Solvency II ratio comparability hindered by diverging choices, says Moody’s

Solvency II ratio comparability is being hampered by insurers the fact that insurers can use one or more methods to enhance their ratios, according to Moody’s.

The US rating firm said in a new report that the use of internal models creates potential for inconsistent assumptions. Methods to enhance ratios that have been used so far, according to the firm, include transitional measures and third country equivalence.

Ratio comparisons are limited by diverging choices about whether to include volatility or matching adjustments in the liabilities' discount rate, according to Moody’s, It said that there have been very few disclosures that quantify the impact of these enhancements.

“Even if the disclosure was available to make adjustments, there is the added complication that Solvency II ratios do not always reflect insurers' economic capitalisation,” said the firm.

The comfort level of an insurer over a 100 percent Solvency II ratio is a function of the ratio's volatility, according to Moody’s. It said most groups have published sensitivities which vary greatly and can be very high for financial market movements. However, comparability is hindered by the inconsistency of reporting templates, and a lack of information on ratios' convexity, according to the Moody’s.

It said that for most players, the quality of capital is generally high with Tier 1 capital representing the vast majority of their financial resources, suggesting that a rush on Tier 1 issuances should not be expected.

Most groups currently have spare capacity to issue Tier 2 debt, but with most solvency ratios well above 100 percent, Moody’s does not expect much activity for solvency purposes beyond re-financing.

However, it does expect further new debt issuance over the next two years, driven, for example, by the continued growth in mergers and acquisitions activity.