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Fitch: Ratings risk posed by Solvency II

EUROPEAN insurers may struggle to keep their credit ratings under stringent new capital requirements proposed by Brussels, assessment house Fitch warned yesterday.

Insurance companies are expected to be ordered to increase the amount of capital they hold against their liabilities under Solvency II, the European Commission’s regulatory regime due to be introduced in 2012.

In a special report, Fitch said insurers faced with steep demands for extra core capital could struggle to raise fresh equity, given market turbulence and investors’ reluctance to back large rights issues. Raising debt remains an expensive alternative, the credit ratings agency added.

Fitch analyst Clara Hughes said while the requirements of Solvency II would stay unclear until April next year, there would be “rating implications” for insurers unable to pump up their capital reserves.

“We expect the proposals are likely to raise capital requirements for the industry in aggregate,” Hughes said. “This could have rating implications for individual insurers if final Solvency II requirements are significantly more onerous than under the current regime.”

An EC survey using insurers’ balance sheets at the end of 2007 found an average solvency ratio – the key measure of an insurer’s financial health – of 200 per cent. But Fitch said ratios were likely to have fallen since then as positions deteriorated in 2008 and early 2009.

Fitch said one way of reducing the amount of core capital required without resorting to cash calls or debt issuances would be for insurers to reduce their exposure to “capital-intensive” assets like equities. But it conceded the impact on insurers’ profitability could be too great to bear, particularly for companies with long-tailed liabilities.

Q&A: SOLVENCY II EXPLAINED
Q. WHAT IS SOLVENCY II, AND WHEN WILL IT COME IN?

A. Solvency II is an overhaul of Europe’s insurance rulebook. Solvency I, the current regime, dates back to the early 1970s, since when companies have introduced sophisticated risk management systems. The new regulations will make capital requirements directly dependent on an insurer’s assets and liabilities, and will apply to all firms operating in the European Union. It is expected to come into effect on 1 November 2012.

Q. HOW MUCH EXTRA CAPITAL WILL INSURERS HOLD?

A. According to a January study by EMB, an independent actuarial consultancy, general insurers in the UK face a €15bn (£13bn) jump in capital requirements. Separately, UK life insurers have said they may have to hold between £30bn and £70bn extra. In a letter last September, the Association of British Insurers pointed out this would need fresh equity capital equal to the industry’s current market capitalisation. “It is hard to see how such a massive recapitalisation could be achieved,” then-director general Stephen Haddrill wrote. But Fitch’s Clara Hughes told City A.M. yesterday it was still very unclear what capital requirements the EC would settle on.

Q. WHY IS FITCH CONCERNED NOW, BUT WAS NOT EARLIER?

A. Indications are the European Commission’s next Qualitative Impact Study – number five – will put forward harsher capital requirements than previously thought. The study is expected in the second half of this year. In preparation for the likely implications, the ratings agency is asking insurers to guide it through six areas: expected solvency positions, possible sources of extra capital, options for reducing capital requirements, using hybrid debt as core capital, internal modelling and issues specific to the life sector.