• New rules could handicap insurance industry
• Insurers fear volatility in new capital requirements
• Likely to lead to consolidation among medium-sized players

A showdown between major European insurers and European authorities over Solvency 2 is expected to develop over the coming weeks and months over rules setting new minimum capital requirements for the European insurance industry.

At stake is whether Solvency 2, 10 years in the making, can begin to be implemented before the end of 2013, when Solvency 1 regulations are due to expire. Industry sources are concerned that the European Commission (EC) will seek a directive on Solvency 2 – which is the insurance equivalent of Basel III for banks – at all costs before next year. That prospect is putting pressure on the industry to quickly reach a compromise that is acceptable to regulators or deal with a final text that could put them at a competitive disadvantage with insurers based outside of Europe.

“We are working towards a compromise with the [EU] Parliament and the Council of Ministers. I am confident and determined” that a text will be approved, Michel Barnier, European Commissioner in charge of internal markets and regulation, told this news service.

Much of the European industry, including French, German, UK and other insurers, oppose the latest text produced by EIOPA, the European insurance regulator, and endorsed by the EC. They fear it will cause a great deal of volatility in capital requirements, hurt competiveness and hinder the industry’s ability to finance European growth. Insurers, particularly those involved in life and annuities, are major holders of sovereign and corporate bonds, as well as shares of European companies.

The main problem for insurers with the new regulation is the volatility produced by mark-to-market rules. Under Solvency 1, assets are evaluated at historical prices taking into consideration that the liabilities are very long term, sometimes as long as 30 years.

Solvency 2, by contrast, proposes to evaluate assets at market prices in order to have a finer view of their economic value. When spreads change, capital requirements evolve. “Our problem is that the liabilities are long term but assets go up and down,” said a French industry source. This is particularly the case now, with spreads of government bonds varying wildly, he added.

Martina Baumgaertel, head of group regulatory policy at Allianz [ALV GR] in Munich, explained that regulation has to be adapted to the insurance business model: “We have long-term obligations and long-term investments, so spread changes do not really matter.”

The texts now on the table “are intolerable”, said Hugh Savill, director of prudential regulation at the Association of British Insurers (ABI). The major retirement product in Britain is annuities, provided by leading FTSE-listed companies including Legal & General [LGEN LN], Standard Life [SL/ LN] and Prudential [PRU LN] among many others. Clients give their capital to the insurance company in return for a fixed income payout that is guaranteed for life. The industry holds several trillions of pounds in annuities, which are financed by the insurer mainly by buying bonds that are then held to maturity. “The mark to market evaluation is in principle right,” said Savill. “But if you are not going to sell the bonds, it is irrelevant.”

So the British industry is working on a “matching adjustment” so that the discount curve of Solvency 2 takes into account the illiquid nature of British annuities.

There is also alarm in France, where global insurers including AXA [CS FP] could find themselves handicapped. “A regulation that would hurt the competitiveness of the European insurance industry would be worse than no regulation,” said Bernard Spitz, head of the French Insurance Federation (FFSA). “There is a consensus with German, Italian, English, Spanish colleagues that the latest concessions made by the EIOPA fall short of the significant adjustments required to the text.”

The CFO Forum, which represents chief financial officers of major European Insurance companies, has come up with a combination of “counter-cyclical measures”. The idea is to modify, at least to some extent, the evaluation of liabilities when the value of assets changes, to avoid having to add capital at every turn in the market.

EIOPA has considered such proposals to be too advantageous to the industry and has presented its own counter-cyclical measures, which are in turn deemed insufficient by the European industry.

Impact on industry structure

Should an EC directive be finally implemented, it is sure to be much tougher than present regulations, a number of industry leaders surveyed said. This is bound to shake up the industry and encourage consolidation.

A German industry source said this is particularly the case in Germany, which has a number of small and medium-sized companies.

A second industry source and a credit analyst pointed out that German insurers are already at a disadvantage because life insurance contracts provide guaranteed interest payments to customers at a time when yields on bonds are near historical lows.

The credit analyst said the most affected would be mutual life insurers that “have relatively high guarantees on their back book”, under which they are obliged to pay out 3%-4% annually at a time when German bunds are yielding less than 2%. He said that to be able to pay out on those premiums, insurers will need to invest in higher risk assets, including stocks, thereby generating a higher capital requirement. Among listed life insurers, he said Nuernberger Beteiligungs [NBG6 GR] may find itself exposed to the impact.

A mutual insurance industry source agreed that Nuernberger exemplifies the kind of medium-sized regional player that could find itself disadvantaged by the new solvency framework. But he added that the answer for many of the more than 1,000 small and medium insurers in Germany could be in the proportionality principle, which provides for flexible valuation methodologies on the basis of their limited complexity, scale and objectives as mutual insurers or as pension funds operating as insurers under German law.

In France, Life Insurance contracts can be withdrawn at any time, which is seen by regulators as vulnerability under the new Solvency 2 rules. French insurers respond that life insurance contracts in the country carry significant tax advantages that encourage clients to keep them through to maturity.

Even so, according to a French regulation official, the new Solvency 2 framework will encourage small mutual companies to merge.

At the political level, the latest EIOPA text will be the basis for so-called “Trilogues” between the Council of Ministers, the European Parliament and the EC. Such meetings will take place until the November deadline.

Allianz’s Baumgaertel said finance ministers are well aware of the problems and “are talking to each other”. She believed the absence of agreement would be harmful. “We would have 28 different systems; this would raise, among other things, consumer protection issues.” She warned that the absence of a common framework within Europe will make it impossible to compare products among European insurance companies. “We need a single system within a single European market.”

At the European Parliament level, there is also a feeling of urgency. Jean Paul Gauzes, “coordinator” of the PPE Group, the largest political group of the European Parliament, and a member of ECON (Economic and Monetary Commission), said he is aware the text as it now stands presents serious difficulties, particularly for the German industry.

By Blanca Riemer and Henry Teitelbaum
www.dealreporter.com