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  1. 1. Insurersand societyHow regulation affects the insuranceindustry’s ability to fulfil its roleA report from the Economist Intelligence Unit Sponsored by: © The Economist Intelligence Unit Limited 2012 xx
  2. 2. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE contents Executive summary 2 Preface 4 About this report 4 Introduction 5 1 Striking the right balance 6 2 Who will pay the price? 9 3 Shifting down the risk spectrum 14 4 Implications for companies seeking financing 17 5 Predicting the unintended consequences 19 Conclusion 21 Appendix 221 © The Economist Intelligence Unit Limited 2012
  3. 3. executive summaryAs discussion of the details of the Solvency II regime rolls on, insurers arethinking long and hard about how they will manage and monitor their riskstrategies and capital bases. But the implications of their decisions will reachfar beyond the boardroom, affecting both their relationships with corporateand individual policyholders, and also their role as major investors in the debtand equity capital markets.The new regulations were designed to ensure better protection for policyholders,but raise important questions about the extent to which consumers andcorporates will ultimately foot the bill for Solvency II, either directly throughhigher costs or indirectly via less comprehensive products.Meanwhile, the demands of the new regime threaten to disrupt the key roleplayed by insurers as investors in the capital markets, by pushing them towards‘safer’ assets with lower capital charges, and away from the equities and non-investment grade debt on which much private industry depends for financing.This could be a particularly troubling outcome for businesses seeking to raisecapital, given that banks remain reluctant to lend because of their own balancesheet constraints.The Economist Intelligence Unit, on behalf of BNY Mellon, conducted a surveyof 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 potentialimpact of Solvency II on the retail consumer, the insurance industry itself andindustry more broadly, including how insurers are likely to behave as debt andequity investors.Key findings include: S olvency 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. © The Economist Intelligence Unit Limited 2012 2
  4. 4. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE P olicyholders will ultimately issuers more significant, as insurers, bear the costs driven by capital charge considerations, Almost three-quarters (73%) of are increasingly pushed towards survey respondents agree that the investment-grade debt. However, costs to insurers of compliance with corporates (non-FIs) seem less aware the new regulations will be passed of this shift, with just 48% agreeing on to policyholders, and there is compared with 62% of insurers and 79% concern that both corporates and of FIs (excluding insurers). The reality individuals may choose to be under- is that companies are likely to have to insured as a consequence. However, either adjust their capital structure to insurers are markedly less convinced achieve investment-grade status or (57%) than FIs (excluding insurers) offer higher yields in compensation for (82%) and corporates (non-FIs) the capital cost to insurers. (69%) that policyholders will pick up the tab, raising the question of how R egulators should revisit they see the costs of regime change their capital charge levels being met. Also, over one-half (51%) Given the economic risks attached to of respondents believe the shift to many EU countries at present, there unit-linked policies, which put the is strong support, particularly among investment risk on the policyholder, insurers (50%), for regulators to will have a negative long-term affect reassess the zero capital charge for on pension and long-term savings sovereign bonds—despite the fact that provision, with life insurance and a readjustment would mean they would annuities considered the products be required to hold further capital. A most likely to be affected. further 41% of insurers would like to see the capital charges for all assets I nsurers expect to further de-risk reconsidered. Overall, less than one- their asset allocations quarter (22%) of respondents believe A clear shift down the risk spectrum that regulators should maintain the is anticipated by respondents. Assets current capital charges. expected to attract more interest include investment-grade corporate I s Solvency II creating a ‘squeezed bonds, cash and short-dated debt, middle’ among insurers? at the expense of non-investment- While large insurers are able to grade bonds, equities and long-dated absorb the costs of preparation for debt. Almost three in five (58%) Solvency II and enjoy the benefits of respondents overall believe that shift economies of scale, and the small, will happen gradually, giving time local or specialist providers prevalent for market adjustment. But nearly in continental Europe may either one-third of corporates (non-FIs) fall outside the scope of Solvency II (32%) do not believe the changes altogether or have a sufficiently strong will have an adverse impact on any niche market to survive and thrive, the asset class, suggesting they may not mid-sized mutual insurers could be at a fully understand the wider financial disadvantage. Only 16% of respondents implications of the new regime. expect no material impact from Solvency II on the structure of smaller C orporates seem less aware of friendlies and mutuals, and more than the impact Solvency II will have on one-half (54%) believe the pressures of debt issuance the new regime will result in a spate of Among insurers and FIs (excluding consolidations to achieve scale, while insurers) there is a strong consensus 36% of insurers believe these players that Solvency II will make the tenor will outsource more in order to access and rating of bonds from corporate scale.3 © The Economist Intelligence Unit Limited 2012
  5. 5. prefaceInsurers and Society is an Economist Intelligence Unit report, sponsoredby BNY Mellon. The findings and views expressed in the report do notnecessarily reflect the views of the sponsor. The author was Faith Glasgowand the editor was Monica Woodley. about this reportIn January 2012, the Economist Intelligence Unit, on behalf of BNY Mellon,surveyed 254 respondents from companies in Europe to get their views onhow 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-suiteor board level. They were drawn from Europe, with the UK, Spain, Germany, theNetherlands, Denmark and Sweden each having over 20 respondents.In addition, in-depth interviews were conducted with six experts. Our thanks aredue to the following for their time and insight (listed alphabetically): J enny Carter-Vaughan, managing director of the Expert Insurance Group J ames Hughes, chief investment officer at HSBC Insurance J ulian James, UK CEO of broker Lockton International and president of the Chartered Insurance Institute (CII) R avi Rastogi, senior investment consultant at Towers Watson J ay Shah, head of business origination at the Pension Insurance Corporation R andle Williams, group investment actuary at Legal General © The Economist Intelligence Unit Limited 2012 4
  6. 6. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE introduction Insurance companies have But these changes are set to upset traditionally been viewed by wider the status quo, not just for insurers society as the bearers and managers but for policyholders and also of formalised risk, freeing individual for companies looking to attract policyholders from financial worries investors through the capital in the event that things go wrong, markets. Policyholders are likely, for and providing institutions with example, to see the cost of premiums an efficient mechanism by which rise—potentially pushing some to to transfer risk. They have also opt to reduce or ditch their cover historically played a central role rather than pay more. Companies as institutional investors, seeking investors, meanwhile, may channelling funds into the capital find it harder to raise funds in the markets and providing industry capital markets—at the very time with crucial flows of both equity when banks, for their own reasons, and debt capital. are reluctant to lend. Insurers themselves are likely to have to Are those longstanding roles adjust their investment timescales under threat with the impending and strategies of asset allocation, introduction of Solvency II in the potentially finding themselves under European Union? Solvency II aims, conflicting strains as they try to among other things, to provide find the best balance between risk, policyholders with more robust return and capital efficiency. protection by requiring insurers to hold capital according to all In this report, we explore the danger their business risks—including that regulation may, ironically, force the differing risks attached to the insurers to reduce the amount of risk various asset classes in which they they take—and instead offload that invest clients’ cash. risk on to their stakeholders.5 © The Economist Intelligence Unit Limited 2012
  7. 7. 1 Striking the right balance As insurers play a central economic and measuring risk on consistent principles and linking social role in modern Western societies, it has capital requirements directly to those principles. been accepted since the 1970s that some form They will apply throughout the EU, harmonising of prudential supervision by the authorities standards and providing a level playing field for is necessary. insurers across the euro zone. Until now, the focus has tended to be on measures But our survey findings indicate that although to guarantee the solvency of insurers or minimise there is a perception that something needs to the disruption caused by their insolvency. be done to improve the current situation and Solvency II raises the stakes across the board harmonisation should bring its own benefits, by introducing a risk-based capital approach, 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% 39% 25% agree neutral disagree Corporates (non-FIs) 33% 36% 31% agree neutral disagree Insurers 44% 38% 18% agree neutral disagree FIs (excluding insurers) 36% 40% 24% agree neutral disagree © The Economist Intelligence Unit Limited 2012 6
  8. 8. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE On the one hand, just over one-third (36%) of Chart 2: Do you agree or disagree with the following statement? respondents believe that most insurers already Solvency II goes too far in ensuring insurers have sufficient have enough capital to meet their guarantees, capital to meet their guarantees. and even among insurers themselves that confidence only rises to 44%. So there is a Corporates (non-FIs) Insurers FIs (excluding insurers) broad acknowledgement that measures to improve the capital cover of insurance companies are in order. On the other hand, just 16% of all respondents 13% 39% % agree that Solvency II will strike the right balance 15 in ensuring that insurers are properly capitalised in 1% line with their guarantees, and over one-half (51%) 16% 2 say that it goes too far. As Jenny Carter-Vaughan, managing director of the Expert Insurance Group, disagree observes: “No one has gone down in the insurance industry for a very long time; I’d say the current 33% solvency regime is very robust.” 55% all 51% Randle Williams, group investment actuary at Legal respondents agree General, points out that it is unsurprising that the industry feels that the authorities are setting 34% the capital charges too high. “It’s important to neutral remember that some EU countries don’t have any 31 compensation net comparable to the UK’s Financial % Services Compensation Scheme in place to protect consumers. But the tendency of regulators is to go too far—they always want more capital,” he says. % 40 % 55 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 Chart 3: Do you agree or disagree with the following statement? Most insurers already have sufficient capital to meet their guarantees. Life 32% 47% 21% agree neutral disagree General 50% 27% 23% agree neutral disagree Composite 50% 43% 7% disagree agree neutral7 © The Economist Intelligence Unit Limited 2012
  9. 9. generalise. “Some insurers will see their capital sovereign debt should be reconsidered—a sensiblerequirements increase, but others will see a suggestion in the light of the self-evident mismatchdecrease,” he says. “For consumers, though, between these supposedly ‘risk-free’ government-the important thing is the knowledge that the issue assets and continuing deep uncertainty overinsurer will have the same level of capital cover the extremely fragile economic situation in someif they buy in France or Germany as if they were EU states.buying in the UK.” Insurers are less likely than other surveyInsurers and FIs (excluding insurers) are markedly respondents to support the proposed capitalmore critical of the looming regime than corporates charges of Solvency II—just 9% compared with(non-FIs), with 55% believing it will go too far and 22% of FIs (excluding insurers) and 26% ofinsurers will be over-capitalised for the level of corporates (non-FIs). But what is surprising isguarantees they have to meet, compared with 39% that one-half of insurers favour just reassessingof corporates (non-FIs). This raises the question the capital charge for euro zone debt, comparedof whether corporates, while attracted by the idea with 41% who would like to see charges for all assetof greater security, fully understand the potential classes reconsidered.implications of an over-capitalised insuranceindustry for their future activities in the financial The dramatic events in Europe over the pastmarkets. months, reflected in a series of bond market crises, have made it clear that it is not realistic,Looking specifically at the capital charges that nor sensible, to talk about a zero risk rate at theSolvency II will institute for different asset present time. However, any alteration to theclasses, survey respondents are in favour of a capital charge of this debt will have to be upward—reassessment—just 22% say the current charges which will certainly not be in insurers’ interests.should be maintained. Most are in favour of an “I can’t see why any insurer would want to see aacross the board reassessment (43%), but 35% reassessment,” says Ms Carter-Vaughan of Expertsay that only the zero capital charge for euro zone 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% © The Economist Intelligence Unit Limited 2012 8
  10. 10. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE 2 Who will pay the price? There is a clear feeling that the bill for Solvency although one-half feel that price increases II—both the costs of testing and implementation are an acceptable trade-off for the additional and the ongoing costs of holding a greater amount security provided by enhanced capital of capital—will have to be absorbed by insurance guarantees. companies’ customers. Almost three-quarters (73%) of survey respondents see it as inevitable “It’s inevitable that the new regulations will be that Solvency II will ultimately be paid for paid for by policyholders. Greater security is a by policyholders through higher costs, 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. 7% 17% 69 % % 16 % 11% 12 disagree 26% 16% neutral all 57% 73% 15% respondents agree 82% Corporates (non-FIs) Insurers FIs (excluding insurers)9 © The Economist Intelligence Unit Limited 2012
  11. 11. Chart 6: Do you agree or disagree with the 15% following statement? % 27 46 Solvency II will lead % to higher costs for 20% % 21 policyholders but this disagree is acceptable in view of the additional security provided by all 50% 41% the capital guarantees. respondents agree 4 4% 30% neutral 29 % Corporates (non-FIs) Insurers % 34 % 57 FIs (excluding insurers)probably won’t feel they get value from it—I think which means premiums have to go up anyway,it will depend on how much more they have to regardless of the regulatory changes. Solvencypay,” comments Mr Williams of Legal General. II will exacerbate that trend because it’s likely toHe points out that long-term products with result in fewer small and medium firms, so there’llgreater requirements for extra capital charges be less supply to meet demand.”will be particularly hard-hit. “Annuity prices, forexample, could well rise and they’ll feed through Rising premiums are likely to bring their ownto consumers.” ramifications. The survey shows there is some concern that policyholders faced with price risesMs Carter-Vaughan agrees. “A few years ago, they consider unacceptable may simply reviewinsurers could make a loss on their underwriting their insurance needs and cut corners: 41% ofbook because they could rely on investment profits respondents expect companies to choose to beto offset it—but low interest rates and a poor under-insured in the wake of Solvency II, withinvestment climate have put an end to that. So now a similar percentage (39%) anticipating thatthey have to make a profit on the underwriting, 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 Solvency II will lead to higher costs to individual policyholders, which will lead to corporate policyholders, which will lead to more more people choosing to be under-insured. companies choosing to be under-insured. 39% agree 41% agree 30% neutral 28% neutral 31% disagree 31% disagree © The Economist Intelligence Unit Limited 2012 10
  12. 12. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE But Mr James of Lockton gives that idea short shrift. “I think under-insurance is highly unlikely,” Chart 8: Do you agree or disagree he responds. “There is a highly competitive with the following statement? insurance market across the EU, and consumers Solvency II will ultimately be will be able to shop around. The harmonisation paid for by policyholders through of EU capital standards is a worthy goal, in that it inferior products. makes that option possible.” 28% 36% The survey suggests that it is less likely that insurers will respond to higher costs by reducing 19 % % 44 the quality of their products—for instance, by incorporating less-extensive guarantees—with 32% 29% disagree agree only 29% overall expecting the emergence of all 31% inferior products. respondents 23% The interviewees are divided in their views on this hypothesis. Mr James’s view is that “there will be a rebalancing of product ranges” in response to 39% % 43 the new parameters of Solvency II, but there is % neutral 4 3 no reason to assume those products should be of poorer quality. 37% But Ms Carter-Vaughan is emphatic that product Corporates (non-FIs) Insurers ranges and quality will deteriorate, although she anticipates that relatively commoditised products FIs (excluding insurers) such as motor insurance will be less affected than more unusual or bespoke cover. “It’s bound to Chart 9: Do you agree or disagree with the following statements? INSURERS Solvency II will lead to higher costs to Solvency II will ultimately be paid for by corporate policyholders, which will lead to policyholders through inferior products. more companies choosing to be under-insured. 37% 44% 27% 35% 38% neutral disagree agree neutral disagree 19% agree Solvency II will ultimately be paid for by Solvency II will lead to higher costs to policyholders through higher costs. individual policyholders, which will lead to more people choosing to be under-insured. 57% 26% 22% 35% 43% agree neutral agree neutral disagree 17% disagree11 © The Economist Intelligence Unit Limited 2012
  13. 13. happen because we will lose medium and smallerinsurers, and that is where more innovative, flexible Chart 10: Which products do you think will be most negativelyunderwriting goes on, in contrast to the very by-the- affected by Solvency II? Select up to approach of the big insurers,” she explains.Interestingly, insurers responding to the survey Other, please specify 1%are markedly more optimistic across the board that Personal linesthe financial fallout from Solvency II will not havean adverse impact on policyholders. Given that of insurance 15%insurers are likely to have thought more about thecost implications of the new regime than any other Commercial insurance 25%group, are these surprising findings? Are the FIs(excluding insurers) and corporates (non-FIs) beingoverly cynical in their assessment of the obvious Catastrophe insurance 26%outcome? Are the insurers being naïve or do theyhave a solution up their sleeves? Annuities 43%Our interviewees are convinced that there is onlyone, inevitable outcome. “Policyholders will Life insurance 67%undoubtedly end up shouldering the costs—thebottom line is that there’s nothing free on anybalance sheet,” says Mr James.Concerns over how increased costs will affectdifferent types of insurance products show Chart 11:that the longer-duration products are expected Do you agree or disagree with the following statements?to be hit hardest. As seen in the chart below,shorter-duration products such as personal lines, With-profits policies With-profits policies, The shift to unit-linkedcommercial and catastrophe are predicted to be less have been largely driven which smooth the policies, which put the out of existence because volatility of returns, investment risk on thenegatively affected than longer-term products such of capital charges and would be valued by policyholder, will have aas life insurance and annuities. accounting rules. retail customers in negative long-term affect today’s turbulent on pension and long-Looking at the effect of regulation on insurers’ market conditions. term savings provision.savings products and a broader shift to unit-linked policies, which put the investment risk onthe policyholder, over one-half (51%) of survey 39% 45% 51% agree agree agreerespondents believe that a shift (to unit-linkedproducts) will have a negative long-term effect onpension and savings provision. The survey also findssome regrets at the demise of with-profits productsin favour of unit-linked policies, with 45% saying 38%with-profits policies would be valued by retailcustomers, given the turbulence of current market neutral 39% 31%conditions. But 39% concur with the idea that theyhave been driven out of existence by excessive neutralcapital charges and accounting rules. neutral “When unit-linked policies came onto the market,they were seen as cheaper and more transparent, 23%and customers preferred them,” comments disagree 16% 18%Mr Williams. “With-profits are still very popular in disagree disagreeother EU countries such as Germany, because of theguaranteed returns always offered there, but LGwon’t be offering new with-profits products.” © The Economist Intelligence Unit Limited 2012 12
  14. 14. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE Will pension The European Commission is keen to introduce a Solvency II-style regime for defined benefit schemes also (DB) occupational pensions as well, forcing pension schemes to account for their liabilities be subjected to by using a ‘risk-free’ rate of return. At present, Solvency II-style the proposals are still being considered, but it is clear that pension funds in general are regulation? 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 doesn’t 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 © The Economist Intelligence Unit Limited 2012
  15. 15. 3 Shifting down the risk spectrum The survey also examined the impact of Solvency The assets most widely expected to lose II on insurers’ role as investors in capital markets. favour are equities, non-investment-grade Respondents were asked to indicate, from a lengthy corporate bonds, hedge funds and long- list, those assets they expected to become less dated debt. The top beneficiaries include popular with insurers in the light of the new regime, investment-grade corporate bonds, cash and those they thought would grow in popularity. 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 55% 8% Investment-grade corporate bonds 17% 43% Equities 56% 9% Long-dated debt 44% 24% Short-dated debt 17% 39% Emerging market sovereign debt 30% 16% Developed but non- eurozone sovereign debt 21% 16% Eurozone sovereign debt 26% 21% Hedge funds 45% 8% Infrastructure investment 26% 15% Property 25% 29% Private equity 37% 14% Cash 16% 40% Other, please specify 1% 1% © The Economist Intelligence Unit Limited 2012 14
  16. 16. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE Specifically in the case of insurers’ responses, that reduced appetite for equities and lower-grade Chart 13: Because of Solvency II, corporate debt is even more pronounced. Insurers insurers will have a reduced/increased are also markedly more negative on infrastructure appetite or which of the following and property investment than respondents overall, assets? Select all that apply. with 44% anticipating a downturn in demand for insurers both those asset classes. That said, they are more comfortable with euro zone sovereign debt and reduced increased somewhat more enthusiastic about investment- Non-investment-grade corporate bonds grade bonds. 67% 6% So there are indications of a clear shift down the Investment-grade corporate bonds risk spectrum by insurers. Is there a concern that such a shift could leave insurers looking at their 24% 49% market capital requirements in isolation, rather Equities than in the wider context of return on capital? Ravi Rastogi, senior investment consultant at Towers 64% 11% Watson, believes that in practice insurers will not Long-dated debt be able to afford to ignore investment return. “They will have to make trade-offs between return 42% 16% on capital and capital charges,” he comments. Short-dated debt One possible outcome, indicated by respondents’ views on likely shifts in asset allocation, is that 26% 35% they may move away from investing right through Emerging market sovereign debt the cycle on a buy and hold basis, and towards a more active approach to asset allocation, moving 42% 16% into capital-intensive assets only when the Developed but non-eurozone sovereign debt outlook is particularly positive. The question is then, is Solvency II a force for good in that it forces 35% 9% insurers to become sufficiently sophisticated to Eurozone sovereign debt look at risk-return against capital charge, with an eye to where a given asset class is in its cycle, 24% 40% or will it promote a less positive but more easily Hedge funds implemented short-termist agenda? 47% 6% Mr Rastogi believes that, in some respects, Infrastructure investment changing regulations may actually work to insurers’ benefit as investors provide a broader potential investment choice for them. “Solvency 44% 7% I favours yield-producing assets so insurers Property have a bias towards them even if non-yielding assets make macro-economic sense; there is also 44% 18% an inbuilt bias towards sticking with the home Private equity currency,” he explains. 29% 24% “Solvency II has no such constraints—there Cash is no bias towards yield, and the risk capital requirements will not vary according to territory 27% 36% (although there will of course be differences Other, please specify between the credit-worthiness of different countries). That means insurers should 0% 2% have better opportunities for economically15 © The Economist Intelligence Unit Limited 2012
  17. 17. driven diversification, and also for more allowing clients to show more detailed analysis onglobalised investment.” their entire portfolio.”Nonetheless, although insurers are allowed Mr Shah makes the additional point that there is ain principle to hold a range of risk assets, in danger that the new regime will not be sufficientlypractice their decisions under Solvency II will flexible to allow the fine-tuned treatment ofbe constrained by the need to match assets different asset classes. “Solvency II needs to beand liabilities and to optimise returns within a written to allow the emergence of new assets suchlimited capital charge budget—and that will have as infrastructure. These investments tend to beimplications for the make-up of their portfolios. secure, very long-term ones; they pay a high yield because the money is tied up during that time, not“There is a risk that the Solvency II regulations just because there is an element of capital risk.might push many insurers towards a narrow Solvency II could prejudice such investments if itrange of investment options, which could lead to penalises them with excessive capital charges.”increased volatility in those areas. But nimblerinsurers could exploit that herd mentality The fact is that the rules are not yet set in stone,by making use of less popular asset classes,” and until they are it is not clear how assetcomments Jay Shah, head of business origination allocation will be affected. The survey gives someat the Pension Insurance Corporation (PIC). hope that the transition may not be too painful. A majority (58%) of respondents are confidentFor James Hughes, chief investment officer that changes to asset allocation will be phasedat HSBC Insurance, the issue is not just about in gradually by insurers, which should give theregulation forcing insurers in and out of different corporates hoping to attract their capital timeasset classes, but also how to make assets more to adjust to the new funding paradigm. But therecapital-efficient. “Solvency II is making everyone is less reassurance from the finding that almostthink very hard about every strategy—it is not just one-third (32%) of corporates (non-FIs) areabout risk and return but now has a greater focus confident that the changes will have no adverseon capital implications,” he says. “I’ve seen fund of effect on demand for any asset class—again raisinghedge funds marketing themselves as potentially the question of whether they have fully graspedmore capital-efficient because they are offering the wider implications of the new regime forgreater transparency through risk analytics, financial markets. Chart 14: How do you think insurers will implement All respondents any changes to asset allocation? FIs (excluding insurers) In different ways, so no asset class is adversely impacted. Insurers 23% 16% 25% 32% Corporates (non-FIs) 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% © The Economist Intelligence Unit Limited 2012 16
  18. 18. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE 4 Implications for companies seeking financing There is a strong consensus among FIs (excluding insurers) and insurers that the new regulations Chart 15: Do you agree or disagree with will make the tenor and rating of corporate the following statement about corporate bonds more significant, as insurers, driven by debt issuance? Solvency II makes capital charge considerations, are increasingly the tenor and rating of bonds from pushed towards investment-grade debt at the corporate debt issuers more significant. expense of lower-grade debt. Insurers obviously 48% 62% 79% Corporates (non-FIs) Insurers FIs (excluding insurers) understand their own capital considerations and agree agree agree 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: 31% only 48% concur, and 21% disagree outright. neutral 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 31% shorter-dated debt on a more frequent basis. They neutral may also adjust their capital structure to achieve investment-grade status, or offer higher yields in compensation for the capital costs to insurers. 21% 17% disagree neutral 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 7% are markedly less convinced. Only 39% agree, disagree 3% disagree compared with 73% of FIs (excluding insurers) and 53% of corporates (non-FIs) This suggests that,17 © The Economist Intelligence Unit Limited 2012
  19. 19. 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. 60% 53% 39% 73% Corporates (non-FIs) All respondents Insurers FIs (excluding insurers) agree agree agree agree 37% neutral 31% 25% neutral neutral 16% 15% 16% 24% neutral disagree 11% disagree disagree disagreeunlike other groups with less knowledge of the An examination of the implications of Solvencyimplications of the new regulations, they know II for companies trying to raise debt throws upthey may be unable to afford the capital charges another concern—that the regulators may haveassociated with such companies’ debt, no matter failed to consider the big picture, and that therehow generous the yield. is a mismatch between the aims of this piece of regulation and those of Basel III.“Of course, insurers will have to assess the riskversus reward profile for any corporate debt they When asked whether the two directives represent aconsider buying, but they will only have a finite conflict of interests for banks and insurers, and ifamount of capital available as cover,” comments so what the consequences might be, the majorityMr Rastogi of Towers Watson. “It will be a question of survey participants who offered an opinion wereof finding the optimal mix of assets within their in agreement, although they gave a wide range ofspecific risk budget.” possible outcomes.Mr Williams of Legal General speculates that “I think these regulations might create conflict;insurers may be allowed to appeal to the authorities they may increase demand for sovereign debton the grounds that they have built up a strong from both banks and insurers,” commented oneportfolio of BBB-rated debt and therefore have the UK-based bank respondent. Others suggested thatexpertise to make distinctions on the grounds of a the main consequence could be a more volatilecompany’s security and quality. He believes that the market. “The potential conflict between these twoshift away from non-investment-grade debt could directives could put EU banks and their funding atcause significant difficulties for many companies. risk,” added a composite insurance respondent“EIOPA wants to see a lower chance of default on from the UK.insurers’ investments, through the use of higher-grade debt. But many smaller, well-established A number were more cautious, admittingindustrial firms across the EU are graded BBB. Of that until Solvency II comes into force, itcourse they are not as secure as blue-chips, and will be very difficult to predict how the clashthey pay higher yields to compensate, but they are of interests will affect those involved. “I thinknot inherently risky propositions. Importantly, it’s that these regulations are going to createthese companies that tend to lead their countries conflicting goals, but the consequences areout of recession, and if the banks are not lending still unknown. We will have to wait until theirand the insurers are penalised for buying their debt, implementation,” said a bank respondent basedthey will face a big problem.” 3in Denmark. © The Economist Intelligence Unit Limited 2012 18
  20. 20. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE 5 Predicting the unintended consequences There are fears that the regulatory regime of Solvency II will introduce a host of unforeseen Chart 17: Do you agree or disagree with problems. The survey findings indicate that there the following statement on regulation? is little sense of any profound need for additional The current level of regulation is regulation in terms of insurers meeting their sufficient to ensure that the insurance obligations to policyholders. Most respondents— industry is able to fulfil its obligations particularly insurers (62%) and pension funds to policyholders. (64%), unsurprisingly—consider the current level All respondents of regulation sufficient. 56% 18% 26% agree neutral disagree 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 Corporates (non-FIs) in the survey highlight the sheer range of potential problems. 48% 21% 31% agree neutral disagree A number of respondents are worried about the idea of introducing a complex and potentially restrictive regime at a time when both EU Insurers economies and markets are so fragile. As one bank 62% 17% 21% respondent from Denmark puts it: “Capital markets agree neutral disagree 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, FIs (excluding insurers) adds that it is not only macroeconomic factors 58% 16% 26% that are at risk, “but also the pressure put on the agree neutral disagree 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 are19 © The Economist Intelligence Unit Limited 2012
  21. 21. Chart 18: How will Solvency II impact the structure of smaller friendly societies and mutuals? 20% 54% 11% 16% They will They will They will There will be outsource more consolidate to close to new no material to access scale achieve scale business impactbeing dissuaded from buying long-term bonds Ms Carter-Vaughan of Expert Insurance Companyunder the EU Solvency II rules,” says a life agrees that the insurance giants are in a strongerinsurance respondent from the UK. But others position because of their resource base. Medium-are worried about the impact on equity markets, sized firms, especially broker-only businessesgrowth in demand for derivatives, the trend without their own direct distribution arm, are in atowards a more concentrated range of asset particularly difficult position, exacerbated by theclasses and the risk of a further credit crunch as a economic climate.consequence of over-regulation. “These businesses may be well-capitalised, withA further area of uncertainty focuses on the impact generous solvency margins—but if they’re investedof the new regime on smaller friendly societies, in government bonds and banks, and the ratingsmutuals and monoline insurers. Mr Williams of agencies take a view on that investment base andLegal General makes the point that large insurers downgrade their ratings, as has happened already towith a range of products have the resources to some firms, the insurance brokers will have to dropabsorb additional overhead costs, and that at away,” she explains. “Solvency II will make this muchthe other end of the spectrum the industry in worse—it couldn’t be happening at a worse time.”Europe is much more skewed towards small mutualspecialists serving a local community, who have However, Mr Shah of PIC disagrees that it is all atheir own well-established niches and may be matter of scale, observing that large multi-nationalbelow the minimum size to qualify for Solvency II insurers with subsidiaries in different EU countriesregulation anyway. “It’s the monoline providers in are likely to face their own problems. “Beforethe middle who are likely to be more disadvantaged Solvency II, local regimes often understated thethan either of these groups,” he says. amount of capital needed by insurers, on the grounds that the multi-national parent was holdingMore than one-half (53%) of all respondents a sensible amount at group level, albeit in otherexpect to see a spate of consolidation as smaller jurisdictions. Solvency II will push the obligationinsurers try to achieve economies of scale; a to hold the right amount down to subsidiary level,further 20% anticipate that they will move towards and limit companies’ ability to move capital aroundoutsourcing more functions. between countries as needed.” © The Economist Intelligence Unit Limited 2012 20
  22. 22. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE conclusion It is clear that while some boost to the current corporate debt and towards ‘safer’ assets such regulatory situation may be necessary, both the as cash and investment-grade debt. But that potential consequences and the timing of Solvency may leave a tranche of smaller companies— II are a source of considerable concern. Indeed, companies that could be leading European it seems that while the new regime would be economies back towards growth—with serious bound to have ramifications regardless of when funding problems because they do not have a it is introduced, the euro zone’s current difficult high enough debt rating. political and economic climate and wider tough investment conditions are all set to make things So what is the prognosis for the future, and for worse for insurers and their stakeholders alike. Solvency II’s progress onto the statute books? Mr James of Lockton emphasises that what There are various implications for policyholders, the insurance market really wants is “absolute but the bottom line is that premiums are clarity as to how the rules will be applied”. likely to increase in price—as a result of the Implementation is still two years away, in 2014, implementation and overhead costs of Solvency and clearly there will be many discussions before II, the further reliance on underwriting profit everything is clarified, particularly given the rather than investment return and because the highly uncertain political and economic backdrop range of providers may shrink as firms are pushed against which decisions must be made. into consolidation. Some policyholders may be forced to reduce their levels of cover or drop some One area where regulators must consider the insurances altogether because of price increases. implications of Solvency II is the impact on There is also a risk that they will find it harder to the cost of guarantees. EU regulators seem to source more unusual types of cover because of the want safety at all costs and appear to be more contraction in the number of middle-sized firms, comfortable with people being under-insured which have traditionally played an innovative role rather than properly insured but somewhat at in the insurance marketplace. risk of the guarantee not being met by the insurer. Savings and investment products are also likely Mr Shah of PIC believes that the European to be affected. As the costs of guarantees become authorities are likely to have to agree on clearer, they will inevitably increase. Investors substantial compromises to make it more workable generally see guarantees as attractive but do not and acceptable to national regulators and the place the same value on them as the cost to hedge industry, if it is to be in place roughly on time. those guarantees—the challenge to the industry will be to find the right balance. There is also pressure to get things right as Solvency II’s reach has potential to go beyond the The possible consequences are arguably also EU. “Many foreign regulators, particularly those in serious for companies seeking to raise money in developing markets, look to the EU and the US for the capital markets, where insurance companies guidance on key principles as they don’t want to be are major institutional investors. Insurers are out of sync with these major markets,” comments likely to shift their portfolios down the risk Mr Hughes of HSBC Insurance. “This could make spectrum, away from equities and lower-quality Solvency II even more far-reaching in the future.”21 © The Economist Intelligence Unit Limited 2012
  23. 23. appendix: survey resultsIn which country are you personally located?(% respondents)Spain 18United Kingdom 16Denmark 13Germany 12Netherlands 11Sweden 10Finland 6France 6Luxembourg 5Belgium 1Ireland 1Note: numbers do not add to 100% due to rounding 0 0 0What is your primary job function?(% respondents) 0Finance 72Risk 24IT 2General management12Operations and production1 0 0 0 0 © The Economist Intelligence Unit Limited 2012 22
  24. 24. INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE 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 Note: numbers do not add to 100% due to rounding 0 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 223 © The Economist Intelligence Unit Limited 2012
  25. 25. What is your main business?(% respondents)Pension fund 25Bank 25Non-financial corporates 25General 9Life 8 25Composite - both life and general 6Asset manager 1Other, please specify 1 2500 What are your companys annual global revenues?0 (% respondents)0 €500m or less 210 €500m to €1bn 440 €1bn to €5bn 150 €5bn to €10bn 90 €10bn or more 5 11 10 15 20 25 0 What are your organisation’s 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 © The Economist Intelligence Unit Limited 2012 24 0