17 August 2015

Financial Times: Confusion clouds European insurers’ efforts to bolster capital

More than £10bn-worth of mergers and acquisitions have been linked to the Solvency II regime in the UK alone. But tactics can be hard to read, and relative strength may remain nebulous until the final score.

Solvency II is intended to harmonise and strengthen capital standards within Europe’s €8.4tn insurance industry, as a piece of post-crisis housekeeping. Banks’ moves to strengthen their capital in line with the incoming Basel III standard have already been well documented. They include hurried retreats from debt trading, falling returns and investors weeping alone in their bedrooms. By contrast, the impact of Solvency II is fuzzier. But here, too, there will be winners and losers.

Insurers can demonstrate compliance with the new requirements using an off-the-peg or bespoke model.

Some claim that the latter approach will trigger no extra requirement for loss-absorbing capital among better-padded insurers. However, it is assumed that more money will be needed across the sector. That drain on resources is occurring at a time when low rates are putting pressure on insurers’ profitability, as Eamonn Flanagan of Shore Capital points out. Bond yields have shrunk even as hot capital has kept a lid on insurance premiums

Analysts tend to view takeovers through the prism of solvency. For example, when two UK annuity specialists, Just Retirement and Partnership Assurance, announced a £1.7bn merger last week, some saw capital as a driver. Under Solvency II, the buffer that insurers are expected to set aside for annuities is set to rise from 8 per cent to 15 per cent.

Meanwhile, Zurich Insurance is seeking to exploit the relative certainty concerning its own capital position to buy RSA, a UK non-life insurer, for more than £5bn in cash. Since Switzerland is not a member of the European Union, Zurich stands aside from the scrimmage to comply with Solvency II. It already meets tough Swiss risk control standards. That means it has $3bn to either spend or return to shareholders.

RSA, in contrast, has the task later this year of convincing the Prudential Regulation Authority, the UK’s systemic risk watchdog, that it complies with Solvency II. Chief executive Stephen Hester, former boss of state-controlled Royal Bank of Scotland, also has to convince investors that prospects of a turnround at RSA are good enough to ensure it has an independent future.

A flurry of takeover activity in the UK market does not mean that insurers there are more likely to flunk the capital test than continental counterparts. Barrie Cornes of stockbroker Panmure Gordon says that UK insurers have benefited from complying with local rules that are tougher than some in EU markets. “Some continental insurers are under greater pressure and that’s why they lobbied so hard for extensions to the Solvency II timetable,” he says.

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