Last month’s decision by UK voters that they would prefer the country to end its membership of the European Union (EU) came as an unpleasant shock to many industries; particularly for companies in the insurance sector. When the referendum date was announced back in February, Lloyd’s of London – the capital’s 328-years old insurance market – was among the first to state that despite the EU’s imperfections continuing as a member was preferable to ‘Brexit’.
This was despite the EU’s introduction of new capital adequacy rules in the form of Solvency II. Introduced at the beginning of this year, Solvency II codifies and harmonises EU insurance regulation but also borrows a leaf from the Basel III regime imposed on the banking industry by outlining the minimum levels of capital that insurers must hold. Many insurers launched an ultimately unsuccessful campaign against the launch of Solvency II, arguing that the industry had survived the 2008 global financial crisis in much better shape than the banks.
Credit ratings agency (CRA) Moody’s held its annual flagship conference, ‘New Models for a New World’ in London last month in the week preceding the EU referendum. A poll of its 150 professional market participants, who possibly expected the result to favour the Remain camp, decided that low growth represents the single greatest threat to insurers over the next five years, followed by the impact of regulation.
Moody’s reports that slow and fragile economic growth, particularly in Europe, together with persistently low interest rates continue to pressure insurers’ earnings. Its analysis found that the European sector’s return on equity (ROE), although improved since the 2008 global financial crisis, remained far below the pre-crisis level of 2007 and is only just covering the industry’s cost of equity. The CRA also forecasts gradually declining reserve releases within the industry, which is set to lower underwriting profitability for European property and casualty (P&C) insurers.
“As the macroeconomic environment remains unfavourable, insurers are finding ways to adapt, with mixed credit implications,” adds Moody’s. “This includes on-going, albeit modest, changes to the asset mix in the search for yield, a shift towards lower investment grade credit risk and a focus on cost reductions rather than top line growth.”
Since the referendum result was announced on June 24, Lloyd’s chief executive officer (CEO) Inga Beale has said that while the insurance market had clearly advocated the positive economic case for remaining “Lloyd’s and the London insurance market will adapt to the new environment we will be operating in once the UK has officially left the EU.”
Beale was adamant that London could maintain its foremost position as the world’s leadimg centre of the specialist insurance and reinsurance market post-Brexit.
“The challenge for Lloyd’s, and the industry as a whole, is to ensure our platform remains attractive and to demonstrate that we are best placed to provide businesses with the risk transfer products they need,” she wrote in the Financial Times.
“Ensuring we can continue to attract the best talent from across Europe and the globe will be critical to London preserving its status. Cutting off or restricting access to the diverse, multilingual, multi-ethnic talent pool in the EU is unthinkable and will make it that much harder to remain competitive in a rapidly evolving insurance market. The industry will be watching carefully to see what the UK negotiates.”
Moody’s has also re-reviewed the outlook for the industry in the wake of the Brexit shock. “Economic growth in Europe remains slow and fragile with a number of risk potentially raising market volatility, as it has been the case with the UK’s referendum vote to leave the EU,” said Helena Kingsley-Tomkins, Moody’s assistant vice president analyst. “While concerns about Greece leaving the euro area have receded, it also remains a downside risk.
“Furthermore we maintain a negative outlook on the UK life sector to reflect the risk arising as a result of the referendum decision. Following the ‘leave’ vote, we believe there is an elevated risk of capital, growth and profit deterioration”.
Moody’s singles out UK domestic life insurers as the most affected insurance groups and cites three factors:
• their high asset leverage.
• a significant exposure to UK investments – given their policy to match sterling-denominated liabilities with sterling-denominated assets.
• the discretionary nature of some life insurance products, whose sales are correlated to the economic cycle.
Beale also highlights several issues that have to be addressed in the coming months. “Most importantly for business is how Brexit will affect access to the single market. This is now the most important question for chief executives throughout the sector.”
None of this bodes well for providers of commercial insurance and reinsurance, where premium rates have been in steady decline. This partly reflects an influx of capital that has brought new entrants into the market while increasing competition and relatively benign claims experience since 2011, when the Japanese earthquake and tsunami, quakes in New Zealand, hurricane Irene and floods in Burma resulted in substantial payouts.
Challenging conditions are likely to trigger further merger and acquisition (M&A) activity within the industry, which in 2015 saw more than 700 deals worth over US$114bn. They included last July’s US$28.3bn purchase of insurer Chubb by Ace, the sector’s second-largest deal ever and Tokio Marine’s US$7.5bn acquisition of HCC that gave the Japanese insurer a greater presence in North America.
Insurers are also looking beyond their mature markets in the Western economise for future growth. Moody’s has predicted that P&C insurance in the emerging markets will record annual growth of more than 5% over the next couple of years, against 1%-2% in Europe and 2%-3% in North America.
Lastly, as with the banking industry the rapid advances in financial technology (fintech) – or ‘InsurTech’ as PwC dubs it in its recent report ‘Top Insurance Industry Issues in 2016’ – is “emerging as a game-changing opportunity for insurers to innovate, improve the relevance of their offerings, and grow.”
While GDPR and Europe’s revised Payment Services Directive (PSD2) are not contradictory, the fact that the regulators and many banks work on them in silos is problematic, AccessPay executives argue.
We live in interesting times – at least that’s what political and economic commentators keep telling us – However, you could easily say we are experiencing very uncertain and, some might suggest, disconcerting times.
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