27 April 2023

How the matching adjustment has 'misfired' at many Spanish lifers

The MA has saved UK lifers truly vast sums of Solvency II capital. In Spain it's delivered some very mixed outcomes, David Walker reports.

The theory of Solvency II's matching adjustment (MA) is fairly simple, even if the mechanism itself is not.

Apply the MA to a lifer's qualifying investments, matched to deliver the enduring cashflows of some designated 'MA life liabilities', and that lifer's overall solvency capital requirement (SCR) should fall, while the eligible own funds it has to cover its SCR, should rise.

The MA should have a divergent effect on the two constituents of one's Solvency II capital bill, in other words, But overall, so the theory goes, 'MA = capital benefit'.

'Well, so much for that theory,' many Spanish lifers that use the MA might well scoff - 'now, take a look at the MA in practice'.

Spain is the only other country subject to Solvency II whose lifers have made sizeable use of Solvency II's MA since 2016.

Like in the UK, it is often applied in respect to Spaniards' annuities liabilities, and backed by fixed income-generating assets. There, though, significant similarities stop, it might be argued.

For Spaniards the MA has often been more a 'capital headache' then 'capital-pain relief'.

Not uncommonly, it has delivered no capital benefit to Spaniards at all – quite the opposite, in fact.

Across 72 instances of Spaniards applying the MA annually since 2016, on about 20 occasions the solvency ratio actually fell when the MA was applied.

Frequently, applying the MA sent one (if not both) of the key variables determining lifers' solvency ratios in the 'wrong' direction.

In nearly 50 of 72 instances that Spanish insurers applied the MA since 2016, their SCRs were worse – higher – with it, than without it. The MA's effect on their EOFs at least seemed to 'work better', as their EOFs only got worse – fell - three times in 72 readings, upon applying the MA.

When the MA did enhance capital ratios, oftentimes that enhancement was vanishingly small.

When one orders the percentage point (pp) moves in ratios from using the MA since 2016, some 15 of 72 positive changes were of under 5pp, and eight were under 2pp. And, as noted above, about 20 times the ratio fell upon applying the MA.

Why the sad face?

There are more influences on the solvency ratios of MA users than the MA's effects per se – as Ibercaja Vida explained in its most recent solvency report.

All insurers in Solvency II receive some capital benefit if their investments are diversified.

But when standard formula users use the MA, the capital benefit that comes from diversification between any investments held inside the MA cannot be shared with the 'diversification capital benefits' from investments held outside the MA.

An MA portfolio of investments is insulated from a non-MA portfolio in this regard. And that means, undertakings using the MA and using the standard formula – which is all but two of Spain's MA users - can 'lose' a portion of the capital benefit they would otherwise derive from investment diversification, because of the very fact they use the MA.

And, it seems, that happened at Ibercaja Vida. The capital benefits that the lifer could 'win' from other facets of its MA, was more than knocked out, by the loss of fuller diversification benefits.

And so in 2020 and 2021 its solvency ratio with the MA was worse than without it – 220.5% versus 237.1% in 2020, then 265.1% versus 287.5% in 2021. Figures were not yet available for Ibercaja Vida for 2022, to see if that had righted itself.

EIOPA has recommended doing away with the prohibition on the cross-over diversification between portfolios for MA users, and in 2021 the European Commission signalled a willingness to consider this, too.

Mercurial outcomes

It must be said Spaniards generally did not need the MA to make an insufficient ratio sufficient – indeed since 2016 only VidaCaixa S.A.U. de Seguros y Reaseguros had sub-100% ratios without the MA's benefits, and each time the MA put it right.

For some lifers the improvement was seismic – at Santander Seguros y Reaseguros Compania Aseguradora S.A. in 2016, the MA boosted coverage by 175pp, from 300.6% to 475.7%, then by 138.8pp in 2017, though it since calmed significantly, to add around 30pp annually from 2019 to 2021.

The annual moves at VidaCaixa are worth spelling out. In 2016 a 141.9pp ratio uplift was evident. This reflected an extraordinary state of affairs where the MA's use was responsible for 'providing' €2,096m of the lifer's €2,098m EOFs - meaning a solvency ratio of just 0.14% without the MA became a far healthier 142% with the MA. In 2017 VidaCaixa received a 149.9pp boost to its ratio (15.4% to 165.2%), then an 129.1pp increase in 2018 (42.1% to 171.2%). Having the MA has seemed a volatile cocktail for that lifer.

Notwithstanding such extreme changes in some cases, it should also be noted that each year from 2016 to 2019 at least, overall the MA did its job in Spain. Average solvency cover ratios of its users were the better off for it.

Mixed fortunes

What can be said is, the MA across the years since 2016 seems to have been a decidedly mixed blessing to Spanish users, and called upon the patience of lifers to see its benefits.

And what can be mooted is, as Spanish lifers watch to their north as the UK government plans reforming the MA, to create an 'octane-variant' with more and easier investments, and potentially more eligible liabilities as well, some Spanish users might reconsider the value they gain - if any - from keeping applying 'their variant' of the MA.

After all, five of the 13 Spanish lifers that have used the MA since 2016 have then stopped using it, either temporarily or, it seems in some cases, forever.

Further explanation of the MA's use in Spain will be in this Friday's Chart of the Week on Insurance Asset Risk. This feature forms part of Insurance Asset Risk's 'SFCR season'. To read other features in the series, click here to read how the MA has given UK lifers £482bn in capital relief since 2016; click  here  to read  How German lifers' CIOs feel relieved as their ZZRs gave back some money, in 2022; here to read How UK SFCR drafters described last September's 'gilts storm'; and here to read how Lloyd's syndicates' investments turned out in 2022. And here to read how French lifers are assessing, and planning for, policy 'lapse risk', and here to read how Spanish CIOs are welcoming rising rates. And click here to read how equities exposure is still a theme among Scandinavian and Nordic insurers, and here to read how Benelux insurers' interest rate capital bills fluctuated, sometimes wildly, in 2022.

Ibercaja Vida