EC offers smaller insurers ray of hope on Solvency II claim rating agencies

The transition measures that the EC recently suggested for Solvency II, which could delay important elements of the package by up to 10 years from 2013 to 2023, has been welcomed by the credit rating agencies as good news for the insurance sector in Europe. Two of the leading agencies believe that if the commission adopts the proposals announced under its Omnibus II proposals by European Commissioner Michel Barnier, it could significantly relieve the immediate stress on capital requirements for insurers and give smaller carriers, in particular, more time to prepare for the changes. This in turn could prevent the dramatic consolidation in the sector, reduction in capacity and sharp rise in rates for high-risk business that many risk managers in Europe fear could be the result of Solvency II if implemented too rigorously. The rating agencies note also, however, that bigger insurers that have invested heavily in preparation for Solvency II, partly in the hope that they will be able to take advantage of weaker competition that struggles to cope, will probably be upset that their early action may be wasted and competitive advantage gained from the early movers will be lost. hideRating agency Moody’s said that the allowance for transition measures under Omnibus II is a ‘broadly credit positive’ development for the European re/insurance industry that would help avoid ‘market disruption’. “In particular, Moody’s believes that this would benefit smaller, less prepared players in the move to what is a radically different regulatory environment. Conversely, larger, more sophisticated groups, who are already well prepared for the switch, would lose a potential competitive advantage,” said Dominic Simpson, a Moody’s senior credit officer. Moody’s said that the transition measures would be ‘particularly positive’ for smaller companies with little business line diversity and a reliance on the standard formula, that are likely to face the biggest challenges in meeting the new Solvency Capital Requirement (SCR). “The resource and cost implications of having to meet risk management and reporting standards will be a significant burden for some. With Solvency II compliance potentially a major challenge on several fronts, transition measures should enable smaller companies to progressively adopt the new standards,” added the credit rating agency. Moody’s noted that the commission has not yet taken the decision to adopt the transition measures and may yet backtrack. But it said that it believes that the proposed amendments indicate that some form of transition is likely. Standard & Poor’s (S&P) said that, if adopted, the measures would ‘significantly mitigate’ potential market disruption. “From our reading, the transitional arrangements in Omnibus II cover much of the Solvency II regime and might extend until 2023. We believe that most insurers will welcome the proposals because they would allow them more time to adapt to the full rigors of Solvency II, particularly in terms of capital adequacy,” stated the agency in its response. “Solvency II continues to hold out the prospect of a radical EU-wide modernisation of insurance supervision, putting such supervision on a much more risk-sensitive footing than most other regimes around the world. If EU legislators were to adopt the proposed revisions as drafted, these benefits would be partly deferred, but our ratings on European insurers would likely be more stable than without the revisions. Investors, in our view, would also be reassured that Solvency II would not represent the event risk that it may currently pose in the run up to Jan. 1, 2013, when the new regime takes effect,” it added. S&P has stated previously that it believed that Solvency II could spark a ‘significant’ market consolidation and that it also believed that insurers may need to fundamentally re-examine their business models. This could affect product design, matching of asset classes, pricing, distribution and international competitiveness. It suggested in its latest opinion, however, that if the Omnibus II transition measures are adopted then these effects would be less likely to occur in such a dramatic way than if the regulation was implemented in 2013 as originally planned. S&P said that some of the proposals contained in Omnibus II were widely anticipated but added that other more significant ones were not. According to the credit rating agency these proposals relate mainly to maximum transition periods for the new regulations, such as: Hybrid capital instruments (10 years) Third country supervisory equivalence (five years) Solvency capital requirement (10 years) Valuation of assets and liabilities (10 years) Technical provisions (10 years) Information to be provided for supervisory purposes (five years) General governance requirements (three years) and Content of report on solvency and financial condition (three years). S&P agreed with Moody’s that, if adopted, the proposals would allow the EC the flexibility to include some or all of the transitions in the implementation measures for the directive and would give insurers more time to prepare for the full implementation of Solvency II, especially the capital adequacy element of the new rules. “However, we believe there may be some discontent among those insurers that have already invested heavily in resources to prepare themselves for full implementation in 2013,” it also noted. S&P believes that the hybrid capital instruments, third country equivalence and solvency capital requirement transition periods if adopted would ‘collectively substantially increase insurers’ available capital and reduce their required capital in 2013 compared with our current expectations’. The agency said that transitional arrangements were widely expected for the treatment of hybrid instruments. It explained that, if adopted, the arrangements would mean that instruments approved under the current Solvency I regime would continue to count towards fulfilment of the SCR beyond the Solvency II implementation date. “Accordingly, we would expect insurers to replace hybrid instruments with scheduled call dates (subject to supervisory approval) with Solvency II-compliant instruments over the transition period,” said S&P. This would presumably give smaller insurers in particular more time to find such instruments to suit their needs and avoid a capital crunch. The proposed five-year transition period for third-country supervisory equivalence would mean, for example, that the supervisors of European insurance groups with large US subsidiaries may be given the discretion to use the deduction and aggregation approach to group solvency, argued S&P. The US is not included in the first wave of supervisory equivalence reviews. S&P said that without this discretion, the available capital and capital requirements might only have been determined using consolidated Solvency II concepts and, in some cases, solvency margin coverage might have been ‘materially lower’. “In our reading, the transition period would allow, for example, the EC to assess the US for supervisory equivalence after the US has completed the Solvency Modernization Initiative that is currently underway,” said S&P. This seems to confirm the analysis of many in the industry that the EC would seriously hamper the European insurance industry compared with US competitors if Solvency II was fully implemented before the US is ready to upgrade its solvency regime, which could well take years. The proposed transitional arrangements for the capital requirements could be very significant. S&P said that a minimum transitional SCR has been proposed, which would be the already proposed minimum capital requirement (MCR) plus 50% of the difference between the SCR and MCR. “Assuming an MCR calibrated at a confidence interval of 85%, we estimate that this transitional SCR equates to a confidence interval of approximately 95%–97%, compared with that of the SCR under full implementation, which is set at 99.5%,” explained S&P. Another big industry concern over Solvency II was that it would be implemented before the International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB) have worked out how to deliver a level playing field for insurance accounting based upon the IASB’s insurance contracts project. This project could well take some time as many of the key details are hotly contested and the FASB and IAS do not exactly see eye to eye. The prospect of the accounting and solvency projects progressing out of step has been a big worry for insurers already struggling with the time and cost required. S&P suggested that the EC may have seen sense here too. “The proposals relating to the valuation of assets and liabilities and technical provisions may allow the Phase II International Financial Reporting Standard (IFRS 4 Phase II) to become established and form the basis of valuation under Solvency II. IFRS 4 Phase II is not expected to be implemented before 2014. In our view, all of the proposals would also serve to reduce insurers’ overall administrative burden with regard to Solvency II,” it stated. But much remains up in the air about all of these measures, as the EC will not announce its final decisions on them until the summer. Also, as S&P noted, the proposals provide few details on the transitions, other than the maximum periods. And the EC has yet to fully digest the results of the latest quantitative impact study QIS5, the results of which will be announced in mid- March. “The rules that will take effect on Jan 1, 2013, and the potential steps toward full implementation will ultimately be determined in the EC’s implementing measures in conjunction with the European Insurance and Occupational Pensions Authority (EIOPA). We believe that these implementing measures will be influenced by the upcoming results of the fifth Solvency II Quantitative Impact Study (QIS 5),” predicted S&P.

EC offers smaller insurers ray of hope on Solvency II claim rating agencies

Want to read this article?

Read Next

Switzerland’s Kessler rolls out ESG ratings to pension funds

Alstom becomes latest firm to register French captive

Amrae re-elects Wild as president and names new board members

Favourable aviation insurance market for now, says WTW

London Market increases contribution to UK economy

Switzerland’s Kessler rolls out ESG ratings to pension funds

Alstom becomes latest firm to register French captive

Amrae re-elects Wild as president and names new board members

Favourable aviation insurance market for now, says WTW

London Market increases contribution to UK economy

Want to read this article?

Read Next

Switzerland’s Kessler rolls out ESG ratings to pension funds

Alstom becomes latest firm to register French captive

Amrae re-elects Wild as president and names new board members

Favourable aviation insurance market for now, says WTW

London Market increases contribution to UK economy

Related Articles