OREANDA-NEWS. Fitch Ratings says in a new report that Solvency II (S2) and its internal Prism Factor Based Capital Model have a similar philosophy in measuring insurers' capital strength, but there are some important differences in a few key aspects.

S2 and Prism both consider available and required capital in a stress scenario, start from a market view of assets and give some credit for future profits expected to arise from existing business. Both also factor in capital buffers for asset price falls and defaults, with higher charges applied to assets deemed to be higher-risk, and include significant capital benefit for insurers with high diversification in their business mix or asset portfolios.

S2 includes the concept of additional risk margin capital for risks deemed to be non-hedgeable. As longevity risk is deemed non-hedgeable, this leads to higher capital requirements under S2 for annuity business, exacerbated by the effect of low interest rates on the calculation. This is driving insurers to reinsure longevity risk, as the resulting counterparty risk charges for the reinsurance are low in comparison. In contrast, the impact of longevity reinsurance on Prism scores tends to be much less pronounced.

For many insurers, the headline S2 figures reported to date include the impact of transitional measures, rather than being on a "fully loaded" S2 basis. This means that some S2 results are calculated based more on the older, less risk-based Solvency 1 approach rather than on "true" S2. This does not affect the Prism model, which is not affected by regulatory capital rules. Full S2 disclosure will begin with insurers' 2016 annual results and it will then be possible to strip out the impact of the transitional measures.

Our analysis shows only a weak correlation between Prism scores and S2 ratios reported to date. The weak correlation is likely to be largely attributable to the distorting influences of transitional measures and equivalence on S2 ratios. We expect a much stronger correlation between Prism and the fully loaded S2 figures that are due to be disclosed in 2017, excluding the impact of transitionals.