Increased M&A activity in a changing economic climate could drive misalignments between the old economic view and the current economic environment.
Although Solvency II was once designed as an economic framework, the result is a framework based on a combination of market principles and politics. The most obvious example is the use of an Ultimate Forward Rate (UFR) in the interest rate curve. From this perspective, it makes sense for a regulator to ask the insurance industry for an economic view on their balance sheet, in parallel to the regular Solvency II reporting. The aim of developing an economic view is to ensure the transferability of an insurer's liabilities, irrespective of its Solvency II position. In 2016, the topic has been introduced by DNB in their good practice for the capital management policy, with the explicit request to include an economic view in the risk management system of insurers. DNB did not prescribe what this 'economic view' should be, but only shared some general principles. With these principles, insurers have developed their own methodology of an economic solvency framework, and thresholds were defined in the capital management policy based on this economic framework.
Since 2016 a lot has changed. Not only has the economy evolved, with the continuous low interest rates as most notable example, but also the insurance market itself has changed, given the increase in M&A activity and new players entering the market. The result is that the economic view developed a few years ago may no longer align with the current economic climate. We know several examples of insurance companies which had to take action, because limits on their economic solvency levels were inadequate in this changing environment.
Some examples of where we believe the old 'economic view' is not aligned with the current economic environment are:
This misalignment is not just an academic discussion: if the capital management policy includes limits based on the old economic framework, it means the company is managed based on outdated thresholds. We have seen examples where companies had to take action after breaching these previously determined economic solvency limits, which may not have been breached if the economic solvency was better aligned with the current economic situation.
Over the past two years the Dutch insurance market has experienced a lot of dynamics, especially due to the increased M&A activity for life insurance portfolios. It is important to understand that the economic environment is subject to change and the consequent developments should be monitored closely, in order for your economic framework to align with the actual transferability.
In case you want to discuss your economic solvency framework, feel free to reach out to us. We can help you make your economic framework more [truly] 'economic'.
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