Solvency II will kill soft market and slam captives warn carriers

Senior managers at a leading European primary insurer and reinsurer, however, told Commercial Risk Europe that the soft market is destined to end soon. This is because combined ratios are not justified by underlying rates and Solvency II will inevitably increase the cost of capital to insurers.

The reinsurer also warned that he supports the rising fear among insurance buyers groups that the new capital regulations will make life much harder for captives and captive owners may have to seek alternative risk transfer solutions.

According to the President of SIRM, the Swiss insurance buyers’ association, for now the rating outlook remains rosy for buyers even if it is more difficult than in the past to predict exactly which insurer will prove to be the most aggressive and quotes can vary wildly.

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Dieter Berger, Leader of the Insurance Department at Alpiq Management AG and President of SIRM, recently told Commercial Risk Europe in an interview in Zurich that there is ‘plenty’ of capacity and the market is ‘pretty stable’ for insurance buyers at an attractive level.

“It still depends upon the individual loss ratio of course but overall the situation is pretty good. I, and many colleagues in SIRM, have found that it is a more difficult market to predict. It is difficult to predict how the market will react when you go out with a submission,” explained Mr. Berger.

“Two years ago you knew that some insurers were consistently aggressive and, say, 10% cheaper than the rest of the market. The situation has changed in the sense that you still have a couple of insurers that will quote below the level of the competition. But, it is really hard to predict which companies will do that. I think they are really fighting for volume because they have to meet targets,” added Mr. Berger.

“They also have clients that they have been targeted to win and so need to fight but, as a buyer, you do not know if you are a target! Fresh capacity from markets like Bermuda has had an impact and the divergence in quotes can be huge. We recently gave a submission to eight insurers for the reconstruction of one of our power plants and provided them with a complete policy. The most expensive quote was almost 5 times higher than the cheapest one for the same wording. A year ago, the company that quoted the highest premiumwas known as the most aggressive!” he continued.

Mr. Berger said that he does not expect ‘major changes’ for the rest of the year, but, expects a tougher market in the medium term, as wider financial markets offer more attractive returns for investors and the cost of capital may rise because of Solvency II.

“It always depends on the general economic situation. I also believe that as soon as investors see that it is possible to make decent returns again in the wider financial markets with a reasonable level of risk they will reduce their investment in the insurance sector and therefore capacity will be reduced. Currently, insurance is regarded as stable and a safe way to make money. But changes in the wider financial markets and the arrival of Solvency II may well change that as the cost of capital will rise for insurers,” said the insurance buyer.

A senior executive at AXA Corporate Solutions agreed with Mr. Berger that the market remains stable at best, but, believes that many rival insurance companies are fooling themselves that the underwriting environment is healthier than it really is and could be in for a nasty shock soon.

Regis Demoulin, Chief Commercial Officer at ACS, conceded during an interview in Paris that the recent storm Xynthia that ravaged much of western France and parts of Northern Europe was above all a ‘human drama’.

He said that it will not be a huge loss for AXA Corporate Solutions because most of the losses were suffered by individuals through losses to cars and houses and smaller SME business.

Mr. Demoulin told Commercial Risk Europe, however, that despite the fact that the insurance market will not be badly damaged by Xynthia or the Chile earthquake, the losses underline how the market is under constant threat from catastrophes that need funding. And, this funding can only be gathered by realistic pricing.

“There have been concerns expressed by many in our company that average rate levels are not sufficient to fund corporate risks exposed to catastrophes in particular and we think there is a danger for a lot of insurance companies to suffer the ‘Trompe l’oeil’ effect,” said Mr. Demoulin.

“By this, I mean people see what they think is reality and act upon it but it is not real. They may see a very clever painting of an open door on a wall and walk into it. The risk for this industry is if the market continues at this kind of level of pricing it is in danger of walking into the wall!” he continued.

Mr. Demoulin said that he does not think that the combined ratios posted by some insurers are sustainable and agreed with Mr. Berger at SIRM that Solvency II will make it even harder to post such numbers if prices remain soft, unless reserves are not adequate.

“My impression is that some competitors may not appreciate the real situation. How do some companies deliver 85% -95% combined ratios with rates at this level? Are they properly reserving? We are all writing the same business so how can this occur? This is a key point,” said Mr. Demoulin.

“We are at the turning point and to deliver what our shareholders expect on an economic combined ratio basis followed by the up-coming Solvency II effect, we decided that we had to be among those insurers that would charge a realistic rate. There are only a few companies doing that,” he continued.

Nikolaj Beck, Managing Director, Head of Specialties at Swiss Re, agreed that Solvency II would have an impact on the capacity available for insurance buyers as the tougher requirements currently proposed take effect. But, he told CRE during an interview in Zurich that the impact will be felt by more thinly capitalised and less well diversified companies than his own, including captives.

“Due to its risk-based nature, it [Solvency II] will increase transparency and clarity about the true costs of capital. We welcome this. Insurers and captives need to look hard at what drives their capital costs. They need to look at portfolio diversification, the volatility of peak risks, volatility of technical provisions and in many instances Solvency II will make it worthwhile to cede risks to a partner that is more diversified and allow them to free up capital at lower costs,” he said.

Mr. Beck said that he fears for the position of many captives as recently expressed by insurance buyer groups such as FERMA and ECIROA.

“For captives we fear that many, particularly smaller captives, will not be able to meet Standard Capital Requirements or even Minimum Capital Requirements and that it will be difficult for many captive owners to face up to some tough decisions on whether to continue and recapitalise, redomicile or de-risk the captive and potentially exit some lines of business,” he said.

Mr. Beck said that many captives will probably find the modeling requirements of Solvency II a challenge and may need to call for help from others.

“We focus on helping our clients work out how to de-risk and potentially exit some lines of business. Overall the challenge is really to ask what you use the captive for and how you buy insurance and reinsurance. In the past, these questions were often budget-driven considerations, whereas now captive owners are faced with quite sophisticated demands that ask how much capital is needed to run a certain business. The standard formula is, by default, more conservative and often an inefficient way to allocate capital. But, internal models are difficult to build, costly and take a great deal of effort to explain to the regulators. So it can help to ask others to help with the models and use traditional quota share arrangements to help take out peak risks with multi-year solutions, for example. The Holy Grail has not been found yet,” said Mr. Beck.