The U.S. life units of companies affected by Europe’s Solvency II rules are already reducing exposure to spread-based products such as fixed annuities, immediate annuities, indexed annuities and guaranteed investment contracts, according to an analyst at Moody’s Investors Service.

Solvency II is an updated set of regulatory requirements that is supposed to take effect in the European Union and the European Economic Area in January 2013.

The “Pillar 1″ quantitative requirements in Solvency II will require European insurers to Eurohold more capital, especially when meeting capital requirements for products with profits that depend on the difference, or spread, between a fixed rate of return paid to product holders and the rate an insurer is earning on its own investments.

In the past, a European insurers could use what they thought were reasonable assumptions about investment returns when establishing reserves. Starting in 2013, Solvency II will require the companies to use the “risk-free” rate earned on investments in government bonds when discounting insurance reserves, Bazer says.

Solvency II also penalizes insurers that try to increase returns by using higher-risk investments in other situations, and it also penalizes an insurer for efforts to boost returns by using higher-yielding investments with durations that clash with the durations for the insurer’s liabilities, Bazer says.

The Solvency II requirements will not have a direct effect on the U.S.-domiciled life units of European companies, but any Solvency II requirements with a companywide effect on the European parents could affect the U.S. affiliates, Laura Bazer, an analyst at Moody’s, New York, writes in a new commentary.

European regulators will be able to decide whether the U.S. insurance regulatory system is “equivalent” to the new Solvency II system, Bazer says.

If European regulators decides the U.S. system is equivalent to the European system, then European parent companies could use the lower U.S. local capital requirements in companywide solvency calculations, Bazer says.

If European regulators decide that the U.S. system is not equivalent, and that U.S. local capital

requirements are too low, then that could affect how the U.S. companies are treated in the consolidated solvency calculations.

Some U.S. subsidiaries of European insurers have been continuing to focus on the U.S. fixed annuity market and the market for U.S. variable annuities with benefits guarantees, but some seem to be shifting toward fee-based business and away from spread-based business, Bazer says.

European-owned U.S. insurers have been shedding higher-risk structured assets and alternative assets, and they are being more conservative about asset-liability management in general, Bazer says.

Any big changes at European-owned U.S. life insurers could have a noticeable effect on the U.S. life market, because those insurers held about 20% of the top 25 U.S. life insurance groups’ total statutory assets, Bazer says.

- Allison Bell

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