Chart of the Week - When the MA goes 'the wrong way' for Spanish lifers

Sometimes, much to the regret of parties involved, marriages can go 'the wrong way', and so it has been recently at some Spanish lifers using the 'Ajuste por Casamiento', or matching adjustment, which rather delightfully can translate to English as the 'marriage adjustment'.

The mechanism of Solvency II is supposed to reduce the burden of life insurers - one way the MA should equate to a healthy marriage - by cutting a user's solvency capital requirement (SCR) while enhancing the eligible own funds, in good times and in bad, in regard to liabilities and designated assets that the insurer agrees to have and to hold, to maturity. (You'll be pleased to hear that's all the dubious marriage puns now out of the way).

UK lifers are its main users by number and by capital benefit, but 13 Spanish undertakings have used the MA since 2016, and a smattering of other countries' insurers.

For some of the Spaniards applying it, not uncommonly their capital coverage ratios have actually deteriorated, when the MA is applied.

Why capital cover sometimes went the 'wrong way'

Ibercaja Vida, one user, explained in its 2022 solvency and financial condition report (SFCR) that lower levels of credit risk in recent years meant that the compensation for capital gains/losses of assets to be had, when applying the MA to value its liabilities, had reduced, and it had effectively lost capital benefits from investment diversification when quantifying risks - and remember, diversification in MA portfolios cannot be mixed in with capital calculations for other portfolios, and as the loss of some diversification benefit was "more harmful [to its ratio] than the improvement in valuation of liabilities," overall the firm's coverage ratio sank upon applying the MA, not rose.

For Ibercaja that happened from 2019 to 2021. One must delve back to 2018 to find the lifer enjoy net capital benefits to its solvency ratio - 198% with the MA, 181% without.

Ibercaja Vida, and various other lifers suffering similar outcomes from their MAs more recently, may hope for a reversal of fortunes as the interest rate environment changes.

It is worth noting as an aside, the European Commission has uttered in the past about whether prohibiting recognising diversification benefits to capital, between MA and non-MA portfolios of standard formula users, is logical. When EIOPA studied it, it found "separate management [of MA and non-MA investment programmes] does not per se prevent diversification in practice and the general prohibition of diversification benefits in the standard formula calculation may have resulted in unnecessarily high capital requirements for companies applying the MA", the EC said in 2021. It said back then it would "therefore consider dropping that general prohibition in the context of MA portfolios [so] the resulting additional diversification benefits for [standard formula] companies using the MA...would reduce their capital requirements".

Not always very helpful

In 2019 and 2021 the benefit was not exactly enormous.

The lowish effect on EOFs and SCRs of the MA in most years is shown by how close the users' average solvency ratios with the MA and without it are to each other each year.

In a normal situation a user would want the impact of removing the MA to be a fall in its EOFs (such that adding the MA back in, would enhance EOFs). And happily, in all but two of the 70 readings since 2016 - once for AXA Aurora Vida S.A. de Seguros y Reaseguros, once for Bankinter Seguros de Vida S.A. de Seguros y Reaseguros - that was the case.

And in a normal situation a user would want the impact of removing the MA to be a rise in its SCR (such that adding the MA back in, would shrink the capital requirement). But in many of the readings since 2016 the SCR fell upon removal of the MA - so, it was giving boosts, not benefits, to the SCRs of those undertakings. Some groups have not yet received a reduction in their SCRs in any year of applying the MA to them.

Pragmatic patience

Ibercaja Vida is pragmatic, and patient, about the mechanism's longer-term value: "The company considers that the MA provides stability on the level of available capital in stress situations, which compensates for the fact that, at times like the present, the impact of this measure may worsen the solvency level."

Vida Caixa, which got its MA approval in 2015, said the MA had "proven to be effective in maintaining the solvency and solidity of the insurance sector, as well as having made it possible to offer insured guaranteed long-term savings insurance products."

Working with the MA "results in better risk management and a more robust control of the risks of theseportfolios and, therefore, in greater protection for the insured", Vida Caixa adds. "And is essential for the correct valuation of guaranteed savings products under Solvency II."

In a simplified way, the MA allows for valuing liabilities, while considering the profitability of the assets assigned to be covered until maturity.

For Spain's MA-using lifers, the assets in MAs are the standard types also found in UK MA portfolios, though what is reported in SFCRs is a little less 'exotic' in Spain.

For instance, FIATC Mutua de Seguros y Reaseguros notes having "bonds and debentures and other assets with similar cash flow characteristics, to cover the best estimate of the insurance or reinsurance obligation portfolio, and [it] plans to maintain said assignment throughout the life of obligations, except to maintain the replication of expected cash flows between assets and liabilities when these cash flows have changed substantially."

The €23bn gift from Brussels

Overall, the MA users have still benefitted in capital terms, to the aggregate tune of about €23bn ($25.4bn).

That is not, to be fair, a benefit anywhere near the £482bn that UK undertakings using the MA have reaped - but it is nonetheless, worth analysing.

In Spain use of the MA has sometimes been a stop-start affair.

For Aegon Espana is was 'start-stop' - after reporting a benefit in 2018, it then suffered its solvency ratio going sub-100% during 2019 whereupon Spain's Dirección General de Seguros y Fondos de Pensiones (DGSFP) told it in Q3 to end using it.

For Ibercaja Vida the pattern was start-stop-start. It, also, was ordered by the watchdog to stop using the MA, for 24 months, in 2018 after the DGSFP found Ibecaja Vida had "failed to comply with one of the requirements indicated by Solvency II regulations for applying the MA - although it was verified," Ibercaja's SFCR continued at the time, "that this breach had at no time compromised the solvency of the entity nor posed any additional risk to the protection of policyholders".

Ibercaja adjusted its earlier ratios accordingly, for good measure in its SFCRs, and was green-lighted to recommence using the MA by December 2018.

For AXA's Aurora Vida it was start-stop, reporting after just one set of MA benefits recorded in 2017 - though its halt came without any evidence of insufficient ratios, or problematic use.

For others it was 'start late' - BanSabadell Vida S.A. de Seguros y Reaseguros, for instance, whose capital adjustments from the MA only commenced in 2020.

BanSabadell Vida noted in its latest SFCR that "the application of the MA to part of the entity's liabilities reduces, notably" its sensitivity to interest rates.

MA on-again-off-again

The application of the MA at some Spaniards have been, one might say, stuttering.

BBVA Seguros, for example, had €8.9bn of assets in its MA in 2016, backing €9bn of liabilities. Those figures held steady during 2017, but then in 2018 each softened to €8.7bn and €8.8bn, respectively, then climbed to €9.1bn (assets) and €9.2bn (liabilities) in 2019, before falling back to €9bn of each in 2020, then further to €8bn (assets) and €8.1bn (liabilities) for 2021, then sharply to just €6bn of each, last year.

Still, the MA capital benefits to some lifers have been significant - some 40.3pp for a 310.8% solvency ratio at Mapfre CCM Vida Pensiones in 2021, for instance.

As Spanish lifers delve into lower-rated fixed income assets that might qualify for MA inclusion, they specifically note use of adjusting the 'fundamental spread' - a capital adjustment in addition to the MA, to cover downgrade and default risk of assets in their MAs, while the MA structure itself covers off illiquidity risk of the assets in it. In particular, the insurers note the fundamental spread in regard to sub-IG assets.

BBVA's SFCR says: "For bonds with a rating below BBB, an adjustment is made to the fundamental spread to ensure that the MA does not exceed that of assets with a BBB rating".

And what of the liabilities in Spanish MAs, which assets are matching?

In short, they're longer-term annuities.

For Caja de Seguros Reunidos Compania de Seguros y Reaseguros, S.A., there are standard and deferred life annuities.

Average solvency ratio of Spanish MA users with/out MA, 2016-2022 (%)*

*Note: No capital effects are included for Meridiano, S.A. Compania Espanola de Seguros Sociedad Unipersonal which in 2016 provided figures, but said it "does not apply the MA therefore no impact is derived from this". Its figures would have added €96.2m to the MA's total effect on Spanish lifers, since 2016. The 2022 SFCR for CCM Vida Y Pensiones de Seguros y Reaseguros had not yet been located.

The SFCRs for Spanish undertakings and groups from 2016, with discussions, explanations and quantifications of the capital benefits of any MA they use, are loaded into Insurance Risk Data, the insurance data and research service from the publishers of Insurance Asset Risk. For more details contact phil.manley@fieldgibsonmedia.com. This piece forms part of Insurance Asset Risk's 'SFCR season'. To read other features in the series, 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 Benelux insurers' interest rate capital bills fluctuated, sometimes wildly, in 2022.

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