Increased volatility in the capital requirements being placed on insurers under Solvency II could make investors skittish, Moodys has warned.
In a report published yesterday, the ratings agency said the new rules governing Europe's insurance industry would not necessarily result in higher solvency ratios - the size of their capital relative to premiums written - but it could lead to more complexity, making it harder for insurers to access capital.
'In most jurisdictions the volatility in current Solvency I ratios is easy to understand and essentially tracks changes in the market value of assets,' it said. 'On the contrary, under Solvency II, solvency ratios' volatility will be more difficult to interpret and changes in solvency ratios will not be easily understood without a clear understanding of the details of the ratios' computation.'
For example, the report explained, life insurers with reinvestment risk would see their Solvency II capital ratios weaken as interest rates fall, whereas under the current regulatory system, Solvency I, this would have seen their solvency strengthen. On the other hand, firms with a good match between the value of their assets and liabilities, and therefore low interest rate risk, would be less likely to see their solvency ratio change as a result of interest rate volatility under the new system.
'Overall, we expect that available capital (the numerator of solvency ratios) and solvency ratios will not necessarily be more volatile under Solvency II (and may actually be less volatile under certain circumstances). However, required capital (the denominator of the ratio) will definitely be more volatile under Solvency II,' the report added.
This complexity and volatility could make investors 'skittish', Moody's said. In particular, insurers could be more likely to come under regulatory scrutiny. 'Higher solvency ratios' volatility, coupled in some instances with potential lower absolute levels of solvency coverage, would also increase the risk of approaching or breaching the 100% regulatory coverage threshold and increase the possibility of supervisory intervention,' the report explained.
'Furthermore, the complexity of this volatility will likely reinforce the already-existing perception of complexity within the insurance sector, especially for non specialists. Complexity may also result in opacity, especially if solvency ratios were computed via internal models,' it said.
'Although regulators will have to approve the use of internal models, which may reduce the level of inconsistencies between models, internal models will by definition be unique. Despite the high level of disclosure requested under Solvency II, it will be practically impossible for investors to fully seize the differences between all the models.'
This could reduce investors' to provide capital to insurers, and the cost of capital for them could increase, Moody's concluded.