Yemisi Izuora/Agency Report
European insurers are having to juggle increased regulatory pressure, the low interest rate environment and expansion into emerging markets, according to AM Best.
According to the ratings agency, insurers in Europe, the Middle East and Africa are concerned with the unintended consequences of Solvency II, Europe’s new capital and risk management rules for insurers.
Solvency II, which is due to come into force in January 2016, has the potential to make certain insurance products and asset classes unappealing due to high regulatory capital requirements, according to Stefan Holzberger, Chief Ratings Officer at AM Best.
There is also “serious concern” among European insurers over potential conduct-related fines and penalties, such as those seen by the banks, AM Best said.
Regulation is also putting expense ratios under pressure with increased compliance and IT costs.
With Solvency II implementation just months away, a number of smaller insurers were using surplus relief reinsurance as a form of regulatory arbitrage, according to Mr Holzberger.
Larger companies are able to benefit from the use of their own internal models to set regulatory capital, while smaller insurers are relying on the standard model. This creates a mismatch among insurers that reinsurers are able to take advantage of, he said.
Insurers were responding to increased regulation by consolidating legal entities and business in favour of fewer core carriers.
This meant fewer regulators to deal with, said Mr Holzberger.
Another trend identified by AM Best was mergers and acquisitions (M&A) among insurers.
These do not appear to be slowing, and are no longer a result of financial distress, according to Mr Holzberger.
M&A is now also the result of a deliberate attempt to build product, geographical scope, as well as a bid to reach a critical mass to be more relevant with big brokers and appealing to capital providers, he explained.
AM Best is concerned that the high valuations paid in some cases will exert pressure on management to grow and achieve levels of profitability that are likely out of reach in the current soft market.
Execution and integration risks are also of concern, as only time will tell if the distinct corporate cultures will come together, post-merger, AM Best said.
In particular, European insurers have shifted their focus away from consolidating their positions in Europe in favour of building platforms in emerging markets.
According to AM Best, in the last ten years a number of leading companies have more than doubled the proportion of total business originated from emerging markets.
At the same time, M&A activity in eastern Europe had increased as local insurers struggle to compete with multinational insurers moving into their markets and higher catastrophe losses.
While European insurers are expected to continue to expand in emerging markets, it has not proven to be an easy task to date.
The expected liberalisation of some of the BRIC countries is taking longer than expected and insurers have made losses in Brazil and Russia, which have resulted in some carriers taking corrective measures and exiting particular lines of business.
The low interest rate environment is another factor shaping European insurers’ strategies, according to AM Best.
Mr Holzberger said the search for yield in today’s low interest rate environment is leading some European insurers to take riskier investments and take on more investment risk.
At the Insurance Market Briefing in London, AM Best also outlined plans to change its ratings model.
The ratings agency is currently upgrading Best’s Capital Adequacy Ratio (BCAR) rating model to include stochastic modelling.
“We are building a new BCAR using more granular data and more sophisticated modelling technology. For insurance buyers this should give them more comfort that our view of a company is more informed than under the current model,” said Mr Holzberger.
AM Best’s new BCAR model will stress insurers for an event with up to a one in a 200-year probability. It will also look at insurers across five levels of probability.
“If you ask your insurer to protect you against a very low probability and very high severity event, the new BCAR will have a view of the capital way out in the tail. The highest rated companies will be viewed in terms of their ability to withstand remote events,” he said.