EU insurance sector overhaul to trigger merger and acquisition activity

The Commission unveiled its proposed Solvency II directive on 10 July, introducing a major reform of the supervisory framework for the insurance and reinsurance industries. The proposal was welcomed by large industry players who see it as an opportunity to expand their activities in other European states.

The new Directive proposed by the Commission eyes wide-ranging reforms for insurers and re-insurers. The new rules are set to improve the protection of policyholders and beneficiaries, as well as further to integrate and boost competitiveness of the European insurance market. The Commission expects that mass products in particular, such as motor and household insurances, will become cheaper.

  • Economic risk-based solvency requirements

Solvency rules prescribe the minimum of financial resources that insurers and re-insurers must hold in order to cover the risks to which they are liable and withstand adverse events, such as natural catastrophes or serious car accidents. The new system constitutes a move away from a “flat rate” system to a “risk-based approach”. Therefore, the minimum financial resource requirement will depend on the level of risk taken on by insurers.

The 20 largest insurance groups account for more than 50% of the market. They usually have more diversified risks, as they operate different types of insurance as well as across borders. Therefore, major players, such as Allianz, Axa, Aviva and Swiss Re, are most likely to reap the benefits of the new calculation for the capital requirements and free up surplus capital.

Moreover, the new calculus also takes into account the risk level of insurers’ investments undertaken, as well as credit and operational risk, which affect insurers’ solvency.

The new system also includes an “early-warning mechanism”, in which supervisors will take action when an insurer’s resources hit a certain threshold, but before they fall under the minimum capital requirement, when an insurer’s liabilities are transferred and the business closed. The new regime seeks to avoid scandals such as the recent Equitable Life case (EURACTIV 19/06/07).

  • New supervisory system

Solvency II foresees extending the role of supervisory authorities to not only calculate the appropriate capital requirement level for insurances, but also assess their quality of risk management.

Another important innovation is the strengthening of the role of the group supervisor, with the insurer’s home-country supervisor taking a lead, with whom the group supervisor, however, will also work in close co-operation.

  • Increased transparency

The new Directive will set out standards for the disclosure of information, which will be available to policyholders and investors and public authorities.

Internal Market Commissioner Charlie McCreevy said: "This is an ambitious proposal that will completely overhaul the way we ensure the financial soundness of insurers. We are setting a world-leading standard that requires insurers to focusl on managing all the risks they face and enables them to operate much more efficiently. It's good news for consumers, for the insurance industry and for the EU economy as a whole."

Socialist MEP and Solvency II Directive Rapporteur Peter Skinner, stated: "This draft legislation will help Europe's insurance system to retain its place as the world's most efficient insurance market. It will bring about the modernisation of the supervisory framework while strengthening and improving a level playing field in insurance across Europe. It widens the choice of insurance products and protects European consumers more effectively. It will also increase the competitiveness of the European insurance industry in general."

Michaela Koller, director-general of the European Insurance and Reinsurance Federation (CEA), said: "CEA very much welcomes this initiative to modernise and expand solvency requirements in the insurance industry. Solvency II is needed to deliver more appropriate solvency requirements, both quantitative and qualitative, for insurers, and harmonisation in the requirements of national supervisory authorities." CEA also underlined the importance of the proposed risk-based approach and supervisory harmonisation.

The Association of British Insurers (ABI) believes that the new Directive may cause a wave of consolidation among large industry players. ABI Director Peter Vipond  told The Times: "In principle we would expect Solvency II to generate more mergers and acquisitions." He added: "There will be a single point of lead supervision, which will be where the company is head-quartered. Axa will be supervised out of Paris, Allianz out of Germany and Aviva out of the UK."

Rym Ayadi, CEPS research fellow and head of the Financial Institutions Research Programme is positive about the effect of the Solvency II directive on the European insurance industry, which could help to improve their international competitiveness in the medium term. However, the expert cautions that there are "still many details to be sorted out". According to Ayadi, the real issue will be formulating the concrete implementation measures of the Directive.

Philip Scott, future group finance director of Aviva, said: "For multinational groups, it's vital that the capital requirements reflect the complete picture, including the spreading of risk. Diversification of risk is one of the fundamental principles of insurance and transcends corporate legal structures." 

He added: "With the emergence of large pan-European players, insurance groups operating across the EU face the burden of multiple compliance regimes, which can lead to capital inefficiencies. We therefore welcome today's proposal for group supervision, which provides a pivotal role for the home supervisor to determine group capital requirements."

The Commission is seeking to complete its financial services action plan (FSAP) with a proposal to establish capital rules for insurance firms, as the capital requirements directive did for banking.

The Solvency I Directive has set out the "solvency margin" requiring insurers to hold extra capital; this extra source of capital should help to meet unexpected events and protect the policyholders of an insurance undertaking. However, these rules, which were developed in the 1970s, needed to be adapted to the new challenges the industry faces today.

The Solvency II Directive is intended better to match solvency requirements to the risks insurance companies face and encourage them to improve their measurement and monitoring of risks. The new regulatory framework will apply to roughly 5,000 insurance and reinsurance undertakings in the EU.

  • The proposed Framework Directive now passes to the Parliament and Council for consideration.
  • Similar to the Capital Requirements directive, Solvency II will be adopted using the so-called Lamfalussy process, thus setting out the high-level principles in a Framework Directive as a first step. Next, after agreement by the Parliament and Council (possibly before the 2009 European elections), the implementing measures are drafted with the help of the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS). 
  • 2012: The Commission aims to implement the new system.

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