A discount rate add-on switched on when credit spreads widen, designed to stop an insurer selling its bonds at the worst moment.
A life insurer holds bonds to maturity to back long liabilities, so a widening of credit spreads depresses the market value of its assets without changing the cash flows it will receive. Recognized without a correction, that spread would collapse its solvency ratio and push it to sell at the worst possible moment, the procyclical behavior regulation is precisely trying to prevent. The volatility adjustment, provided for in Article 77d of the Solvency II Directive, therefore adds to the discount curve a fraction of the credit spread observed on a reference portfolio, lifting the rate and lowering liability values in mirror of the fall in assets. The device is effective and contested for the same reason: it damps the volatility of the ratio but it also conceals it, and its calibration rests on a reference portfolio belonging to no single undertaking. Its use is not automatic in every member state and must be disclosed, which makes it an item to strip out before comparing ratios across insurers.
During the sharp widening of credit spreads in March 2020, the volatility adjustment published for the euro rose steeply, cushioning the fall in solvency ratios reported by European life insurers for the first quarter.
volatility adjustment, VA, correction pour volatilité Solvabilité II