Brussels, 14 March 2019
Interinstitutional files:
2017/0230(COD)
WK 3753/2019 INIT
LIMITE
EF
ECOFIN
CODEC
WORKING PAPER
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WORKING DOCUMENT
From:
Commission services
To:
Working Party on Financial Services (ESFS Review)
Subject:
The Volatility Adjustment in Solvency II
- Commission services non-paper
WK 3753/2019 INIT
LIMITE
EN
Commission Services Non-Paper
DISCLAIMER
This draft has not been adopted or endorsed by the European Commission. Any views may not in any
circumstances be regarded as stating an official position of the Commission. The information transmitted is
intended only for the Member State or entity to which it is addressed for discussions and may contain
confidential and/or privileged material.
The Volatility Adjustment in Solvency II
The volatility adjustment is a component of the discount rates for insurance liabilities under Solvency
II. The volatility adjustment aims to “prevent pro-cyclical investment behaviour” (Recital 32 of
Directive 2014/51/EU). It is by default calculated at the level of currencies. For Member States of the
Euro Area, the volatility adjustment can be increased by a country component, where the following
two conditions are met on the reference date for the financial statement (Art. 77d(4) of Directive
2009/138/EC):
(i)
the risk-adjusted spread for the country is at least twice as high as the risk-adjusted
spreads for the Euro Area (relative threshold); and
(ii)
the risk-adjusted spread for the country must be 100 basis points or higher (absolute
threshold).
The financial statements are prepared according to a quarterly cycle. The activation or an absence of
activation of the country component can have a significant impact on the own funds of the insurance
companies in the respective countries.
Unintended consequences of the country component
With the current mechanism, the country component can alternate between activated and not activated
between two reference dates. In fact, this has been observed under the current market environment for
Italy over the past months. The alternation between activation and absence of activation leads to
volatility in own funds for the insurers in the country and therefore contradicts the aim of preventing
pro-cyclical behaviour. As a consequence, the volatility adjustment cannot produce its intended
effects.
The chart below illustrates the alternation between activation and no activation for the country
component of the volatility adjustment for Italy from June 2018 to December 2018. While the country
component was activated for the months August, October and November, it was not activated during
the other months and the Euro volatility adjustment without any increase applied for Italy. When
activated, the difference in volatility adjustment ranged from 32 basis points in November to 45 basis
points in October and August.
While the relative threshold was exceeded throughout the entire period, the risk-adjusted country
spread for Italy has been moving around both sides of the absolute threshold. In spite of continuous
large relative differences between the risk-adjusted spreads in Italy and other countries of the Euro
Area, the country component was not activated during several months. The risk-adjusted country
spread fell short of the absolute threshold on the reference date despite small changes in financial
markets. A striking example was observed in December, when the risk-adjusted spread for Italy was
99 basis points and hence the country component could not be activated, leading to a drop of the
volatility adjustment for Italy from 54 basis points to 24 basis points. The drop in the volatility
adjustment reduces the own funds of insurance companies to a significant degree.
Volatility adjustment in 2018
0.70%
0.60%
0.50%
0.40%
0.30%
0.20%
0.10%
0.00%
June
July
August
September October November December
VA - EUR
VA - IT
Conclusions
The current activation of the country component of the volatility adjustment leads to undesired effects.
In order to address those structural problems effectively, a fundamental review of the volatility
adjustment is necessary under the 2020 review of the Solvency II Directive to allow it to produce its
intended effects. The Commission has already invited the European Insurance and Occupational
Pensions Authority to provide technical advice on this issue.
In the meantime, a reduction of the absolute threshold set out in Art. 77d(4) of Directive 2009/138/EC
is necessary to mitigate temporarily the cliff edge effects implied by the current activation mechanism
until the fundamental review in 2020.
Document Outline