Chris Cundy asks (InsuranceERM today) whether the Solvency II matching adjustment (MA) provides an appropriate “benefit” to insurers in pandemic-hit markets.
Yes, says Steven Findlay, assistant director and head of prudential regulation at the Association of British Insurers.
The MA continues to function as it was designed to do: a cushion for long-term investment backing long-term liabilities, which reduces artificial balance sheet volatility in the short-term and reduces procyclicality.
That’s all right then. No masks, only cushions. But Nick Ford (head of transactions in the life & financial services division at Hymans Robertson) is not entirely sure.
“If you have a market shock, the fundamental spread doesn’t react very much. The fundamental spread now [end of April] is similar to what it was at the end of December. To illustrate the example, not using real numbers, say credit spreads have gone from 100bps to 200bps. The fundamental spread for that credit quality has stayed at roughly 30bps. That means the MA has gone from 70bps to 170bps.
“It is very unlikely that all of that increase is due to some form of illiquidity premium, rather than any increase in downgrade or default allowance. At the moment, the market is expecting higher downgrades. So, in practice, we should expect to see an increase in the cost of downgrade, because the probability is higher.”
Good job he was not using real numbers!
Dean Buckner (yes him) adds
The question whether spread widening is ever due to illiquidity has always been dubious, and is more likely an industry-driven compromise. In the current situation with Covid-19, it is almost certain that it is driven by fear of default or downgrade. The current provisioning announced by the banks is clear evidence of that.
More like a rock with a nasty sharp bit where it hurts.
Keep taking the pills!