Insurance and Society: How Regulation Affects The Insurance Industry's Ability To Fulfil Its Role

Insurers and society
How regulation affects the insurance industrys ability to fulfil its role
A report from the Economist Intelligence Unit
Sponsored by:
The Economist Intelligence Unit Limited 2012
xx
INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRYS ABILIT Y TO FULFIL ITS ROLE
contents
Executive summary
Preface
About this report
Introduction
1 2 3 4 5
Striking the right balance
Who will pay the price?
Shifting down the risk spectrum
14
Implications for companies seeking financing
17
Predicting the unintended consequences
19
Conclusion
21
Appendix
22
executive summary
As discussion of the details of the Solvency II regime rolls on, insurers are thinking long and hard about how they will manage and monitor their risk strategies and capital bases. But the implications of their decisions will reach far beyond the boardroom, affecting both their relationships with corporate and individual policyholders, and also their role as major investors in the debt and equity capital markets. The new regulations were designed to ensure better protection for policyholders, but raise important questions about the extent to which consumers and corporates will ultimately foot the bill for Solvency II, either directly through higher costs or indirectly via less comprehensive products. Meanwhile, the demands of the new regime threaten to disrupt the key role played by insurers as investors in the capital markets, by pushing them towards safer assets with lower capital charges, and away from the equities and noninvestment grade debt on which much private industry depends for financing. This could be a particularly troubling outcome for businesses seeking to raise capital, given that banks remain reluctant to lend because of their own balance sheet constraints. The Economist Intelligence Unit, on behalf of BNY Mellon, conducted a survey of 254 EU-based companies, including insurers, other financial institutions (FIs, excluding insurers) and corporates (non-financial institutions, or non-FIs). The findings shed light, from a broad range of perspectives, on the potential impact of Solvency II on the retail consumer, the insurance industry itself and industry more broadly, including how insurers are likely to behave as debt and equity investors.
Key findings include:

Solvency II goes too far in its requirements Survey respondents believe that Solvency II oversteps the mark, with only 16% agreeing that it strikes the right balance in ensuring insurers have sufficient capital to meet their guarantees. Insurers and FIs (excluding insurers) are more critical of Solvency II, with 55% believing the directive goes too far compared with 39% of corporates (non-FIs). Less than one in five insurance respondents believe that most insurers are insufficiently capitalised under the present regime.
Policyholders will ultimately bear the costs Almost three-quarters (73%) of survey respondents agree that the costs to insurers of compliance with the new regulations will be passed on to policyholders, and there is concern that both corporates and individuals may choose to be underinsured as a consequence. However, insurers are markedly less convinced (57%) than FIs (excluding insurers) (82%) and corporates (non-FIs) (69%) that policyholders will pick up the tab, raising the question of how they see the costs of regime change being met. Also, over one-half (51%) of respondents believe the shift to unit-linked policies, which put the investment risk on the policyholder, will have a negative long-term affect on pension and long-term savings provision, with life insurance and annuities considered the products most likely to be affected. Insurers expect to further de-risk their asset allocations A clear shift down the risk spectrum is anticipated by respondents. Assets expected to attract more interest include investment-grade corporate bonds, cash and short-dated debt, at the expense of non-investmentgrade bonds, equities and long-dated debt. Almost three in five (58%) respondents overall believe that shift will happen gradually, giving time for market adjustment. But nearly one-third of corporates (non-FIs) (32%) do not believe the changes will have an adverse impact on any asset class, suggesting they may not fully understand the wider financial implications of the new regime. Corporates seem less aware of the impact Solvency II will have on debt issuance Among insurers and FIs (excluding insurers) there is a strong consensus that Solvency II will make the tenor and rating of bonds from corporate
issuers more significant, as insurers, driven by capital charge considerations, are increasingly pushed towards investment-grade debt. However, corporates (non-FIs) seem less aware of this shift, with just 48% agreeing compared with 62% of insurers and 79% of FIs (excluding insurers). The reality is that companies are likely to have to either adjust their capital structure to achieve investment-grade status or offer higher yields in compensation for the capital cost to insurers. Regulators should revisit their capital charge levels Given the economic risks attached to many EU countries at present, there is strong support, particularly among insurers (50%), for regulators to reassess the zero capital charge for sovereign bondsdespite the fact that a readjustment would mean they would be required to hold further capital. A further 41% of insurers would like to see the capital charges for all assets reconsidered. Overall, less than onequarter (22%) of respondents believe that regulators should maintain the current capital charges. Is Solvency II creating a squeezed middle among insurers? While large insurers are able to absorb the costs of preparation for Solvency II and enjoy the benefits of economies of scale, and the small, local or specialist providers prevalent in continental Europe may either fall outside the scope of Solvency II altogether or have a sufficiently strong niche market to survive and thrive, the mid-sized mutual insurers could be at a disadvantage. Only 16% of respondents expect no material impact from Solvency II on the structure of smaller friendlies and mutuals, and more than one-half (54%) believe the pressures of the new regime will result in a spate of consolidations to achieve scale, while 36% of insurers believe these players will outsource more in order to access scale.
preface
Insurers and Society is an Economist Intelligence Unit report, sponsored by BNY Mellon. The findings and views expressed in the report do not necessarily reflect the views of the sponsor. The author was Faith Glasgow and the editor was Monica Woodley.
about this report
In January 2012, the Economist Intelligence Unit, on behalf of BNY Mellon, surveyed 254 respondents from companies in Europe to get their views on how regulation is changing insurers role in society. The survey reached insurers, financial institutions (FIs, excluding insurers) as well as corporates (non-financial institutions, or non-FIs). Respondents are very senior, with over one-half (133) coming from the C-suite or board level. They were drawn from Europe, with the UK, Spain, Germany, the Netherlands, Denmark and Sweden each having over 20 respondents. In addition, in-depth interviews were conducted with six experts. Our thanks are due to the following for their time and insight (listed alphabetically): Jenny Carter-Vaughan, managing director of the Expert Insurance Group James Hughes, chief investment officer at HSBC Insurance Julian James, UK CEO of broker Lockton International and president of the Chartered Insurance Institute (CII) Ravi Rastogi, senior investment consultant at Towers Watson Jay Shah, head of business origination at the Pension Insurance Corporation Randle Williams, group investment actuary at Legal & General
introduction
Insurance companies have traditionally been viewed by wider society as the bearers and managers of formalised risk, freeing individual policyholders from financial worries in the event that things go wrong, and providing institutions with an efficient mechanism by which to transfer risk. They have also historically played a central role as institutional investors, channelling funds into the capital markets and providing industry with crucial flows of both equity and debt capital. Are those longstanding roles under threat with the impending introduction of Solvency II in the European Union? Solvency II aims, among other things, to provide policyholders with more robust protection by requiring insurers to hold capital according to all their business risksincluding the differing risks attached to the various asset classes in which they invest clients cash.
But these changes are set to upset the status quo, not just for insurers but for policyholders and also for companies looking to attract investors through the capital markets. Policyholders are likely, for example, to see the cost of premiums risepotentially pushing some to opt to reduce or ditch their cover rather than pay more. Companies seeking investors, meanwhile, may find it harder to raise funds in the capital marketsat the very time when banks, for their own reasons, are reluctant to lend. Insurers themselves are likely to have to adjust their investment timescales and strategies of asset allocation, potentially finding themselves under conflicting strains as they try to find the best balance between risk, return and capital efficiency. In this report, we explore the danger that regulation may, ironically, force insurers to reduce the amount of risk they takeand instead offload that risk on to their stakeholders.
Striking the right balance

As insurers play a central economic and social role in modern Western societies, it has been accepted since the 1970s that some form of prudential supervision by the authorities is necessary. Until now, the focus has tended to be on measures to guarantee the solvency of insurers or minimise the disruption caused by their insolvency. Solvency II raises the stakes across the board by introducing a risk-based capital approach, measuring risk on consistent principles and linking capital requirements directly to those principles. They will apply throughout the EU, harmonising standards and providing a level playing field for insurers across the euro zone. But our survey findings indicate that although there is a perception that something needs to be done to improve the current situation and harmonisation should bring its own benefits, the proposed regime could be overly cautious.
Chart 1: Do you agree or disagree with the following statement? Most insurers already have sufficient capital to meet their guarantees.
All respondents
36%
agree
39%
neutral
25%
disagree
Corporates (non-FIs)
33%
agree
Insurers
36%
neutral
31%
disagree
44%
agree
38%
neutral
18% 24%
disagree
disagree
FIs (excluding insurers)
36%
agree
40%
neutral
Chart 2: Do you agree or disagree with the following statement? Solvency II goes too far in ensuring insurers have sufficient capital to meet their guarantees.
Corporates (non-FIs) Insurers FIs (excluding insurers)
On the one hand, just over one-third (36%) of respondents believe that most insurers already have enough capital to meet their guarantees, and even among insurers themselves that confidence only rises to 44%. So there is a broad acknowledgement that measures to improve the capital cover of insurance companies are in order. On the other hand, just 16% of all respondents agree that Solvency II will strike the right balance in ensuring that insurers are properly capitalised in line with their guarantees, and over one-half (51%) say that it goes too far. As Jenny Carter-Vaughan, managing director of the Expert Insurance Group, observes: No one has gone down in the insurance industry for a very long time; Id say the current solvency regime is very robust. Randle Williams, group investment actuary at Legal & General, points out that it is unsurprising that the industry feels that the authorities are setting the capital charges too high. Its important to remember that some EU countries dont have any compensation net comparable to the UKs Financial Services Compensation Scheme in place to protect consumers. But the tendency of regulators is to go too farthey always want more capital, he says. However, Julian James, UK CEO of Lockton International, a broker, and president of the Chartered Insurance Institute (CII), observes that harmonisation across the EU means that there will be both winners and losers, so it is difficult to
% 15
13%
39%
2
33%
1%
16%
disagree
55%
respondents
all
51%
agree
34%
neutral
% 31
Life
40
55
Chart 3: Do you agree or disagree with the following statement? Most insurers already have sufficient capital to meet their guarantees.
32%
agree
General
47%
neutral
21% 27%
neutral
disagree
50%
agree
Composite
23%
disagree 7%
50%
agree
43%
neutral
disagree
generalise. Some insurers will see their capital requirements increase, but others will see a decrease, he says. For consumers, though, the important thing is the knowledge that the insurer will have the same level of capital cover if they buy in France or Germany as if they were buying in the UK. Insurers and FIs (excluding insurers) are markedly more critical of the looming regime than corporates (non-FIs), with 55% believing it will go too far and insurers will be over-capitalised for the level of guarantees they have to meet, compared with 39% of corporates (non-FIs). This raises the question of whether corporates, while attracted by the idea of greater security, fully understand the potential implications of an over-capitalised insurance industry for their future activities in the financial markets. Looking specifically at the capital charges that Solvency II will institute for different asset classes, survey respondents are in favour of a reassessmentjust 22% say the current charges should be maintained. Most are in favour of an across the board reassessment (43%), but 35% say that only the zero capital charge for euro zone
sovereign debt should be reconsidereda sensible suggestion in the light of the self-evident mismatch between these supposedly risk-free governmentissue assets and continuing deep uncertainty over the extremely fragile economic situation in some EU states. Insurers are less likely than other survey respondents to support the proposed capital charges of Solvency IIjust 9% compared with 22% of FIs (excluding insurers) and 26% of corporates (non-FIs). But what is surprising is that one-half of insurers favour just reassessing the capital charge for euro zone debt, compared with 41% who would like to see charges for all asset classes reconsidered. The dramatic events in Europe over the past months, reflected in a series of bond market crises, have made it clear that it is not realistic, nor sensible, to talk about a zero risk rate at the present time. However, any alteration to the capital charge of this debt will have to be upward which will certainly not be in insurers interests. I cant see why any insurer would want to see a reassessment, says Ms Carter-Vaughan of Expert Insurance Group.
Chart 4: Do you agree or disagree with the following statement? Solvency II sets capital charges for different assets according to their risk level, with EEA sovereign bonds given a zero-credit risk charge. In light of the eurozone debt crisis, what do you think should happen to the capital charges of Solvency II?
All respondents FIs (excluding insurers) Insurers Corporates (non-FIs)
Regulators should maintain the current capital charges
22%
22%
9%
26%
Regulators should reconsider the capital charges for all asset classes
43%
42%
41%
48%
Regulators should reconsider the capital charge for sovereign bonds
35%
36%
50%
26%
Who will pay the price?

There is a clear feeling that the bill for Solvency IIboth the costs of testing and implementation and the ongoing costs of holding a greater amount of capitalwill have to be absorbed by insurance companies customers. Almost three-quarters (73%) of survey respondents see it as inevitable that Solvency II will ultimately be paid for by policyholders through higher costs, although one-half feel that price increases are an acceptable trade-off for the additional security provided by enhanced capital guarantees. Its inevitable that the new regulations will be paid for by policyholders. Greater security is a quid pro quo [for the higher cost], but people
Chart 5: Do you agree or disagree with the following statement? Solvency II will ultimately be paid for by policyholders through higher costs.
12
% 16
7% 17%
11%
69 %
disagree
26%
16%
neutral
57%
15%
respondents
all
73%
agree
82%
Chart 6: Do you agree or disagree with the following statement? Solvency II will lead to higher costs for policyholders but this is acceptable in view of the additional security provided by the capital guarantees.
15%
% 27
21 %
46
20%
disagree
respondents
all
50%
4 4%
41%
agree
30%
neutral
29
%
34
57
probably wont feel they get value from itI think it will depend on how much more they have to pay, comments Mr Williams of Legal & General. He points out that long-term products with greater requirements for extra capital charges will be particularly hard-hit. Annuity prices, for example, could well rise and theyll feed through to consumers. Ms Carter-Vaughan agrees. A few years ago, insurers could make a loss on their underwriting book because they could rely on investment profits to offset itbut low interest rates and a poor investment climate have put an end to that. So now they have to make a profit on the underwriting,
which means premiums have to go up anyway, regardless of the regulatory changes. Solvency II will exacerbate that trend because its likely to result in fewer small and medium firms, so therell be less supply to meet demand. Rising premiums are likely to bring their own ramifications. The survey shows there is some concern that policyholders faced with price rises they consider unacceptable may simply review their insurance needs and cut corners: 41% of respondents expect companies to choose to be under-insured in the wake of Solvency II, with a similar percentage (39%) anticipating that individual policyholders will take such action.
Chart 7: Do you agree or disagree with the following statements?

Solvency II will lead to higher costs to individual policyholders, which will lead to more people choosing to be under-insured. Solvency II will lead to higher costs to corporate policyholders, which will lead to more companies choosing to be under-insured.
39% agree 30% neutral 31% disagree
41% agree 28% neutral 31% disagree
10
But Mr James of Lockton gives that idea short shrift. I think under-insurance is highly unlikely, he responds. There is a highly competitive insurance market across the EU, and consumers will be able to shop around. The harmonisation of EU capital standards is a worthy goal, in that it makes that option possible. The survey suggests that it is less likely that insurers will respond to higher costs by reducing the quality of their productsfor instance, by incorporating less-extensive guaranteeswith only 29% overall expecting the emergence of inferior products. The interviewees are divided in their views on this hypothesis. Mr Jamess view is that there will be a rebalancing of product ranges in response to the new parameters of Solvency II, but there is no reason to assume those products should be of poorer quality. But Ms Carter-Vaughan is emphatic that product ranges and quality will deteriorate, although she anticipates that relatively commoditised products such as motor insurance will be less affected than more unusual or bespoke cover. Its bound to
Chart 8: Do you agree or disagree with the following statement? Solvency II will ultimately be paid for by policyholders through inferior products.
28%
36%
% 19
44 %
32%
23%
disagree
29%
respondents
all
agree
31%
37%
Corporates (non-FIs) FIs (excluding insurers)
Insurers
INSURERS
Solvency II will lead to higher costs to corporate policyholders, which will lead to more companies choosing to be under-insured. Solvency II will ultimately be paid for by policyholders through inferior products.
27% 35%
agree neutral
disagree
38%
37%
neutral
disagree
44%
19%
agree
Solvency II will ultimately be paid for by policyholders through higher costs.
Solvency II will lead to higher costs to individual policyholders, which will lead to more people choosing to be under-insured.
57%
agree
26%
neutral
22%
agree
35%
neutral
disagree
43%
17%
disagree
11
39%
neutral
%
4
43
happen because we will lose medium and smaller insurers, and that is where more innovative, flexible underwriting goes on, in contrast to the very by-thebook approach of the big insurers, she explains. Interestingly, insurers responding to the survey are markedly more optimistic across the board that the financial fallout from Solvency II will not have an adverse impact on policyholders. Given that insurers are likely to have thought more about the cost implications of the new regime than any other group, are these surprising findings? Are the FIs (excluding insurers) and corporates (non-FIs) being overly cynical in their assessment of the obvious outcome? Are the insurers being nave or do they have a solution up their sleeves? Our interviewees are convinced that there is only one, inevitable outcome. Policyholders will undoubtedly end up shouldering the coststhe bottom line is that theres nothing free on any balance sheet, says Mr James. Concerns over how increased costs will affect different types of insurance products show that the longer-duration products are expected to be hit hardest. As seen in the chart below, shorter-duration products such as personal lines, commercial and catastrophe are predicted to be less negatively affected than longer-term products such as life insurance and annuities. Looking at the effect of regulation on insurers savings products and a broader shift to unitlinked policies, which put the investment risk on the policyholder, over one-half (51%) of survey respondents believe that a shift (to unit-linked products) will have a negative long-term effect on pension and savings provision. The survey also finds some regrets at the demise of with-profits products in favour of unit-linked policies, with 45% saying with-profits policies would be valued by retail customers, given the turbulence of current market conditions. But 39% concur with the idea that they have been driven out of existence by excessive capital charges and accounting rules. When unit-linked policies came onto the market, they were seen as cheaper and more transparent, and customers preferred them, comments Mr Williams. With-profits are still very popular in other EU countries such as Germany, because of the guaranteed returns always offered there, but L&G wont be offering new with-profits products.
Chart 10: Which products do you think will be most negatively affected by Solvency II? Select up to two.
Other, please specify Personal lines of insurance Commercial insurance Catastrophe insurance Annuities Life insurance
1% 15% 25% 26% 43% 67%

With-profits policies have been largely driven out of existence because of capital charges and accounting rules. With-profits policies, which smooth the volatility of returns, would be valued by retail customers in todays turbulent market conditions. The shift to unit-linked policies, which put the investment risk on the policyholder, will have a negative long-term affect on pension and longterm savings provision.
agree
39%
agree
45%
51%
agree
38%
neutral
neutral
39%
neutral
31%
23%
disagree
disagree
16%
disagree
18%
12
Will pension schemes also be subjected to Solvency II-style regulation?
The European Commission is keen to introduce a Solvency II-style regime for defined benefit (DB) occupational pensions as well, forcing pension schemes to account for their liabilities by using a risk-free rate of return. At present, the proposals are still being considered, but it is clear that pension funds in general are against such a proposal. Two-thirds of pension funds responding to the survey agree with the idea that pensions should be separately regulated from insurers. As Jay Shah, head of business origination at the Pension Insurance Corporation, observes: This is set to be hugely controversial over the next two years. Pension schemes are concerned because their funding position is likely to look worse as a consequence of Solvency II. Of course, unlike insurers who have to be fully funded, pension schemes can rely on a corporate sponsor, and they would have to work out what the value of that sponsorship amounted to. But the liability side doesnt differ between the two, he adds. Insurance companies and defined benefit schemes are promising the same thing to the individual member, so why should there be a need for different regulation? He expects that although the Solvency II rules will not be applied precisely to DB pension schemes, the principles will, so that in an adverse scenario the scheme could meet 100% of its liabilities to members.
13
Shifting down the risk spectrum

The survey also examined the impact of Solvency II on insurers role as investors in capital markets. Respondents were asked to indicate, from a lengthy list, those assets they expected to become less popular with insurers in the light of the new regime, and those they thought would grow in popularity. The assets most widely expected to lose favour are equities, non-investment-grade corporate bonds, hedge funds and longdated debt. The top beneficiaries include investment-grade corporate bonds, cash and short-dated debt.
Chart 12: Because of Solvency II, insurers will have a reduced/increased appetite for which of the following assets? Select all that apply
reduced increased
NON-INVESTMENT-GRADE CORPORATE BONDS INVESTMENT-GRADE CORPORATE BONDS EqUITIES LONG-DATED DEBT SHORT-DATED DEBT EMERGING MARKET SOVEREIGN DEBT DEVELOPED BUT NONEUROzONE SOVEREIGN DEBT EUROzONE SOVEREIGN DEBT HEDGE FUNDS INFRASTRUCTURE INVESTMENT PROPERTY PRIVATE EqUITY CASH OTHER, PLEASE SPECIFY
55% 17% 56% 44% 17% 30% 21% 26% 45% 26% 25% 37% 16% 1%
8%
43%
9%
24% 39% 16% 16% 21%

8%
15% 29% 14% 40% 1%
14
Specifically in the case of insurers responses, that reduced appetite for equities and lower-grade corporate debt is even more pronounced. Insurers are also markedly more negative on infrastructure and property investment than respondents overall, with 44% anticipating a downturn in demand for both those asset classes. That said, they are more comfortable with euro zone sovereign debt and somewhat more enthusiastic about investmentgrade bonds. So there are indications of a clear shift down the risk spectrum by insurers. Is there a concern that such a shift could leave insurers looking at their market capital requirements in isolation, rather than in the wider context of return on capital? Ravi Rastogi, senior investment consultant at Towers Watson, believes that in practice insurers will not be able to afford to ignore investment return. They will have to make trade-offs between return on capital and capital charges, he comments. One possible outcome, indicated by respondents views on likely shifts in asset allocation, is that they may move away from investing right through the cycle on a buy and hold basis, and towards a more active approach to asset allocation, moving into capital-intensive assets only when the outlook is particularly positive. The question is then, is Solvency II a force for good in that it forces insurers to become sufficiently sophisticated to look at risk-return against capital charge, with an eye to where a given asset class is in its cycle, or will it promote a less positive but more easily implemented short-termist agenda? Mr Rastogi believes that, in some respects, changing regulations may actually work to insurers benefit as investors provide a broader potential investment choice for them. Solvency I favours yield-producing assets so insurers have a bias towards them even if non-yielding assets make macro-economic sense; there is also an inbuilt bias towards sticking with the home currency, he explains. Solvency II has no such constraintsthere is no bias towards yield, and the risk capital requirements will not vary according to territory (although there will of course be differences between the credit-worthiness of different countries). That means insurers should have better opportunities for economically
Chart 13: Because of Solvency II, insurers will have a reduced/increased appetite or which of the following assets? Select all that apply.
INSURERS
reduced increased
NON-INVESTMENT-GRADE CORPORATE BONDS
67% 24%
6% 49% 11%
LONG-DATED DEBT
INVESTMENT-GRADE CORPORATE BONDS
EqUITIES
64% 42% 26% 42% 35% 24%

HEDGE FUNDS
16%
SHORT-DATED DEBT
35% 16% 9% 40% 6% 7%
EMERGING MARKET SOVEREIGN DEBT
DEVELOPED BUT NON-EUROzONE SOVEREIGN DEBT
EUROzONE SOVEREIGN DEBT
47% 44%
INFRASTRUCTURE INVESTMENT
PROPERTY
44%
18%
PRIVATE EqUITY
29% 24%
CASH
27% 0%
36% 2%
OTHER, PLEASE SPECIFY
15
driven diversification, and also for more globalised investment. Nonetheless, although insurers are allowed in principle to hold a range of risk assets, in practice their decisions under Solvency II will be constrained by the need to match assets and liabilities and to optimise returns within a limited capital charge budgetand that will have implications for the make-up of their portfolios. There is a risk that the Solvency II regulations might push many insurers towards a narrow range of investment options, which could lead to increased volatility in those areas. But nimbler insurers could exploit that herd mentality by making use of less popular asset classes, comments Jay Shah, head of business origination at the Pension Insurance Corporation (PIC). For James Hughes, chief investment officer at HSBC Insurance, the issue is not just about regulation forcing insurers in and out of different asset classes, but also how to make assets more capital-efficient. Solvency II is making everyone think very hard about every strategyit is not just about risk and return but now has a greater focus on capital implications, he says. Ive seen fund of hedge funds marketing themselves as potentially more capital-efficient because they are offering greater transparency through risk analytics,
allowing clients to show more detailed analysis on their entire portfolio. Mr Shah makes the additional point that there is a danger that the new regime will not be sufficiently flexible to allow the fine-tuned treatment of different asset classes. Solvency II needs to be written to allow the emergence of new assets such as infrastructure. These investments tend to be secure, very long-term ones; they pay a high yield because the money is tied up during that time, not just because there is an element of capital risk. Solvency II could prejudice such investments if it penalises them with excessive capital charges. The fact is that the rules are not yet set in stone, and until they are it is not clear how asset allocation will be affected. The survey gives some hope that the transition may not be too painful. A majority (58%) of respondents are confident that changes to asset allocation will be phased in gradually by insurers, which should give the corporates hoping to attract their capital time to adjust to the new funding paradigm. But there is less reassurance from the finding that almost one-third (32%) of corporates (non-FIs) are confident that the changes will have no adverse effect on demand for any asset classagain raising the question of whether they have fully grasped the wider implications of the new regime for financial markets.
Chart 14: How do you think insurers will implement any changes to asset allocation?
All respondents FIs (excluding insurers) Insurers Corporates (non-FIs)
In different ways, so no asset class is adversely impacted.
23% 16% 25% 32%
On a phased basis over a long period of time, with no shock effect to markets.
58%
65%
57%
45%
All at once, directly impacting asset markets over a short period of time.
19% 19% 19% 23%
26%
16
Implications for companies seeking financing

There is a strong consensus among FIs (excluding insurers) and insurers that the new regulations will make the tenor and rating of corporate bonds more significant, as insurers, driven by capital charge considerations, are increasingly pushed towards investment-grade debt at the expense of lower-grade debt. Insurers obviously understand their own capital considerations and FIs (excluding insurers), looking at their own funding requirements under Basel III, will be very aware of the importance of tenor. Basel III aims to improve banks stability by requiring them to hold more long-term debt funding than in the past. But that requirement is at odds with Solvency II, which makes holding long-dated debt less attractive to insurers. In other words, there is the risk that banks and insurers are set to find themselves pulling in opposite directions. However, corporates (non-FIs) do not seem to see at this stage the connection between regulatory requirements and their own funding preferences: only 48% concur, and 21% disagree outright. Over time, however, it is likely that debt-issuing companies will adjust their behaviour to try to align with insurers requirements. They may have to issue shorter-dated debt on a more frequent basis. They may also adjust their capital structure to achieve investment-grade status, or offer higher yields in compensation for the capital costs to insurers. Most notably, a clear majority (60%) of survey respondents agree that unrated companies may have to pay higher yields to attract insurers in the aftermath of Solvency II. But insurers as a group are markedly less convinced. Only 39% agree, compared with 73% of FIs (excluding insurers) and 53% of corporates (non-FIs) This suggests that,
Chart 15: Do you agree or disagree with the following statement about corporate debt issuance? Solvency II makes the tenor and rating of bonds from corporate debt issuers more significant.
Insurers
agree
agree
48%
62%
79%
agree
31%
neutral
31%
neutral
21%
disagree
17% 7%
neutral
disagree
3% disagree
17
Chart 16: Do you agree or disagree with the following statement about corporate debt issuance? Unrated corporates will be forced into paying higher yields as that will make their debt more attractive to insurers post-Solvency II.
All respondents
Insurers
agree
agree
agree
60%
53%
39% 37%
73%
agree
25%
neutral
31%
neutral
neutral
15%
disagree
16%
24%
disagree
disagree
16% neutral
11% disagree
unlike other groups with less knowledge of the implications of the new regulations, they know they may be unable to afford the capital charges associated with such companies debt, no matter how generous the yield. Of course, insurers will have to assess the risk versus reward profile for any corporate debt they consider buying, but they will only have a finite amount of capital available as cover, comments Mr Rastogi of Towers Watson. It will be a question of finding the optimal mix of assets within their specific risk budget. Mr Williams of Legal & General speculates that insurers may be allowed to appeal to the authorities on the grounds that they have built up a strong portfolio of BBB-rated debt and therefore have the expertise to make distinctions on the grounds of a companys security and quality. He believes that the shift away from non-investment-grade debt could cause significant difficulties for many companies. EIOPA wants to see a lower chance of default on insurers investments, through the use of highergrade debt. But many smaller, well-established industrial firms across the EU are graded BBB. Of course they are not as secure as blue-chips, and they pay higher yields to compensate, but they are not inherently risky propositions. Importantly, its these companies that tend to lead their countries out of recession, and if the banks are not lending and the insurers are penalised for buying their debt, they will face a big problem.
An examination of the implications of Solvency II for companies trying to raise debt throws up another concernthat the regulators may have failed to consider the big picture, and that there is a mismatch between the aims of this piece of regulation and those of Basel III. When asked whether the two directives represent a conflict of interests for banks and insurers, and if so what the consequences might be, the majority of survey participants who offered an opinion were in agreement, although they gave a wide range of possible outcomes. I think these regulations might create conflict; they may increase demand for sovereign debt from both banks and insurers, commented one UK-based bank respondent. Others suggested that the main consequence could be a more volatile market. The potential conflict between these two directives could put EU banks and their funding at risk, added a composite insurance respondent from the UK. A number were more cautious, admitting that until Solvency II comes into force, it will be very difficult to predict how the clash of interests will affect those involved. I think that these regulations are going to create conflicting goals, but the consequences are still unknown. We will have to wait until their implementation, said a bank respondent based 3in Denmark.
18
Predicting the unintended consequences

There are fears that the regulatory regime of Solvency II will introduce a host of unforeseen problems. The survey findings indicate that there is little sense of any profound need for additional regulation in terms of insurers meeting their obligations to policyholders. Most respondents particularly insurers (62%) and pension funds (64%), unsurprisinglyconsider the current level of regulation sufficient. Moreover, there are serious concerns among respondents that regulators have not thought through the broader impact of the new legislation on capital markets. Answers to an open question in the survey highlight the sheer range of potential problems. A number of respondents are worried about the idea of introducing a complex and potentially restrictive regime at a time when both EU economies and markets are so fragile. As one bank respondent from Denmark puts it: Capital markets are in a bad shape right now and are not ready for a major change. Several voice concerns about the negative impact on wider economic growth, and one, another bank respondent from Denmark, adds that it is not only macroeconomic factors that are at risk, but also the pressure put on the financial sector due to the timing of Basel III and Solvency II. Others highlight the impact on particular asset classes. My main concern is that insurers are
Chart 17: Do you agree or disagree with the following statement on regulation? The current level of regulation is sufficient to ensure that the insurance industry is able to fulfil its obligations to policyholders.
All respondents
56%
agree
18% 26%
neutral disagree
48%
agree
21% 31%
neutral
disagree
Insurers
62%
agree
17% 21%
neutral disagree
58%
agree
16% 26%
neutral
disagree
19
Chart 18: How will Solvency II impact the structure of smaller friendly societies and mutuals?
20%
54%
They will consolidate to achieve scale
11%
16%
They will outsource more to access scale
They will close to new business
There will be no material impact
being dissuaded from buying long-term bonds under the EU Solvency II rules, says a life insurance respondent from the UK. But others are worried about the impact on equity markets, growth in demand for derivatives, the trend towards a more concentrated range of asset classes and the risk of a further credit crunch as a consequence of over-regulation. A further area of uncertainty focuses on the impact of the new regime on smaller friendly societies, mutuals and monoline insurers. Mr Williams of Legal & General makes the point that large insurers with a range of products have the resources to absorb additional overhead costs, and that at the other end of the spectrum the industry in Europe is much more skewed towards small mutual specialists serving a local community, who have their own well-established niches and may be below the minimum size to qualify for Solvency II regulation anyway. Its the monoline providers in the middle who are likely to be more disadvantaged than either of these groups, he says. More than one-half (53%) of all respondents expect to see a spate of consolidation as smaller insurers try to achieve economies of scale; a further 20% anticipate that they will move towards outsourcing more functions.
Ms Carter-Vaughan of Expert Insurance Company agrees that the insurance giants are in a stronger position because of their resource base. Mediumsized firms, especially broker-only businesses without their own direct distribution arm, are in a particularly difficult position, exacerbated by the economic climate. These businesses may be well-capitalised, with generous solvency marginsbut if theyre invested in government bonds and banks, and the ratings agencies take a view on that investment base and downgrade their ratings, as has happened already to some firms, the insurance brokers will have to drop away, she explains. Solvency II will make this much worseit couldnt be happening at a worse time. However, Mr Shah of PIC disagrees that it is all a matter of scale, observing that large multi-national insurers with subsidiaries in different EU countries are likely to face their own problems. Before Solvency II, local regimes often understated the amount of capital needed by insurers, on the grounds that the multi-national parent was holding a sensible amount at group level, albeit in other jurisdictions. Solvency II will push the obligation to hold the right amount down to subsidiary level, and limit companies ability to move capital around between countries as needed.
20
conclusion
It is clear that while some boost to the current regulatory situation may be necessary, both the potential consequences and the timing of Solvency II are a source of considerable concern. Indeed, it seems that while the new regime would be bound to have ramifications regardless of when it is introduced, the euro zones current difficult political and economic climate and wider tough investment conditions are all set to make things worse for insurers and their stakeholders alike. There are various implications for policyholders, but the bottom line is that premiums are likely to increase in priceas a result of the implementation and overhead costs of Solvency II, the further reliance on underwriting profit rather than investment return and because the range of providers may shrink as firms are pushed into consolidation. Some policyholders may be forced to reduce their levels of cover or drop some insurances altogether because of price increases. There is also a risk that they will find it harder to source more unusual types of cover because of the contraction in the number of middle-sized firms, which have traditionally played an innovative role in the insurance marketplace. Savings and investment products are also likely to be affected. As the costs of guarantees become clearer, they will inevitably increase. Investors generally see guarantees as attractive but do not place the same value on them as the cost to hedge those guaranteesthe challenge to the industry will be to find the right balance. The possible consequences are arguably also serious for companies seeking to raise money in the capital markets, where insurance companies are major institutional investors. Insurers are likely to shift their portfolios down the risk spectrum, away from equities and lower-quality
corporate debt and towards safer assets such as cash and investment-grade debt. But that may leave a tranche of smaller companies companies that could be leading European economies back towards growthwith serious funding problems because they do not have a high enough debt rating. So what is the prognosis for the future, and for Solvency IIs progress onto the statute books? Mr James of Lockton emphasises that what the insurance market really wants is absolute clarity as to how the rules will be applied. Implementation is still two years away, in 2014, and clearly there will be many discussions before everything is clarified, particularly given the highly uncertain political and economic backdrop against which decisions must be made. One area where regulators must consider the implications of Solvency II is the impact on the cost of guarantees. EU regulators seem to want safety at all costs and appear to be more comfortable with people being under-insured rather than properly insured but somewhat at risk of the guarantee not being met by the insurer. Mr Shah of PIC believes that the European authorities are likely to have to agree on substantial compromises to make it more workable and acceptable to national regulators and the industry, if it is to be in place roughly on time. There is also pressure to get things right as Solvency IIs reach has potential to go beyond the EU. Many foreign regulators, particularly those in developing markets, look to the EU and the US for guidance on key principles as they dont want to be out of sync with these major markets, comments Mr Hughes of HSBC Insurance. This could make Solvency II even more far-reaching in the future.
21
appendix: survey results

In which country are you personally located?
(% respondents) Spain
18
United Kingdom
16
Denmark
13
Germany
12
Netherlands
11
Sweden
10
Finland
6
France
6
Luxembourg
5
Belgium
1
Ireland
1
Note: numbers do not add to 100% due to rounding 0
0 0
What is your primary job function?

0 (% respondents)
Finance
72
Risk
24
IT
2
General management
12
Operations and production

1 0 0 0 0
22
Which of the following best describes your job title?

(% respondents) CFO/Treasurer/Comptroller
30
Head of department
28
SVP/VP/Director
15
Other C-level executive

9
CEO/President/Managing director
8
Board member
6
Head of business unit

4
CIO/Technology director
1
Other
1
0 0
What is your primary industry?

0 (% respondents)
Automotive 0
1
Chemicals 0
1
Construction and real estate

1
Consumer goods
2
Financial services
71
Government/Public sector
2
Healthcare, pharmaceuticals and biotechnology

2
IT and technology
2
Manufacturing
10
Power & utilities

2
Professional services
2
Retailing
1
Telecommunications
1
Transportation, travel and tourism

2
23
What is your main business?

(% respondents) Pension fund
25
Bank
25
Non-financial corporates
25
General
9
Life
8 25
Composite - both life and general

6
Asset manager
1
Other, please specify

1 0 0 0 25
What are your company's annual global revenues?

(% respondents)
0 500m or less 21 0 500m to 1bn 44 0 1bn to 5bn 15 0 5bn to 10bn 9
10bn or more
11
10
15
20
25
What are your organisations assets under management (AUM)?

0 (% respondents) 0 100m or less 2 0 100m to 500m 14 0 500m to 1bn 11 0 1bn to 10bn 30 0 10bn to 25bn 6 0 25bn to 50bn 3 0 50bn or more 34 0 0 0 0 0 0 0 0
24
What are the most important roles the insurance industry plays in society? Select up to three.
(% respondents) Allowing individuals to protect themselves from risk
74
Allowing institutions to protect themselves from risk

56
Acting responsibly in their dealings with policyholders

35
Acting responsibly as shareholders of corporations

34
Complying with regulations set by government

32
Acting responsibly as providers of debt and equity capital to corporations

30
Generating tax revenues for central government

3 0 0
Do you agree or disagree with the following statements?

(% respondents) It is the duty of insurers to contribute positively to society. It is the duty of insurers to deliver returns to shareholders. It is the duty of insurers to provide financial stability to policy holders/customers. It is the duty of insurers to comply with all applicable laws and regulations, but beyond that, they have no duty to contribute positively to society. The insurance industry in the European Union generally contributes positively to society.
0 41 30 30 0 79 14 7 0 67 20 13 0 82 13 5 0 0
Agree Neutral Disagree
10
20
30
40
50
69
60
70
22
80
0 0
Will Solvency II make it more difficult for insurers to do any of the following? Select all that apply.
0 (% respondents) 0 Take the same level of investment risk as pre-Solvency II 57 0 Achieve similar investment returns as pre-Solvency II 54 0 Achieve investment returns sufficient to maintain current consumer pricing (such as insurance premiums) 52 0 Deliver a similar return on capital to shareholders as pre-Solvency II 56 0 Deliver a return on capital sufficient to satisfy most shareholders 43 0 0 0 0 0 0 0 0
25

(% respondents) Solvency II goes too far in ensuring insurers have sufficient capital to meet their guarantees.
51 34 39 50 41 28 73 16 30 16 25 20 31 11 32 31
Most insurers already have sufficient capital to meet their guarantees.

36
Solvency II will lead to higher costs for policyholders but this is acceptable in view of the additional security provided by the capital guarantees. Solvency II will lead to higher costs to corporate policyholders, which will lead to more companies choosing to be under-insured. Solvency II will ultimately be paid for by policyholders through higher costs. Solvency II will ultimately be paid for by policyholders through inferior products.
29 39 40 30
Solvency II will lead to higher costs to individual policyholders, which will lead to more people choosing to be under-insured.
The shift to unit-linked policies, which put the investment risk on the policyholder, will have a negative long-term affect on pension and long-term savings provision. 51 31 18
With-profits policies, which smooth the volatility of returns, would be valued by retail customers in today's turbulent market conditions.
45 39 38 16 23
With-profits policies have been largely driven out of existence because of capital charges and accounting rules.
39 0 Note: numbers do not add to 100% due to rounding 0 0 0 Which products do you think will be most negatively affected by Solvency II? Select up to two.
(% respondents)
0
Life insurance
67
Annuities
43
Catastrophe insurance
26
Commercial insurance
25
Personal lines insurance

15

1 0 0 0 0 0 0 0 0 0
10
20
30
40
50
60
70
80
26
Because of Solvency II, insurers will have an increased/reduced appetite for these assets? Select all that apply.
(% respondents)
Reduced Increased
Non-investment-grade corporate bonds

55 17 8
Investment-grade corporate bonds

43
Equities
56 9
Long-dated debt
44 24
Short-dated debt
17 39
Emerging market sovereign debt

30 21 16
Developed but non-eurozone sovereign debt

16
Eurozone sovereign debt

26 21
Hedge funds
45 62 26 8
Infrastructure investment
15
Property
25 29
Private equity
37 14
Cash
16 40

11 0
How do you think insurers will implement any changes to asset allocation?
(% respondents) All at once, directly impacting asset markets over a short period of time
19
06
05
04
03
02
01
10
20
30
40
58
50
On a phased basis over a long period of time, with no shock effect to markets In different ways, so no asset class is adversely impacted
23 0 0

0 (% respondents)
0 Solvency II makes the tenor and rating of bonds from corporate debt issuers more significant. 66 0 Corporates will be required to come to market for debt issuance more frequently post-Solvency II. 59 0 Corporates will be forced into paying for ratings as that will make their debt more attractive to insurers post-Solvency II. 59 60 0
Note: numbers do not add to 100% due to rounding
25 28 29 25 69 22
8 13 12 15 9
0 Unrated corporates will be forced into paying higher yields as that will make their debt more attractive to insurers post-Solvency II.
0 0 0 0 0 0 0
27
Solvency II sets capital charges for different assets according to their risk level, with EEA sovereign bonds given a zero credit risk charge (meaning insurers do not need to hold capital against these assets). In light of the eurozone debt crisis, what do you think should happen to the capital charges of Solvency II?
(% respondents) Regulators should reconsider the capital charge for sovereign bonds
35
Regulators should reconsider the capital charges for all asset classes
43
Regulators should maintain the current capital charges

22 0 0
The European regulator is currently considering whether to introduce a Solvency II-style prudential regime 0 for occupational pension schemes. What do you think would be the impact of this? Select all that apply.
(% respondents)
0
It will add significantly to schemes funding requirements It will lead to more defined benefit schemes to reduce investment risk It will lead to the closure of many defined benefit schemes
41
0 0
55 53
It0 lead to more buy-outs of occupational pension schemes will

29 0 0
0 0
0 0
Do you agree or disagree with the following statements? 0 0

(% respondents)
0 0 0 0 0 0
Agree
Neutral
Disagree
It is appropriate to regulate occupational pension fund provision under a separate regime from that which insurers have to comply.
The current level of regulation is sufficient to ensure that the insurance industry is able to fulfil its obligations to policyholders.
56 18
10
20
41
30
61
40
27
12
26 29 25 22
50
12 15 9
59 60
0 How will Solvency II impact the structure of smaller friendly societies and mutuals? 69
(% respondents)
0
They will outsource more to access scale They will consolidate to achieve scale They will close to new business There will be no material impact
0 0 16 0 11 0 0
10
20
20
30
40
50
60
54
0 Note: numbers do not add to 100% due to rounding 0 0 0 0 0 0 0 0 0 0 0

28
notes
29
While efforts have been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd, nor its affiliates can accept any responsibility or liability for reliance by any person on this white paper or any of the information, opinions or conclusions set out in the white paper.
The following regulatory disclosure language only applies to BNY Mellon and the distribution of this report by BNY Mellon. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation. The statements and opinions expressed in this report do not necessarily represent the views of BNY Mellon or any of its respective affiliates. The information in this report is not intended and should not be construed to be investment advice in any manner or form; its redistribution by BNY Mellon may be deemed a financial promotion in non-U.S. jurisdictions. Accordingly, where this report is used or distributed in any non-U.S. jurisdiction, the information provided is for use by professional investors only and not for onward distribution to, or to be relied upon by, retail investors. This report is not intended, and should not be construed, as an offer or solicitation of services or products or an endorsement thereof by BNY Mellon in any jurisdiction or in any circumstance that is otherwise unlawful or unauthorized. BNY Mellon Asset Management International Limited and its affiliates are not responsible for any subsequent investment advice given based on the information supplied. Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than you originally invested.
30
London
26 Red Lion Square London WC1R 4Hq United Kingdom Tel: (44.20) 7576 8000 Fax: (44.20) 7576 8476 E-mail: [email protected]
NewYork
111 West 57th Street New York NY 10019 United States Tel: (1.212) 554 0600 Fax: (1.212) 7576 8476 E-mail: [email protected]
HongKong
6001, Central Plaza 18 Harbour Road Wanchai Hong Kong Tel: (852) 2585 3888 Fax: (852) 2802 7638 E-mail: [email protected]
24
The Economist Intelligence Unit Limited 2012 2011
xx

Insurance and Society: How Regulation Affects The Insurance Industry's Ability To Fulfil Its Role

Uploaded by

Copyright:

Available Formats

Insurance and Society: How Regulation Affects The Insurance Industry's Ability To Fulfil Its Role

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Insurance and Society: How Regulation Affects The Insurance Industry's Ability To Fulfil Its Role

Uploaded by

Copyright:

Available Formats

Insurers and society

The Economist Intelligence Unit Limited 2012

About this report

Striking the right balance

Who will pay the price?

Shifting down the risk spectrum

Implications for companies seeking financing

Predicting the unintended consequences

The Economist Intelligence Unit Limited 2012

Key findings include:

The Economist Intelligence Unit Limited 2012

The Economist Intelligence Unit Limited 2012

about this report

The Economist Intelligence Unit Limited 2012

The Economist Intelligence Unit Limited 2012

Striking the right balance

FIs (excluding insurers)

The Economist Intelligence Unit Limited 2012

The Economist Intelligence Unit Limited 2012

Regulators should maintain the current capital charges

Regulators should reconsider the capital charge for sovereign bonds

The Economist Intelligence Unit Limited 2012

Who will pay the price?

The Economist Intelligence Unit Limited 2012

Chart 7: Do you agree or disagree with the following statements?

39% agree 30% neutral 31% disagree

41% agree 28% neutral 31% disagree

The Economist Intelligence Unit Limited 2012

Corporates (non-FIs) FIs (excluding insurers)

Chart 9: Do you agree or disagree with the following statements?

Solvency II will ultimately be paid for by policyholders through higher costs.

The Economist Intelligence Unit Limited 2012

1% 15% 25% 26% 43% 67%

Chart 11: Do you agree or disagree with the following statements?

The Economist Intelligence Unit Limited 2012

Will pension schemes also be subjected to Solvency II-style regulation?

The Economist Intelligence Unit Limited 2012

Shifting down the risk spectrum

24% 39% 16% 16% 21%

15% 29% 14% 40% 1%

The Economist Intelligence Unit Limited 2012

INVESTMENT-GRADE CORPORATE BONDS

64% 42% 26% 42% 35% 24%

35% 16% 9% 40% 6% 7%

EMERGING MARKET SOVEREIGN DEBT

DEVELOPED BUT NON-EUROzONE SOVEREIGN DEBT

EUROzONE SOVEREIGN DEBT

OTHER, PLEASE SPECIFY

The Economist Intelligence Unit Limited 2012

All respondents FIs (excluding insurers) Insurers Corporates (non-FIs)

In different ways, so no asset class is adversely impacted.

23% 16% 25% 32%

19% 19% 19% 23%

The Economist Intelligence Unit Limited 2012

Implications for companies seeking financing

FIs (excluding insurers)

The Economist Intelligence Unit Limited 2012

FIs (excluding insurers)

Predicting the unintended consequences