Part one: the zero percent capital charge challenge Turmoil in the European government debt markets is calling into question the zero percent capital charge on European government bonds under Solvency II. This two part article explores how firms and regulators are handling the discrepancy between the charge and real default risk, and what life without a risk-free rate might look like. Part one examines the implication of a zero percent capital charge on risk-free assets that are anything but. The Solvency II standard formula capital charges aim to help make sure that insurance firms will be able to match their liabilities at a confidence level of 99.5% over a one year horizon. The charges for a number of asset classes are being contested by the industry but none are more controversial than the 0% capital charge on EEA sovereign bonds issued in their own currency. Let us be clear – what this implies is that these bonds are effectively risk-free and that all countries in the EEA are equally immune to the risk of default. Clearly a proposition few, if any, would accept today. “Should we rethink the concept of zero risk? I think so,” Gabriel Bernardino, Chairman of EIOPA said at the organisation’s first annual conference in Frankfurt in November. Quite what that ‘rethink’ means is unclear. For now, firms need to move forward with Solvency II preparations. While those planning to use an internal model are likely to factor exposure to sovereign risk in their portfolio already, for firms using the standard formula the solution is as clear as mud.