Changes proposed under the 2020 review of Europe's Solvency II capital regime could slash some life insurers' solvency ratios by more than 100 percentage points, according to S&P Global Ratings.
In a new report on the pending review, S&P estimated that the average cut per country would be between 30 and 70 percentage points, before diversification and potential loss-absorbing capabilities.
The effect will vary depending on region, sector and the individual risk exposure of insurers, but the rating agency expects insurers with long-term guaranteed liabilities will be affected the most. As a result, Germany, the Netherlands and the Nordic countries would be particularly impacted.
S&P anticipates that the review will have limited changes to its ratings because its view on insurers' capitalization comes from its own risk-based capital model, unless there is "significant risk" of a company breaching its regulatory capital requirements.
The ratings of hybrid instruments may be affected, however.
"If an issuer's solvency ratio comes under stress due to this update, we could lower the hybrid ratings to reflect the increased risk of coupon nonpayment," S&P said.
Germany bears the brunt
The predictions are based on the cumulative EIOPA estimates for what S&P said are the three most important measures: interest rate stress, the last liquid point, or LLP, and the volatility adjustment, or VA.
The LLP is the cut-off point after which companies stop using market data calculate the interest rate curve used to determine how much they should discount their liabilities. The VA is designed to dampen the effect of short-term volatility in bond spreads on insurers' solvency positions.
Under the wide-ranging Solvency II review, the European Insurance and Occupational Pensions Authority, or EIOPA, has proposed a series of changes to the capital regime. Proposals include reflecting negative interest rates in the regime's interest rate stress module, recalibrating the VA and shifting the LLP for the euro's risk-free curve to 30 or 50 years from the existing 20 years.
The biggest change from the LLP change stands to be felt in Germany. Shifting the LLP to 30 years would knock 110 percentage points from the average solvency ratio in Germany, while a move to 50 years would cut the average ratio by 182 percentage points. The average solvency ratio in the Netherlands would fall by 68 percentage points if the LLP is moved to 30 years, and 119 if it is 50 years, S&P said.
Although the proposals could cut some insurers' solvency ratios, the rating agency welcomed the review and said some of the EIOPA proposals, such as changes to the catastrophe risk and property risk charge, could be beneficial.
The agency did note that it might take until 2023 before the update is applicable, and there may be a transition period.