A new study jointly produced by the EDHEC Risk and Asset Management Research Centre and the EDHEC Financial Analysis and Accounting Research Centre entitled ‘The Impact of IFRS and Solvency II on Asset-Liability Management and Asset Management in Insurance Companies’ reveals the contradictions inherent in the current Solvency II and IFRS provisions for insurance companies.
The report shows notably that the numerous provisions proposed by the IFRS are at odds with the good risk management practices put forward by Solvency II.
While IFRS and Solvency II should lead to a genuine evolution in the management of insurance companies, by empowering them with respect to their risks (identification, measurement and management), one is forced to observe today that the standards implemented often oppose their initial objectives: the adoption of modern asset management and ALM techniques with a view to reducing the exposure to risks is considerably penalised by the IFRS treatment by leading to additional purely accounting volatility, without any connection to the economic reality.
More globally, while nobody would dispute the value of having a real view of the impact of the primary financial and actuarial risk factors on an insurance company’s accounts, the authors of the study feel it is regrettable not only for the insurance sector but for the economy as a whole that the fair value of assets and liabilities be a basis for analysing the financial soundness and solvency of insurance companies.
For most of their activities, insurance companies have long-term or even very long-term liabilities that in turn justify long-term allocation. Measuring their solvency on the basis of short-term values is not only incompatible with the need for investment in assets that, while risky, yield very positive average long-term returns, but also means that any genuine asset-liability management is an illusion, even though the regulators actually hope to promote ALM.
“EDHEC hopes that European regulators and financial analysts will take full stock of the consequences of the new ‘financial’ approach to prudential regulation, Solvency II,” says a spokesman for EDHEC. “This means abandoning all references to external and accounting approaches to solvency evaluation in favour of an evaluation of risk measurement and risk management procedures, internal models and the choice of risk parameters that underpin asset allocation and liability management decisions.”