Conflict between banks and insurers over long-dated bonds
As banks must issue more long-dated bonds under Basel III, insurers shun these bonds under Solvency II. Bloomberg reports that higher charges may drive insurers to hold short-dated bonds and “hedge out the duration” using interest-rate swaps instead. The insurance industry currently purchases 60% of the long-dated bonds in the market.
Under Solvency II, “Firms must hold 8.2 percent of the face value of a five-year bond in reserve in case the issuer defaults and 16.5 percent for a 10-year bond,” according to a report by Morgan Stanley and Oliver Wyman Group.
Simon Hills, an executive director at the British Bankers’ Association, said, “One bit is saying you should have more funding with a longer duration and the other is saying watch out when buying this stuff if you are an insurance company.”
See this post for a discussion on implementing Solvency II.
S&P ‘M-factor’ could reduce economic capital requirements
Using a Solvency II internal model could potentially reduce S&P capital requirements for insurers. A report by the reinsurance broker Willis Re, assessing S&P’s Economic Capital Model Review, says the rating agency will use a measure called the ‘M-factor’ to evaluate an insurer’s Economic Capital Model (ECM). A higher M-factor could result in lower S&P capital requirements.
S&P sounded a cautious note on the equivalence of the Solvency II internal model and its own assessment. “Meeting Solvency II’s (internal model) requirements may result in us assessing the quality of an insurer’s internal model as ‘strong’, ” a senior official said at a conference last year.
The move by S&P is likely to reward firms that have invested heavily in preparation for the Solvency II launch in 2013.
From the Sphere
Side effects of Solvency II
Solvency II could drive a switch out of equities by insurers and could have a destabilising effect on the marker. “We expect to see a major switch of equities to bonds,” said Thierry Flamand, a board member of the Association of the Luxembourg Fund Industry, on the Association’s blog. In 2009 European insurers invested more than €6,800 billion globally. The figure represents 53% of the Europe’s GDP.
The article also discusses the effect of Solvency II on the pensions industry.
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