OREANDA-NEWS. Insurers with large Italian operations would probably have the greatest increase in capital charges if European regulators were to remove the zero risk-weighting for sovereign debt under Solvency II's standard formula, Fitch Ratings says.

The European Insurance and Occupational Pensions Authority has already said insurers using internal models to calculate capital should take account of sovereign risks. But in a speech last week, EIOPA Chairman Gabriel Bernardino highlighted the prospect that this could be extended to cover all insurers by including sovereign risk in the standard formula. Bernardino said such a move would be complex and should be consistent for the entire financial sector.

We believe any incorporation of sovereign risk into the standard formula would therefore take a long time. But to prevent regulatory arbitrage between use of internal models and the standard formula, regulators might consider imposing add-ons for standard formula users in the meantime where they believe sovereign risk is material.

Insurers' sovereign exposure tends to be concentrated in the debt of their home-market sovereign. Italian insurers, or those with large Italian subsidiaries, could be most exposed because they tend to hold a relatively large amount of sovereign debt due to its relatively good yield. Italy's BBB+/Stable sovereign rating is lower than that of most other major European countries and would probably lead to a higher risk-weighting, increasing any capital charge for holding its debt.

Among major European insurers, Generali, Aviva and Allianz have the most significant Italian exposure, although they are likely to use internal models rather than the standard formula. Spain's sovereign rating is also BBB+/Stable, but it is a much smaller market for insurance, especially life insurance which accounts for most of the sector's sovereign bond exposure.

It is unclear what capital charges would apply to sovereign debt and it is likely to be lower than for equivalently rated corporate debt. It is also likely that any rules would focus on the risks of excessive concentration on any single sovereign and that large holdings of debt from a single sovereign would attract a higher charge than those that are part of a more diverse asset portfolio.

Any decision to impose capital charges on sovereign debt holdings would be highly unlikely to affect Fitch's ratings as our primary measure of insurers' capital adequacy is our own Prism factor-based capital model. This already applies capital charges to sovereign debt according to both rating level and duration.