EU eases insurers’ worst capital fears – for now

March 22, 2012

By George Hay

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

For the first time in a month, UK insurers’ pulses are slowing down. On March 21 the European Parliament signed amendments to the EU’s new Solvency II legislation, which in February looked set to deal them a nasty blow. But insurers – and pension providers – can’t yet afford to breathe easily.

The good news surrounds the way financial companies will be allowed to value some of their future commitments. It was feared that Solvency II would require them to discount their liabilities using a rock-bottom risk-free rate. As a result it looked like UK insurers with big annuity books might have to raise billions of pounds in new capital. Now the parliament has accepted that insurers can discount liabilities at a rate more equivalent to the yield on their assets. This neutralises the capital hit.

But insurers will not be permitted to apply the more forgiving discount rates on all assets on their balance sheets – in fact, in some areas the latest draft is stricter. And considerable uncertainty remains over how life assurance and pension liabilities would be treated during a financial crisis like the one in 2008.

Nor have the Euro-parliamentarians given ground over the valuation of global liabilities. Solvency II rules requires firms with non-EU arms to treat them as if they were in Europe. UK based Prudential, for instance, owns Jackson National Life in the United States. Unaltered, Solvency II could oblige insurers like Pru to increase capital requirements against their U.S. fixed annuities books by over 2.5 times. No wonder the UK’s largest insurer is pondering a move offshore.

Meanwhile, the parliament will now spend three months debating the issue with other EU institutions. The pendulum could yet swing further against insurers. A firm decision won’t come until the end of next year.

UK-based insurers are especially exposed to changes in the valuation of liabilities, largely thanks to accidents of history that have left them with vulnerable business streams. Little by little, the EU authorities are beginning to appreciate that Solvency II could have unfortunate, unintended, consequences. But there is a long way to go.

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