European insurers would have to hold an additional €80bn ($86bn) in capital if sovereign bonds were risk-weighted as corporate bonds under Solvency II, according to a report by the European Systemic Risk Board (ESRB).
In three countries the average solvency capital requirement (SCR) would increase by more than 150%, but for more than a half of the countries the change would be less than 20%.
This comes as regulators and central banks move to challenge the risk-free treatment of sovereign bonds in prudential regulation.
The report argues that the current regulatory framework may have led to excessive investment by financial institutions in government debt. However, it also recognises the challenge for reforming existing regulations and opens the door to transitional arrangements.
Under the Solvency II standard formula, government bonds issued by European governments and denominated and funded in the currency of the central bank attract a 0% capital charge against concentration and spread risk.
The benign treatment of sovereign bonds contrasts with that of corporate bonds and loans, which attract charges that increase as the credit rating lowers and duration increases.
In the report, the ESRB estimated insurers' SCR would increase by €80bn if the charges for government bonds were in line with the charges that apply to corporate bonds.
For insurers heavily invested in bonds from Europe's peripheral countries – which have lower credit ratings – a change in the rules would more than the double the level of the SCR.
The increase in required capital would be only €35bn if the bonds were treated as sovereign bonds denominated in foreign currency or issued by a foreign government, which already attract a lower charge than corporate bonds.
Insurers can account for the risks in sovereign bonds in their own risk and solvency assessments or model them in an internal model, but national regulators have been at odds about the approach to take.
Germany's financial supervisor has called on the firms to model sovereign bond risks, but other supervisors are expected to take a more relaxed approach (see InsuranceERM, 4 November 2014, EU supervisors split about sovereign bond charges).
The European Insurance and Occupational Pensions Authority (Eiopa) is finalising an opinion on internal models. However, it is unclear yet whether the treatment of sovereign bonds will be covered, InsuranceERM understands.
In the UK, the Prudential Regulation Authority said it would publish a statement on government bonds in the context of Solvency II before the end of March.
Speaking at The Economist's insurance conference on 3 March, Alberto Minali, group chief financial officer for Generali, supported the view that Solvency II is driving the asset allocation of insurance companies towards government and corporate bonds.
"The capital charge from Solvency II will distort the pricing of asset classes. There will be much more investment in government bonds – which probably do not deserve such huge investment vis-a-vis the equity market," he said.
"That should be corrected, otherwise it is a good chunk of money that we cannot invest in the economy and, in the end, everyone suffers."
Eiopa executive director Carlos Montalvo agreed that the zero charge on sovereign bonds was a distortion, but said any changes would need to be based on reality and not involve cutting capital charges on other assets, as some insurers have demanded.
He added that insurers' rules would need to be changed at the same time as banks.