German insurance group Allianz saw its Solvency II regulatory ratio dip to 218% at end-March, from 229% three months prior, as the firm returned cash to shareholders and factored in the capital-sapping effects of lower interest rates.

The insurer’s own-funds, the numerator for the Solvency II ratio, increased to €78.6 billion ($88 billion) from €76.8 billion (2%) at end-2018, and from €75.4 billion in the year-ago quarter. But its solvency capital requirement (SCR), the ratio’s denominator, grew at a faster pace, to €36.1 billion from the €33.5 billion (8%) posted both three months earlier and in Q1 2018.    

Earnings generated €2.6 billion of own-funds, while positive market moves added a further €2.8 billion. These gains were offset by Allianz buying back €1.5 billion of its shares in the first quarter and €1 billion of dividend payments. 

Of the total SCR increase, €1.7 billion was a result of falling interest rates. The yield on 10-year German bunds dropped to a nadir of –0.086% at the end of March, compared with 0.243% at end-December.

A cut to the ultimate forward rate (UFR) – used to extrapolate liability discount curves past the point where market rates become unreliable – to 3.9% at the start of 2019, from 4.05%, shaved two percentage points off the solvency ratio, as this widened the duration gap between the firm’s assets and liabilities.   

Who said what

“I will say, if rates go down further, you will see the convexity picking up... The only point to note is the bund was at –9 basis points at the end of Q1, and so there is most likely a limit to how much [further] the interest rates can go down... I believe we are approaching the limit to how much [further] down they can go” – Giulio Terzariol, chief financial officer at Allianz.

What is it?

Under Solvency II, an insurer’s solvency ratio is the ratio of eligible own-funds to its solvency capital requirement (SCR). The latter is calculated as the amount of own-funds needed for the insurer to honour policyholder obligations after a one-in-200-year stress event. The SCR is calibrated to each insurer’s risk profile, either through the application of a regulator-set standard formula or the use of a firm’s own internal model.

Why it matters

Insurers’ Solvency II ratios are primarily driven by two forces: interest rates and changes to regulatory calculation formulae. What is tricky for large firms such as Allianz to manage in regard to the former is that their ratio’s sensitivity to declining interest rates increases as rates get lower – an effect known as convexity. 

For example, Allianz estimates a further 50bp decline in key rates would lop eight percentage points off its ratio. Last quarter, such a fall was predicted to remove only four percentage points. The firm’s executives say they believe German bund yields are bottoming out and therefore the convexity effect should peter out, but as of May 13, 10-year yields were still mired in negative territory. 

If rates continue their decline, we can expect Allianz’s solvency ratio to keep on dropping too, which may eventually force it to shake up its asset-liability management or take further action to ensure it stays above its 180% target. 

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How can Allianz and similar insurers brace themselves for further drops in interest rates? Share your thoughts by emailing louie.woodall@infopro-digital.com, sending a tweet to @LouieWoodall or messaging on LinkedIn.

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