European Insurance Watch: Solvency II driven rebalancing will amplify trends in EUR rates

by: Fouad Mehadi

  • Our Solvency II Insurance Model helps us to identify the rebalancing and hedging needs of European insurers under our Base Case, Higher and Lower interest rate scenarios
  • In our Base Case scenario not much rebalancing would be expected in the bond portfolios in 2018. However paying flows in EUR swaps would be needed, consequently putting bear flattening pressure on the long end and ultra-long end
  • Rebalancing in the Higher Interest Rate scenario requires duration shortening in the EGB and credit portfolio, while improvement in credit quality is needed in the latter via covered bonds
  • In addition it will also require insurers to pay in swaps. A fundamentally driven rise in interest rates will be followed by a Solvency II driven second round effect. This enforces the upward trend with increased volatility, resulting in steepening pressure in 10s30s and flattening pressure in 30s50s
  • A significantly lower interest rate scenario would require a decent duration extension of the EGB portfolio and an increase in the hedge ratio
  • A sharp drop in rates will also experience a second round effect with decent receiving flows expected in 20y to 30y area in EUR swaps, resulting in significant flattening pressure in 10s30s and significant steepening pressure in 30s50s

 

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