Italy adjusts Solvency II rules for insurers amid COVID-19 outbreak

Italian government has amended certain aspects of the Solvency II regulations in wake of coronavirus (COVID-19) outbreak. The measures aim to help stabilise and strength insurers' Solvency II ratios.

The country, which is the European epicenter of the COVID-19 outbreak, has reduced the requirements for applying a country-specific volatility adjustment, increasing the likelihood that it can be applied during times of financial market volatility.

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.

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.

According to Moody's, the decree is "credit positive" for Italian insurers because their Solvency II ratios will better reflect the long-term nature of their investments. Compared with most of their European peers, Italian insurers’ investment portfolios are heavily concentrated in Italian sovereign bonds.

"The adjustment reduces the risk that insurers' Solvency II ratios would fall below 100 percent. It also reduces the risk for the insurers' subordinated bondholders because coupon deferrals and equity conversion or write-down features are generally triggered by Solvency II ratios falling below 100 percent," Moody's said.

Italian insurers have criticised current volatility adjustment rules, because it did not adequately reflect their asset allocation. They argued that the threshold for applying the country-specific adjustment resulted in cliff risk, whereby minimal differences in spreads determine whether the mechanism can be applied. Although the lower threshold at 85 basis points (bp) from 100 bp previously does not reduce cliff risk, it makes it more likely that the country-specific volatility adjustment can be applied.

Moody's said "the application of a lower threshold will reduce Italian insurers’ sensitivity to movements in credit spreads, and therefore to spreads on Italian government bonds. Since the beginning of 2020, and increasingly so since the coronavirus pandemic, spreads between Italian and German government bonds have widened approximately 100 bp, considerably reducing the market value of Italian sovereign bonds and consequently Italian insurers’ own funds."