would be wrong to ignore the potential for unwelcome surprises in this final 14 months of Solvency II preparation. There are clearly major challenges ahead in relation to key issues such as internal and standard formula capital modelling plus, for UK annuity underwriters, the matching adjustment,” the report said.
It identified three key challenges. One is internal model approval.
“The PRA is of the clear view that some firms are behind schedule in terms of their internal model development process. It will not hesitate to withhold approval if necessary. Firms are being encouraged to develop robust contingency plans in case their internal model is rejected for use.
“We believe that this is an issue not just for small to medium sized firms—some larger insurers could also struggle to meet the full internal model approval standard,” the bank warned.
The second is standard formula model approval. “The PRA expects 90+ percent of insurers to go down this path. However, insurers have to consider where the standard approach is inappropriate for them. This may attract PRA capital add-ons. For the first two years post Solvency II’s inception, these need not be disclosed. However they become a reporting requirement thereafter,” it said.
The third is matching adjustment approval, described by Morgan Stanley as a key sensitivity for UK annuity underwriters. “A high standard is being set for approval given the significant benefit it brings. Investment strategies may need to be adapted if concerns over asset classes such as callable bonds and equity release mortgages can’t be overcome,” the report said.
