In response to the outbreak of coronavirus (COVID-19), the Italian Government has reduced the requirements for applying a country-specific volatility adjustment to strengthen Italian insurers’ regulatory Solvency II ratios.
The measure is part of a decree aimed at mitigating coronavirus pandemic-related effects, including economic contraction, materially slowing business activity, falling equity markets and interest rates and widening credit spreads.
Ratings agency Moody’s considers the action to be credit positive for Italian insurers because their Solvency II ratios will better reflect the long-term nature of their investments.
It noted that the adjustment reduces the risk that insurers’ Solvency II ratios would fall below 100%, as well as the risk for insurers’ subordinated bondholders.
A Solvency II amendment passed in December 2019 included a reduction in the threshold requirement for applying the country-specific volatility adjustment, increasing the likelihood that it could be applied during times of financial market volatility.
The Italian government has now adopted this directive into law with immediate effect, meaning Solvency II ratios will be subject to lower threshold requirements from the first quarter of 2020.
This is expected to help stabilize Solvency II ratios but not offset the combined negative market movements, according to Moody’s.
The volatility adjustment mechanism was introduced as part of the Solvency II regime to make European insurers’ regulatory solvency ratios less sensitive to capital market volatility.
It does so by allowing the value of insurance liabilities to closely track fluctuations in the value of the matching assets, softening the effect of ‘non-economic’ volatility on regulatory capitalisation.
Moody’s noted that the mechanism previously did not work effectively for Italian insurers because it was calibrated to the average investment portfolio for European insurers, which did not account for the specific characteristics of Italian insurers’ asset mix.
Compared with most of their European peers, Italian insurers’ investment portfolios are heavily concentrated in Italian sovereign bonds, which have lost considerable market value since the escalation of the coronavirus pandemic.
The application of a lower threshold will reduce Italian insurers’ sensitivity to movements in credit spreads, and therefore to spreads on Italian government bonds.