Why is capital a scarce resource

Solvency II: capital as a scarce resource

The European insurance industry is facing a paradigm shift. Regardless of the final design of individual rules and transition periods that are still to be discussed for the introduction, with Solvency II capital is moving as a scarce resource into the center of strategic considerations of insurance companies. On the basis of the current QIS 5 specification and publicly available company key figures, the consulting firms Bain & Company and Towers Watson have achieved solvency and profitability of the capital investment of the 20 largest life, property / casualty and health insurers in the four largest Europeans in the past three months Markets (Germany, France, Italy and Great Britain) analyzed using a standardized model.

The model developed for this purpose takes into account differences in equity capital, business mix and investment structure and contains estimates for non-publicly available data such as investments and the scope of reinsurance programs. Even if the results of the analysis cannot, of course, be congruent with the internal QIS5 calculations of the individual houses, the model delivers results for the German market on a comparable methodological basis.

The first evaluations for the German insurance industry already show that the situation among life insurers is particularly critical. Almost one in four of the simulated companies has a solvency ratio of less than 100 percent. The main cause lies in a disproportion between the terms of the insurance contracts and the terms of the invested assets, the so-called mismatch, which is high in European comparison. In addition, a German peculiarity comes into play: some insurers still use the German Commercial Code (HGB), whose regulations favor shorter terms of assets. The situation with health insurers is more relaxed: none of the companies examined operates with a solvency ratio of less than 100 percent. This good result is essentially based on the fact that the possibility of ongoing premium adjustments is better for health insurers under Solvency II. Property / casualty insurers have traditionally been heavily capitalized. Although the capital required for the examined companies in Germany increases by more than 200 percent compared to this, less than five percent show a solvency ratio of less than 100 percent.

Only a minority of life insurers earn the cost of capital

Under Solvency II, capital becomes a scarce resource and the return on investment becomes the second key figure. In order to be able to compare profitability across Europe, the study uses the average risk-adjusted return (RARoRAC) as a measure of the return on capital employed. The analysis shows that only a minority of life insurers earn the cost of capital. The specific situation depends heavily on the product mix of the respective company. For traditional products with a fixed minimum return on capital, this resulted in an average return of minus four percent. The situation is better for unit-linked products or pure risk policies that can generate double-digit returns.

In private health insurance, the average risk-adjusted return was one percent, although the values ​​vary widely depending on the underwriting result and payout ratio. The return of property / casualty insurers is also an average of one percent, with motor insurers in particular having difficulty earning their cost of capital. Depending on their specific initial situation, two groups of companies can be distinguished. On the one hand are the financially strong and profitable houses that still have room for maneuver in terms of design and pricing in the contested product lines in property insurance and can strengthen their presence in sales channels such as the broker channel. On the other hand, there is the larger group of low-capital or low-yield houses that have to reduce their capital commitment and increase their profitability. The undercapitalized companies will have to optimize their capital and risk structure in the coming months, while adapting their business model and organization. But new opportunities are also opening up for providers with high capital and profitability. Because in 2011 and 2012 they can invest in the development of even more attractive products, take advantage of their price scope, especially in competitive markets such as property insurance, and strengthen their presence in sales organically or through acquisitions.

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