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An annual solvency health check. What do SFCRs tell us about the European Insurance sector?
An annual solvency health check. What do SFCRs tell us about the European Insurance sector?

An annual solvency health check. What do SFCRs tell us about the European Insurance sector?


Marie-Laure Richard

Marie-Laure Richard

BNP Paribas

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Most insurers have disclosed their 2017 Solvency and Financial Condition Reports (“SFCR”). These are mandatory and public regulatory reports under Solvency II. So what do their disclosures tell us?

Overview of Solvency II ratios

Based on a sample of 19 of the largest EMEA insurers, the average Solvency II ratio[1] is 200% which is twice the regulatory minimum. Within that sample, reinsurers continue to disclose the highest ratios (240% on average), followed by multi-line insurers (221%) and life and Property & Casualty insurers (both around 180%). The strong ratios for reinsurers reflect the diversification of the risks they reinsure. The reinsurers in our sample also used an internal model to calculate their ratios, which reflects their advanced risk modelling skills as a result of the business of reinsurance.  

The lowest ratios are in the range of 130-150%, however for tier 1 insurers, such levels could potentially impact dividends, are unlikely to find favour among investment analysts.

Temperature check - ratio composition

Other than the level of the ratio itself, reports are showing significant differences in the composition of the ratio, as demonstrated through an analysis of Eligible Own Funds and Solvency Capital Requirements.

Eligible Own Funds (“EOF”)

Broadly speaking under Solvency II, EOFs are made of (a) shareholder equity (b) subordinated debt (c) deferred tax assets and (d) a “reconciliation reserve”, which is more or less equal to the net of the valuation differences between accounting (IFRS or the Local GAAP balance sheet) and the Solvency II balance sheet. Under Solvency II, future profits[2] are eligible capital and can be included in the reconciliation reserve.

From our analysis of 2017 SFCRs, all 19 insurers have a strong capital base (equity represents at least 30-40% of total EOF) and low leverage (subordinated debt represents less than 20%). It’s worth noting that up to 35% of reinsurers’ EOFs come from future profits, which could be perceived as a  potentially volatile “intangible”. In comparison future profits of life Insurers is 12% of EOF.

Solvency Capital Requirement (“SCR”)

The requirement is based upon a loss materialising once every 200 years, taking into account various parameters (both financial and actuarial) with corresponding correlations.

For life insurers, “market risk” (i.e. losses arising from market volatility), represents 61% of the total SCR and pure insurance risk only 30%. In other words, according to the Solvency II regulation, life insurers (taken as a group), have a risk profile closer to that of a bank than an insurance company. For P&C insurers and reinsurers, we are seeing the reverse.

This may help explain why European life insurers in particular consider that Solvency regulations do not provide an accurate representation of their risks: for a traditional life insurer, the ability to match the guaranteed returns with corresponding assets is key but as opposed to a bank, a fall in the value of the asset does not immediately translate into a loss. This is because, as opposed to banks, life insurers have long dated liabilities which means they have time to wait for the market to recover.

With 2 years of SFCR reporting, we can look at the year-on-year evolution of the Solvency ratio for the first time. Compared to 2016, the average ratio (still based upon our sample) has increased significantly: from 194% to 200% (+6pts).

Although benign market conditions have for the most part positively impacted ratios, a large part of the increase comes from non-operating factors. Management actions (disposals or new debt issuance) and model / regulatory changes have been the largest vectors of growth. This clearly shows two things: firstly insurers are becoming more and more sophisticated in their actual understanding and modelling of their risks and secondly the changes in business models (particularly for life insurers) are starting to pay off. Such examples of changing business models includes asset management arms becoming third party providers or life insurers moving from traditional life contracts to hybrid or unit-linked business. 

Overall disclosures show that the European insurance sector is generally healthy and well capitalised.  However, there is a chance that 2017 could be a peak year in terms of solvency, particularly if we think about macroeconomic uncertainty and EIOPA’s plans to review the standard formula . The next annual health check up (the 2018 SFCRs) will reveal all.

[1]SCR ratio = eligible own funds / solvency capital requirement

[2]EPIFP: Expected Future Profit included in Future Premium