Insurers and society how regulation affects the insurance industrys ability to fulfil its role

Insurers
and society
How regulation affects the insurance
industry’s ability to fulfil its role

A report from the Economist Intelligence Unit

Sponsored by:

© The Economist Intelligence Unit Limited 2012

xx


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

contents

1

Executive summary

2

Preface

4

About this report

4

Introduction

5

1

Striking the right balance

6

2

Who will pay the price?

9

3

Shifting down the risk spectrum

14

4

Implications for companies seeking financing

17

5

Predicting the unintended consequences

19

Conclusion

21

Appendix

22

© The Economist Intelligence Unit Limited 2012


executive
summary
As discussion of the details of the Solvency II regime rolls on, insurers are
thinking long and hard about how they will manage and monitor their risk
strategies and capital bases. But the implications of their decisions will reach
far beyond the boardroom, affecting both their relationships with corporate
and individual policyholders, and also their role as major investors in the debt
and equity capital markets.
The new regulations were designed to ensure better protection for policyholders,
but raise important questions about the extent to which consumers and
corporates will ultimately foot the bill for Solvency II, either directly through
higher costs or indirectly via less comprehensive products.
Meanwhile, the demands of the new regime threaten to disrupt the key role
played by insurers as investors in the capital markets, by pushing them towards

‘safer’ assets with lower capital charges, and away from the equities and noninvestment grade debt on which much private industry depends for financing.
This could be a particularly troubling outcome for businesses seeking to raise
capital, given that banks remain reluctant to lend because of their own balance
sheet constraints.
The Economist Intelligence Unit, on behalf of BNY Mellon, conducted a survey
of 254 EU-based companies, including insurers, other financial institutions
(FIs, excluding insurers) and corporates (non-financial institutions, or non-FIs).
The findings shed light, from a broad range of perspectives, on the potential
impact of Solvency II on the retail consumer, the insurance industry itself and
industry more broadly, including how insurers are likely to behave as debt and
equity investors.

Key findings include:
S olvency II goes too far in its requirements
Survey respondents believe that Solvency II oversteps the mark, with only
16% agreeing that it strikes the right balance in ensuring insurers have
sufficient capital to meet their guarantees. Insurers and FIs (excluding
insurers) are more critical of Solvency II, with 55% believing the directive
goes too far compared with 39% of corporates (non-FIs). Less than one
in five insurance respondents believe that most insurers are insufficiently
capitalised under the present regime.

© The Economist Intelligence Unit Limited 2012

2


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

 olicyholders will ultimately

P
bear the costs
Almost three-quarters (73%) of
survey respondents agree that the
costs to insurers of compliance with
the new regulations will be passed
on to policyholders, and there is
concern that both corporates and
individuals may choose to be underinsured as a consequence. However,
insurers are markedly less convinced
(57%) than FIs (excluding insurers)
(82%) and corporates (non-FIs)
(69%) that policyholders will pick up
the tab, raising the question of how
they see the costs of regime change
being met. Also, over one-half (51%)
of respondents believe the shift to
unit-linked policies, which put the
investment risk on the policyholder,
will have a negative long-term affect
on pension and long-term savings
provision, with life insurance and
annuities considered the products
most likely to be affected.
I nsurers expect to further de-risk
their asset allocations
A clear shift down the risk spectrum
is anticipated by respondents. Assets
expected to attract more interest
include investment-grade corporate

bonds, cash and short-dated debt,
at the expense of non-investmentgrade bonds, equities and long-dated
debt. Almost three in five (58%)
respondents overall believe that shift
will happen gradually, giving time
for market adjustment. But nearly
one-third of corporates (non-FIs)
(32%) do not believe the changes
will have an adverse impact on any
asset class, suggesting they may not
fully understand the wider financial
implications of the new regime.
C orporates seem less aware of
the impact Solvency II will have on
debt issuance
Among insurers and FIs (excluding
insurers) there is a strong consensus
that Solvency II will make the tenor
and rating of bonds from corporate

3

issuers more significant, as insurers,
driven by capital charge considerations,
are increasingly pushed towards
investment-grade debt. However,
corporates (non-FIs) seem less aware
of this shift, with just 48% agreeing
compared with 62% of insurers and 79%
of FIs (excluding insurers). The reality

is that companies are likely to have to
either adjust their capital structure to
achieve investment-grade status or
offer higher yields in compensation for
the capital cost to insurers.
 egulators should revisit
R
their capital charge levels
Given the economic risks attached to
many EU countries at present, there
is strong support, particularly among
insurers (50%), for regulators to
reassess the zero capital charge for
sovereign bonds—despite the fact that
a readjustment would mean they would
be required to hold further capital. A
further 41% of insurers would like to
see the capital charges for all assets
reconsidered. Overall, less than onequarter (22%) of respondents believe
that regulators should maintain the
current capital charges.
I s Solvency II creating a ‘squeezed
middle’ among insurers?
While large insurers are able to
absorb the costs of preparation for
Solvency II and enjoy the benefits of
economies of scale, and the small,
local or specialist providers prevalent
in continental Europe may either
fall outside the scope of Solvency II

altogether or have a sufficiently strong
niche market to survive and thrive, the
mid-sized mutual insurers could be at a
disadvantage. Only 16% of respondents
expect no material impact from
Solvency II on the structure of smaller
friendlies and mutuals, and more than
one-half (54%) believe the pressures of
the new regime will result in a spate of
consolidations to achieve scale, while
36% of insurers believe these players
will outsource more in order to access
scale.

© The Economist Intelligence Unit Limited 2012


preface
Insurers and Society is an Economist Intelligence Unit report, sponsored
by BNY Mellon. The findings and views expressed in the report do not
necessarily reflect the views of the sponsor. The author was Faith Glasgow
and the editor was Monica Woodley.

about
this report

In January 2012, the Economist Intelligence Unit, on behalf of BNY Mellon,
surveyed 254 respondents from companies in Europe to get their views on
how regulation is changing insurers’ role in society.
The survey reached insurers, financial institutions (FIs, excluding insurers)

as well as corporates (non-financial institutions, or non-FIs).
Respondents are very senior, with over one-half (133) coming from the C-suite
or board level. They were drawn from Europe, with the UK, Spain, Germany, the
Netherlands, Denmark and Sweden each having over 20 respondents.
In addition, in-depth interviews were conducted with six experts. Our thanks are
due to the following for their time and insight (listed alphabetically):
Jenny Carter-Vaughan, managing director of the Expert Insurance Group
James Hughes, chief investment officer at HSBC Insurance
J ulian James, UK CEO of broker Lockton International and president of the
Chartered Insurance Institute (CII)
Ravi Rastogi, senior investment consultant at Towers Watson
Jay Shah, head of business origination at the Pension Insurance Corporation
Randle Williams, group investment actuary at Legal & General

© The Economist Intelligence Unit Limited 2012

4


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

introduction

Insurance companies have
traditionally been viewed by wider
society as the bearers and managers
of formalised risk, freeing individual
policyholders from financial worries
in the event that things go wrong,
and providing institutions with

an efficient mechanism by which
to transfer risk. They have also
historically played a central role
as institutional investors,
channelling funds into the capital
markets and providing industry
with crucial flows of both equity
and debt capital.
Are those longstanding roles
under threat with the impending
introduction of Solvency II in the
European Union? Solvency II aims,
among other things, to provide
policyholders with more robust
protection by requiring insurers
to hold capital according to all
their business risks—including
the differing risks attached to the
various asset classes in which they
invest clients’ cash.

5

But these changes are set to upset
the status quo, not just for insurers
but for policyholders and also
for companies looking to attract
investors through the capital
markets. Policyholders are likely, for
example, to see the cost of premiums

rise—potentially pushing some to
opt to reduce or ditch their cover
rather than pay more. Companies
seeking investors, meanwhile, may
find it harder to raise funds in the
capital markets—at the very time
when banks, for their own reasons,
are reluctant to lend. Insurers
themselves are likely to have to
adjust their investment timescales
and strategies of asset allocation,
potentially finding themselves under
conflicting strains as they try to
find the best balance between risk,
return and capital efficiency.
In this report, we explore the danger
that regulation may, ironically, force
insurers to reduce the amount of risk
they take—and instead offload that
risk on to their stakeholders.

© The Economist Intelligence Unit Limited 2012


1

Striking the right balance
As insurers play a central economic and
social role in modern Western societies, it has
been accepted since the 1970s that some form

of prudential supervision by the authorities
is necessary.

measuring risk on consistent principles and linking
capital requirements directly to those principles.
They will apply throughout the EU, harmonising
standards and providing a level playing field for
insurers across the euro zone.

Until now, the focus has tended to be on measures
to guarantee the solvency of insurers or minimise
the disruption caused by their insolvency.
Solvency II raises the stakes across the board
by introducing a risk-based capital approach,

But our survey findings indicate that although
there is a perception that something needs to
be done to improve the current situation and
harmonisation should bring its own benefits,
the proposed regime could be overly cautious.

Chart 1: Do you agree or disagree with the following statement?
Most insurers already have sufficient capital to meet their guarantees.

All respondents

36%

39%

agree

neutral

Corporates (non-FIs)

33%
Insurers

44%

38%

agree

neutral

FIs (excluding insurers)

36%
agree

36%
neutral

agree

40%
neutral

© The Economist Intelligence Unit Limited 2012

25%

disagree

31%

disagree

18%

disagree

24%

disagree

6


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

Chart 2: Do you agree or disagree with the following statement?
Solvency II goes too far in ensuring insurers have sufficient
capital to meet their guarantees.
Corporates (non-FIs)

2

%
15
1%

Insurers

FIs (excluding insurers)

13%

39%

16%

all

respondents

34%

51%

55%

33%

disagree

agree

%
31

neutral

40

%

55

%

On the one hand, just over one-third (36%) of
respondents believe that most insurers already
have enough capital to meet their guarantees,
and even among insurers themselves that
confidence only rises to 44%. So there is a
broad acknowledgement that measures to
improve the capital cover of insurance companies
are in order.
On the other hand, just 16% of all respondents
agree that Solvency II will strike the right balance
in ensuring that insurers are properly capitalised in
line with their guarantees, and over one-half (51%)
say that it goes too far. As Jenny Carter-Vaughan,
managing director of the Expert Insurance Group,
observes: “No one has gone down in the insurance
industry for a very long time; I’d say the current
solvency regime is very robust.”

Randle Williams, group investment actuary at Legal
& General, points out that it is unsurprising that
the industry feels that the authorities are setting
the capital charges too high. “It’s important to
remember that some EU countries don’t have any
compensation net comparable to the UK’s Financial
Services Compensation Scheme in place to protect
consumers. But the tendency of regulators is to go
too far—they always want more capital,” he says.
However, Julian James, UK CEO of Lockton
International, a broker, and president of the
Chartered Insurance Institute (CII), observes that
harmonisation across the EU means that there
will be both winners and losers, so it is difficult to

Chart 3: Do you agree or disagree with the following statement?
Most insurers already have sufficient capital to meet their guarantees.

Life

32%
agree

47%

21%

neutral

disagree

General

50%
agree

Composite

50%
agree

7

27%
neutral

43%
neutral

© The Economist Intelligence Unit Limited 2012

23%

disagree
7%

disagree


sovereign debt should be reconsidered—a sensible

suggestion in the light of the self-evident mismatch
between these supposedly ‘risk-free’ governmentissue assets and continuing deep uncertainty over
the extremely fragile economic situation in some
EU states.

generalise. “Some insurers will see their capital
requirements increase, but others will see a
decrease,” he says. “For consumers, though,
the important thing is the knowledge that the
insurer will have the same level of capital cover
if they buy in France or Germany as if they were
buying in the UK.”

Insurers are less likely than other survey
respondents to support the proposed capital
charges of Solvency II—just 9% compared with
22% of FIs (excluding insurers) and 26% of
corporates (non-FIs). But what is surprising is
that one-half of insurers favour just reassessing
the capital charge for euro zone debt, compared
with 41% who would like to see charges for all asset
classes reconsidered.

Insurers and FIs (excluding insurers) are markedly
more critical of the looming regime than corporates
(non-FIs), with 55% believing it will go too far and
insurers will be over-capitalised for the level of
guarantees they have to meet, compared with 39%
of corporates (non-FIs). This raises the question
of whether corporates, while attracted by the idea

of greater security, fully understand the potential
implications of an over-capitalised insurance
industry for their future activities in the financial
markets.

The dramatic events in Europe over the past
months, reflected in a series of bond market
crises, have made it clear that it is not realistic,
nor sensible, to talk about a zero risk rate at the
present time. However, any alteration to the
capital charge of this debt will have to be upward—
which will certainly not be in insurers’ interests.
“I can’t see why any insurer would want to see a
reassessment,” says Ms Carter-Vaughan of Expert
Insurance Group.

Looking specifically at the capital charges that
Solvency II will institute for different asset
classes, survey respondents are in favour of a
reassessment—just 22% say the current charges
should be maintained. Most are in favour of an
across the board reassessment (43%), but 35%
say that only the zero capital charge for euro zone

Chart 4: Do you agree or disagree with the following statement?
Solvency II sets capital charges for different assets according to their risk level,
with EEA sovereign bonds given a zero-credit risk charge. In light of the eurozone debt
crisis, what do you think should happen to the capital charges of Solvency II?
All respondents

FIs (excluding insurers)

Insurers

Corporates (non-FIs)

Regulators should maintain the current capital charges

22%

22%

9%

26%

Regulators should reconsider the capital charges for all asset classes

43%

42%

41%

48%

Regulators should reconsider the capital charge for sovereign bonds

35%

36%

50%

© The Economist Intelligence Unit Limited 2012

26%

8


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

2

Who will pay the price?
There is a clear feeling that the bill for Solvency
II—both the costs of testing and implementation
and the ongoing costs of holding a greater amount
of capital—will have to be absorbed by insurance
companies’ customers. Almost three-quarters
(73%) of survey respondents see it as inevitable
that Solvency II will ultimately be paid for
by policyholders through higher costs,

although one-half feel that price increases
are an acceptable trade-off for the additional
security provided by enhanced capital
guarantees.
“It’s inevitable that the new regulations will be

paid for by policyholders. Greater security is a
quid pro quo [for the higher cost], but people

%

%
16

11%

all

respondents

82%
Corporates (non-FIs)

9

Insurers

69
%

disagree

16%
neutral

7%

17%

FIs (excluding insurers)

© The Economist Intelligence Unit Limited 2012

73%
agree

57%

15%

26%

12

Chart 5: Do you agree or disagree with the following statement?
Solvency II will ultimately be paid for by policyholders through higher costs.


15%
%
27

46

%

21

%

20%

disagree

respondents

50%
agree

30%

4 4%

all

41%

Chart 6: Do you agree
or disagree with the
following statement?
Solvency II will lead
to higher costs for
policyholders but this
is acceptable in view
of the additional
security provided by
the capital guarantees.

neutral
29
%

Corporates (non-FIs)
Insurers

34

FIs (excluding insurers)

probably won’t feel they get value from it—I think
it will depend on how much more they have to
pay,” comments Mr Williams of Legal & General.
He points out that long-term products with
greater requirements for extra capital charges
will be particularly hard-hit. “Annuity prices, for
example, could well rise and they’ll feed through
to consumers.”
Ms Carter-Vaughan agrees. “A few years ago,
insurers could make a loss on their underwriting
book because they could rely on investment profits
to offset it—but low interest rates and a poor
investment climate have put an end to that. So now
they have to make a profit on the underwriting,

%

57

%

which means premiums have to go up anyway,
regardless of the regulatory changes. Solvency
II will exacerbate that trend because it’s likely to
result in fewer small and medium firms, so there’ll
be less supply to meet demand.”
Rising premiums are likely to bring their own
ramifications. The survey shows there is some
concern that policyholders faced with price rises
they consider unacceptable may simply review
their insurance needs and cut corners: 41% of
respondents expect companies to choose to be
under-insured in the wake of Solvency II, with
a similar percentage (39%) anticipating that
individual policyholders will take such action.

Chart 7: Do you agree or disagree with the following statements?
Solvency II will lead to higher costs to
individual policyholders, which will lead to
more people choosing to be under-insured.

Solvency II will lead to higher costs to
corporate policyholders, which will lead to more
companies choosing to be under-insured.

39% agree

41% agree

30% neutral

28% neutral

31% disagree

31% disagree

© The Economist Intelligence Unit Limited 2012

10


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

But Mr James of Lockton gives that idea short
shrift. “I think under-insurance is highly unlikely,”
he responds. “There is a highly competitive
insurance market across the EU, and consumers
will be able to shop around. The harmonisation
of EU capital standards is a worthy goal, in that it
makes that option possible.”

44
%

disagree

agree

all

31%

But Ms Carter-Vaughan is emphatic that product
ranges and quality will deteriorate, although she
anticipates that relatively commoditised products
such as motor insurance will be less affected than
more unusual or bespoke cover. “It’s bound to

29%

32%
23%

respondents

%

%

39%

43

neutral

4

3

The interviewees are divided in their views on this
hypothesis. Mr James’s view is that “there will be
a rebalancing of product ranges” in response to
the new parameters of Solvency II, but there is
no reason to assume those products should be of
poorer quality.

36%

28%

%
19

The survey suggests that it is less likely that
insurers will respond to higher costs by reducing
the quality of their products—for instance, by
incorporating less-extensive guarantees—with
only 29% overall expecting the emergence of
inferior products.

Chart 8: Do you agree or disagree
with the following statement?
Solvency II will ultimately be
paid for by policyholders through
inferior products.

37%

Corporates (non-FIs)

Insurers

FIs (excluding insurers)

Chart 9: Do you agree or disagree with the following statements?

INSURERS
Solvency II will lead to higher costs to
corporate policyholders, which will lead to
more companies choosing to be under-insured.

27% 35%
agree

neutral

38%

disagree

Solvency II will ultimately be paid for by
policyholders through inferior products.

37%
neutral

44%

disagree

19%
agree

Solvency II will ultimately be paid for by
policyholders through higher costs.

57%
agree

26%

22%

neutral

agree

17%

disagree

11

Solvency II will lead to higher costs to
individual policyholders, which will lead to
more people choosing to be under-insured.

© The Economist Intelligence Unit Limited 2012

35%
neutral

43%

disagree


happen because we will lose medium and smaller
insurers, and that is where more innovative, flexible
underwriting goes on, in contrast to the very by-thebook approach of the big insurers,” she explains.
Interestingly, insurers responding to the survey
are markedly more optimistic across the board that
the financial fallout from Solvency II will not have
an adverse impact on policyholders. Given that
insurers are likely to have thought more about the
cost implications of the new regime than any other
group, are these surprising findings? Are the FIs
(excluding insurers) and corporates (non-FIs) being
overly cynical in their assessment of the obvious
outcome? Are the insurers being naïve or do they
have a solution up their sleeves?
Our interviewees are convinced that there is only
one, inevitable outcome. “Policyholders will
undoubtedly end up shouldering the costs—the
bottom line is that there’s nothing free on any
balance sheet,” says Mr James.
Concerns over how increased costs will affect
different types of insurance products show

that the longer-duration products are expected
to be hit hardest. As seen in the chart below,
shorter-duration products such as personal lines,
commercial and catastrophe are predicted to be less
negatively affected than longer-term products such
as life insurance and annuities.
Looking at the effect of regulation on insurers’
savings products and a broader shift to unitlinked policies, which put the investment risk on
the policyholder, over one-half (51%) of survey
respondents believe that a shift (to unit-linked
products) will have a negative long-term effect on
pension and savings provision. The survey also finds
some regrets at the demise of with-profits products
in favour of unit-linked policies, with 45% saying
with-profits policies would be valued by retail
customers, given the turbulence of current market
conditions. But 39% concur with the idea that they
have been driven out of existence by excessive
capital charges and accounting rules.
“When unit-linked policies came onto the market,
they were seen as cheaper and more transparent,
and customers preferred them,” comments
Mr Williams. “With-profits are still very popular in
other EU countries such as Germany, because of the
guaranteed returns always offered there, but L&G
won’t be offering new with-profits products.”

Chart 10: Which products do you think will be most negatively
affected by Solvency II? Select up to two.

Other, please
specify
Personal lines
of insurance

1%
15%

Commercial
insurance

25%

Catastrophe
insurance

26%
43%

Annuities

67%

Life
insurance

Chart 11:
Do you agree or disagree with the following statements?
With-profits policies
have been largely driven

out of existence because
of capital charges and
accounting rules.

39%

agree

38%
neutral

23%

disagree

© The Economist Intelligence Unit Limited 2012

With-profits policies,
which smooth the
volatility of returns,
would be valued by
retail customers in
today’s turbulent
market conditions.

45%

agree

39%

neutral

16%

disagree

The shift to unit-linked
policies, which put the
investment risk on the
policyholder, will have a
negative long-term affect
on pension and longterm savings provision.

51%
agree

31%

neutral

18%

disagree

12


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

Will pension
schemes also
be subjected to
Solvency II-style
regulation?

The European Commission is keen to introduce
a Solvency II-style regime for defined benefit
(DB) occupational pensions as well, forcing
pension schemes to account for their liabilities
by using a ‘risk-free’ rate of return. At present,
the proposals are still being considered, but
it is clear that pension funds in general are
against such a proposal. Two-thirds of pension
funds responding to the survey agree with
the idea that pensions should be separately
regulated from insurers.
As Jay Shah, head of business origination at
the Pension Insurance Corporation, observes:
“This is set to be hugely controversial over the
next two years. Pension schemes are concerned
because their funding position is likely to
look worse as a consequence of Solvency II.
Of course, unlike insurers who have to be
fully funded, pension schemes can rely on a
corporate sponsor, and they would have to
work out what the value of that sponsorship
amounted to.”
“But the liability side doesn’t differ between
the two,” he adds. “Insurance companies and

defined benefit schemes are promising the same
thing to the individual member, so why should
there be a need for different regulation?”
He expects that although the Solvency II rules
will not be applied precisely to DB pension
schemes, the principles will, so that in an
adverse scenario the scheme could meet
100% of its liabilities to members.

13

© The Economist Intelligence Unit Limited 2012


3

Shifting down the
risk spectrum
The assets most widely expected to lose
favour are equities, non-investment-grade
corporate bonds, hedge funds and longdated debt. The top beneficiaries include
investment-grade corporate bonds, cash
and short-dated debt.

The survey also examined the impact of Solvency
II on insurers’ role as investors in capital markets.
Respondents were asked to indicate, from a lengthy
list, those assets they expected to become less
popular with insurers in the light of the new regime,
and those they thought would grow in popularity.

Chart 12: Because of Solvency II, insurers will have a reduced/increased appetite
for which of the following assets? Select all that apply

reduced increased
Non-investment-grade
corporate bonds

55%

8%

Investment-grade
corporate bonds

17%
56%

Equities

9%

44%

Long-dated debt

24%
17%

Short-dated debt

Emerging market
sovereign debt

30%

Developed but noneurozone sovereign debt

16%

26%

21%

45%

Infrastructure
investment

8%

26%

15%

25%

Property
Private equity

39%

16%

21%

Eurozone sovereign debt
Hedge funds

43%

29%

37%

14%
16%

Cash

1%

Other, please specify

© The Economist Intelligence Unit Limited 2012

40%
1%

14

INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

Specifically in the case of insurers’ responses,
that reduced appetite for equities and lower-grade
corporate debt is even more pronounced. Insurers
are also markedly more negative on infrastructure
and property investment than respondents overall,
with 44% anticipating a downturn in demand for
both those asset classes. That said, they are more
comfortable with euro zone sovereign debt and
somewhat more enthusiastic about investmentgrade bonds.
So there are indications of a clear shift down the
risk spectrum by insurers. Is there a concern that
such a shift could leave insurers looking at their
market capital requirements in isolation, rather
than in the wider context of return on capital? Ravi
Rastogi, senior investment consultant at Towers
Watson, believes that in practice insurers will not
be able to afford to ignore investment return.
“They will have to make trade-offs between return
on capital and capital charges,” he comments.
One possible outcome, indicated by respondents’
views on likely shifts in asset allocation, is that
they may move away from investing right through
the cycle on a buy and hold basis, and towards a
more active approach to asset allocation, moving
into capital-intensive assets only when the
outlook is particularly positive. The question is
then, is Solvency II a force for good in that it forces
insurers to become sufficiently sophisticated to

look at risk-return against capital charge, with
an eye to where a given asset class is in its cycle,
or will it promote a less positive but more easily
implemented short-termist agenda?
Mr Rastogi believes that, in some respects,
changing regulations may actually work to
insurers’ benefit as investors provide a broader
potential investment choice for them. “Solvency
I favours yield-producing assets so insurers
have a bias towards them even if non-yielding
assets make macro-economic sense; there is also
an inbuilt bias towards sticking with the home
currency,” he explains.
“Solvency II has no such constraints—there
is no bias towards yield, and the risk capital
requirements will not vary according to territory
(although there will of course be differences
between the credit-worthiness of different
countries). That means insurers should
have better opportunities for economically

15

© The Economist Intelligence Unit Limited 2012

Chart 13: Because of Solvency II,
insurers will have a reduced/increased
appetite or which of the following
assets? Select all that apply.

insurers

reduced increased
Non-investment-grade corporate bonds

67%

6%

Investment-grade corporate bonds

49%

24%


Equities

64%

11%



Long-dated debt

42%


16%

Short-dated debt

26%


35%

Emerging market sovereign debt

42%

16%

Developed but non-eurozone sovereign debt

35%


9%

Eurozone sovereign debt

24%


40%

Hedge funds

6%

47%


Infrastructure investment

44%


7%
Property

44%


18%
Private equity

29% 24%


Cash

27%


36%

Other, please specify

0%

2%


driven diversification, and also for more
globalised investment.”

allowing clients to show more detailed analysis on
their entire portfolio.”

Nonetheless, although insurers are allowed
in principle to hold a range of risk assets, in
practice their decisions under Solvency II will
be constrained by the need to match assets
and liabilities and to optimise returns within a
limited capital charge budget—and that will have
implications for the make-up of their portfolios.

Mr Shah makes the additional point that there is a
danger that the new regime will not be sufficiently
flexible to allow the fine-tuned treatment of
different asset classes. “Solvency II needs to be
written to allow the emergence of new assets such
as infrastructure. These investments tend to be
secure, very long-term ones; they pay a high yield
because the money is tied up during that time, not
just because there is an element of capital risk.
Solvency II could prejudice such investments if it

penalises them with excessive capital charges.”

“There is a risk that the Solvency II regulations
might push many insurers towards a narrow
range of investment options, which could lead to
increased volatility in those areas. But nimbler
insurers could exploit that herd mentality
by making use of less popular asset classes,”
comments Jay Shah, head of business origination
at the Pension Insurance Corporation (PIC).
For James Hughes, chief investment officer
at HSBC Insurance, the issue is not just about
regulation forcing insurers in and out of different
asset classes, but also how to make assets more
capital-efficient. “Solvency II is making everyone
think very hard about every strategy—it is not just
about risk and return but now has a greater focus
on capital implications,” he says. “I’ve seen fund of
hedge funds marketing themselves as potentially
more capital-efficient because they are offering
greater transparency through risk analytics,

The fact is that the rules are not yet set in stone,
and until they are it is not clear how asset
allocation will be affected. The survey gives some
hope that the transition may not be too painful.
A majority (58%) of respondents are confident
that changes to asset allocation will be phased
in gradually by insurers, which should give the
corporates hoping to attract their capital time

to adjust to the new funding paradigm. But there
is less reassurance from the finding that almost
one-third (32%) of corporates (non-FIs) are
confident that the changes will have no adverse
effect on demand for any asset class—again raising
the question of whether they have fully grasped
the wider implications of the new regime for
financial markets.

Chart 14: How do you think insurers will implement
any changes to asset allocation?

All respondents
FIs (excluding insurers)

In different ways, so no asset class is adversely impacted.

Insurers

23% 16% 25% 32%

Corporates (non-FIs)

On a phased basis over a long period of time, with no shock effect to markets.

58%

65%

57%

45%

All at once, directly impacting asset markets over a short period of time.

19% 19% 19% 23%

26%

© The Economist Intelligence Unit Limited 2012

16


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

However, corporates (non-FIs) do not seem to see
at this stage the connection between regulatory
requirements and their own funding preferences:
only 48% concur, and 21% disagree outright.
Over time, however, it is likely that debt-issuing
companies will adjust their behaviour to try to align
with insurers’ requirements. They may have to issue
shorter-dated debt on a more frequent basis. They
may also adjust their capital structure to achieve
investment-grade status, or offer higher yields in
compensation for the capital costs to insurers.
Most notably, a clear majority (60%) of survey
respondents agree that unrated companies may
have to pay higher yields to attract insurers in the

aftermath of Solvency II. But insurers as a group
are markedly less convinced. Only 39% agree,
compared with 73% of FIs (excluding insurers) and
53% of corporates (non-FIs) This suggests that,

17

© The Economist Intelligence Unit Limited 2012

48%
agree

62%
agree

FIs (excluding insurers)

Chart 15: Do you agree or disagree with
the following statement about corporate
debt issuance? Solvency II makes
the tenor and rating of bonds from
corporate debt issuers more significant.

Insurers

There is a strong consensus among FIs (excluding
insurers) and insurers that the new regulations
will make the tenor and rating of corporate
bonds more significant, as insurers, driven by
capital charge considerations, are increasingly

pushed towards investment-grade debt at the
expense of lower-grade debt. Insurers obviously
understand their own capital considerations and
FIs (excluding insurers), looking at their own
funding requirements under Basel III, will be very
aware of the importance of tenor. Basel III aims to
improve banks’ stability by requiring them to hold
more long-term debt funding than in the past. But
that requirement is at odds with Solvency II, which
makes holding long-dated debt less attractive to
insurers. In other words, there is the risk that banks
and insurers are set to find themselves pulling in
opposite directions.

Corporates (non-FIs)

4

Implications for companies
seeking financing

79%
agree

31%

neutral

31%

neutral

21%

17%

disagree

neutral

7%

disagree

3% disagree


25%
neutral

15%

disagree

53%
agree

39%
agree

37%
31%

neutral

neutral

16%

disagree

unlike other groups with less knowledge of the
implications of the new regulations, they know
they may be unable to afford the capital charges
associated with such companies’ debt, no matter
how generous the yield.
“Of course, insurers will have to assess the risk
versus reward profile for any corporate debt they
consider buying, but they will only have a finite
amount of capital available as cover,” comments
Mr Rastogi of Towers Watson. “It will be a question
of finding the optimal mix of assets within their
specific risk budget.”
Mr Williams of Legal & General speculates that
insurers may be allowed to appeal to the authorities
on the grounds that they have built up a strong
portfolio of BBB-rated debt and therefore have the
expertise to make distinctions on the grounds of a
company’s security and quality. He believes that the
shift away from non-investment-grade debt could

cause significant difficulties for many companies.
“EIOPA wants to see a lower chance of default on
insurers’ investments, through the use of highergrade debt. But many smaller, well-established
industrial firms across the EU are graded BBB. Of
course they are not as secure as blue-chips, and
they pay higher yields to compensate, but they are
not inherently risky propositions. Importantly, it’s
these companies that tend to lead their countries
out of recession, and if the banks are not lending
and the insurers are penalised for buying their debt,
they will face a big problem.”
© The Economist Intelligence Unit Limited 2012

24%

disagree

FIs (excluding insurers)

agree

Insurers

60%

Corporates (non-FIs)

All respondents

Chart 16: Do you agree or disagree with the following statement about corporate debt issuance?

Unrated corporates will be forced into paying higher yields as that will make their debt more
attractive to insurers post-Solvency II.

73%
agree

16%
neutral
11% disagree

An examination of the implications of Solvency
II for companies trying to raise debt throws up
another concern—that the regulators may have
failed to consider the big picture, and that there
is a mismatch between the aims of this piece of
regulation and those of Basel III.
When asked whether the two directives represent a
conflict of interests for banks and insurers, and if
so what the consequences might be, the majority
of survey participants who offered an opinion were
in agreement, although they gave a wide range of
possible outcomes.
“I think these regulations might create conflict;
they may increase demand for sovereign debt
from both banks and insurers,” commented one
UK-based bank respondent. Others suggested that
the main consequence could be a more volatile
market. “The potential conflict between these two
directives could put EU banks and their funding at
risk,” added a composite insurance respondent

from the UK.
A number were more cautious, admitting
that until Solvency II comes into force, it
will be very difficult to predict how the clash
of interests will affect those involved. “I think
that these regulations are going to create
conflicting goals, but the consequences are
still unknown. We will have to wait until their
implementation,” said a bank respondent based
3in Denmark.

18


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

5

Predicting the unintended
consequences
There are fears that the regulatory regime of
Solvency II will introduce a host of unforeseen
problems. The survey findings indicate that there
is little sense of any profound need for additional
regulation in terms of insurers meeting their
obligations to policyholders. Most respondents—
particularly insurers (62%) and pension funds
(64%), unsurprisingly—consider the current level
of regulation sufficient.
Moreover, there are serious concerns among

respondents that regulators have not thought
through the broader impact of the new legislation
on capital markets. Answers to an open question
in the survey highlight the sheer range of
potential problems.
A number of respondents are worried about the
idea of introducing a complex and potentially
restrictive regime at a time when both EU
economies and markets are so fragile. As one bank
respondent from Denmark puts it: “Capital markets
are in a bad shape right now and are not ready for
a major change.” Several voice concerns about the
negative impact on wider economic growth, and
one, another bank respondent from Denmark,
adds that it is not only macroeconomic factors
that are at risk, “but also the pressure put on the
financial sector due to the timing of Basel III and
Solvency II.”
Others highlight the impact on particular asset
classes. “My main concern is that insurers are

19

© The Economist Intelligence Unit Limited 2012

Chart 17: Do you agree or disagree with
the following statement on regulation?
The current level of regulation is
sufficient to ensure that the insurance
industry is able to fulfil its obligations

to policyholders.

All respondents

56%

18% 26%

agree

neutral disagree

Corporates (non-FIs)

48%
agree

21% 31%
neutral

Insurers

62%

disagree

17% 21%

agree

neutral disagree

FIs (excluding insurers)

58%
agree

16% 26%
neutral

disagree


Chart 18:
How will Solvency II impact the structure of smaller friendly societies and mutuals?

20%

They will
outsource more
to access scale

54%
They will
consolidate to
achieve scale

being dissuaded from buying long-term bonds
under the EU Solvency II rules,” says a life
insurance respondent from the UK. But others

are worried about the impact on equity markets,
growth in demand for derivatives, the trend
towards a more concentrated range of asset
classes and the risk of a further credit crunch as a
consequence of over-regulation.
A further area of uncertainty focuses on the impact
of the new regime on smaller friendly societies,
mutuals and monoline insurers. Mr Williams of
Legal & General makes the point that large insurers
with a range of products have the resources to
absorb additional overhead costs, and that at
the other end of the spectrum the industry in
Europe is much more skewed towards small mutual
specialists serving a local community, who have
their own well-established niches and may be
below the minimum size to qualify for Solvency II
regulation anyway. “It’s the monoline providers in
the middle who are likely to be more disadvantaged
than either of these groups,” he says.
More than one-half (53%) of all respondents
expect to see a spate of consolidation as smaller
insurers try to achieve economies of scale; a
further 20% anticipate that they will move towards
outsourcing more functions.
© The Economist Intelligence Unit Limited 2012

11%

They will
close to new

business

16%

There will be
no material
impact

Ms Carter-Vaughan of Expert Insurance Company
agrees that the insurance giants are in a stronger
position because of their resource base. Mediumsized firms, especially broker-only businesses
without their own direct distribution arm, are in a
particularly difficult position, exacerbated by the
economic climate.
“These businesses may be well-capitalised, with
generous solvency margins—but if they’re invested
in government bonds and banks, and the ratings
agencies take a view on that investment base and
downgrade their ratings, as has happened already to
some firms, the insurance brokers will have to drop
away,” she explains. “Solvency II will make this much
worse—it couldn’t be happening at a worse time.”
However, Mr Shah of PIC disagrees that it is all a
matter of scale, observing that large multi-national
insurers with subsidiaries in different EU countries
are likely to face their own problems. “Before
Solvency II, local regimes often understated the
amount of capital needed by insurers, on the
grounds that the multi-national parent was holding
a sensible amount at group level, albeit in other

jurisdictions. Solvency II will push the obligation
to hold the right amount down to subsidiary level,
and limit companies’ ability to move capital around
between countries as needed.”

20


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

conclusion

It is clear that while some boost to the current
regulatory situation may be necessary, both the
potential consequences and the timing of Solvency
II are a source of considerable concern. Indeed,
it seems that while the new regime would be
bound to have ramifications regardless of when
it is introduced, the euro zone’s current difficult
political and economic climate and wider tough
investment conditions are all set to make things
worse for insurers and their stakeholders alike.
There are various implications for policyholders,
but the bottom line is that premiums are
likely to increase in price—as a result of the
implementation and overhead costs of Solvency
II, the further reliance on underwriting profit
rather than investment return and because the
range of providers may shrink as firms are pushed
into consolidation. Some policyholders may be

forced to reduce their levels of cover or drop some
insurances altogether because of price increases.
There is also a risk that they will find it harder to
source more unusual types of cover because of the
contraction in the number of middle-sized firms,
which have traditionally played an innovative role
in the insurance marketplace.
Savings and investment products are also likely
to be affected. As the costs of guarantees become
clearer, they will inevitably increase. Investors
generally see guarantees as attractive but do not
place the same value on them as the cost to hedge
those guarantees—the challenge to the industry
will be to find the right balance.
The possible consequences are arguably also
serious for companies seeking to raise money in
the capital markets, where insurance companies
are major institutional investors. Insurers are
likely to shift their portfolios down the risk
spectrum, away from equities and lower-quality

21

corporate debt and towards ‘safer’ assets such
as cash and investment-grade debt. But that
may leave a tranche of smaller companies—
companies that could be leading European
economies back towards growth—with serious
funding problems because they do not have a
high enough debt rating.

So what is the prognosis for the future, and for
Solvency II’s progress onto the statute books?
Mr James of Lockton emphasises that what
the insurance market really wants is “absolute
clarity as to how the rules will be applied”.
Implementation is still two years away, in 2014,
and clearly there will be many discussions before
everything is clarified, particularly given the
highly uncertain political and economic backdrop
against which decisions must be made.
One area where regulators must consider the
implications of Solvency II is the impact on
the cost of guarantees. EU regulators seem to
want safety at all costs and appear to be more
comfortable with people being under-insured
rather than properly insured but somewhat at
risk of the guarantee not being met by the insurer.
Mr Shah of PIC believes that the European
authorities are likely to have to agree on
substantial compromises to make it more workable
and acceptable to national regulators and the
industry, if it is to be in place roughly on time.
There is also pressure to get things right as
Solvency II’s reach has potential to go beyond the
EU. “Many foreign regulators, particularly those in
developing markets, look to the EU and the US for
guidance on key principles as they don’t want to be
out of sync with these major markets,” comments
Mr Hughes of HSBC Insurance. “This could make
Solvency II even more far-reaching in the future.”

© The Economist Intelligence Unit Limited 2012


appendix:
survey
results
In which country are you personally located?
(% respondents)
Spain
18

United Kingdom
16

Denmark
13

Germany
12

Netherlands
11

Sweden
10

Finland
6

France
6

Luxembourg
5

Belgium
1

Ireland
1
Note:
0 numbers do not add to 100% due to rounding

0
0

What is your primary job function?
0 respondents)
(%

Finance
72

Risk
24

IT
2

General management
12

Operations and production
1
0
0
0
0

© The Economist Intelligence Unit Limited 2012

22


INSURERS AND SOCIET Y: HOW REGULATION AFFECTS THE INSURANCE INDUSTRY’S ABILIT Y TO FULFIL ITS ROLE

Which of the following best describes your job title?
(% respondents)
CFO/Treasurer/Comptroller
30

Head of department
28

SVP/VP/Director
15

Other C-level executive
9

CEO/President/Managing director
8

Board member
6

Head of business unit
4

CIO/Technology director
1

Other
1
Note:
0 numbers do not add to 100% due to rounding

0
0

What is your primary industry?
0 respondents)
(%

Automotive
0
1

Chemicals

0
1

Construction and real estate
1

Consumer goods
2

Financial services
71

Government/Public sector
2

Healthcare, pharmaceuticals and biotechnology
2

IT and technology
2

Manufacturing
10

Power & utilities
2

Professional services
2

Retailing
1

Telecommunications
1

Transportation, travel and tourism
2

23

© The Economist Intelligence Unit Limited 2012


What is your main business?
(% respondents)
Pension fund
25

Bank
25

Non-financial corporates
25

General
9

Life
25

8

Composite - both life and general
6

Asset manager
1

Other, please specify
1

25

0
0
0

What are your company's annual global revenues?
(% respondents)

0 €500m or less
21
0 €500m to €1bn
44
0 €1bn to €5bn
15
0 €5bn to €10bn

0

9

5

€10bn or more

10

11

15

20

25

0

What are your organisation’s assets under management (AUM)?
0 respondents)
(%
0
€100m
or less
2
0
€100m
to €500m
14

0
€500m
to €1bn
11
0
€1bn
to €10bn
30
0
€10bn
to €25bn
6
0
€25bn
to €50bn
3
0
€50bn
or more
34
0
0
0
0
0
0
0
0
© The Economist Intelligence Unit Limited 2012

0

24