Solvency II drives demand for reinsurance

Trading updates from Europe’s major reinsurance groups, following the crucial January renewals period, reinforce the likelihood that the Solvency II (S2) requirements will increase demand for reinsurance products, says credit ratings agency (CRA) Fitch.

The S2 directive focuses principally on the amount of capital that European Union (EU) insurance companies must hold to reduce the risk of insolvency and Fitch expects them to look to reinsurance as they attempt to strengthen their capital position through risk transfers, Fitch Ratings says.

The main beneficiaries are likely to be the financially strongest reinsurers in the EU and any other country whose regulatory regime is deemed fully equivalent to S2.

The latest update from Germany’s Hannover Re showed that its structured reinsurance business, which can help insurers optimise capital, grew by two-thirds in the January renewals period. This rate of growth probably reflects the timing of some large deals, but the CRA expects demand to remain strong.

France’s biggest reinsurance group, SCOR said it has received a high number of enquiries from insurers wanting to improve earnings stability and optimise capital, while Munich Re’s chief financial officer (CFO) said balance sheet management and regulatory optimisation will become increasingly important drivers of reinsurance business.

Fitch comments that it is too early to get a complete picture of the impact of S2 on reinsurance demand, but one risk insurers are increasingly keen to transfer is longevity risk. This is because the risk margin introduced under S2 creates high capital requirements for longevity risk when interest rates are very low. Transferring longevity risk via reinsurance creates capital charges for counterparty risk, but these tend to be significantly smaller than those for retained longevity risk.

Insurers are also looking for other risk-transfer opportunities that can significantly strengthen their capital position under S2. For example, UK insurer RSA’s disposal earlier this month of £834m (€976m) of legacy liabilities to run-off specialist Enstar Group will boost its S2 capital ratio by as much as 20 percentage points.

Reinsurers in the EU or a country that has been granted equivalence for reinsurance supervision will have an advantage in winning S2-related business. Firms outside these jurisdictions could be required to post collateral or liaise with local European regulators, adding costs and delays.

The biggest and financially strongest reinsurers will also have an advantage, says Fitch. Counterparty default capital charges will often be lower when transferring risk to one or two very highly rated reinsurers than they would be for transferring the risk to a larger pool of reinsurers with a slightly lower credit rating. Risk-transfer transactions are also likely to be across multiple regions and products, which will make it harder for small, specialist reinsurers to compete.

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