French insurers' capital adequacy will unlikely be as good in 2014 and subsequent years as in 2013, owing to low long-term interest rates and declining bond yields this year, says Standard & Poor's Rating Services in a report published Friday.
As a result, French insurers are likely to manage capital adequacy conservatively this year and next in preparation for the 2016 introduction of the Solvency II regime, says the report titled: "Resilient Earnings Help French Insurers Shore Up Capital Ahead Of Solvency II".
"We estimate that the average risk-adjusted capital adequacy of French insurers we rate improved during 2013, building on 2012 gains after hitting a low in 2011," said Standard & Poor's credit analyst Merryleas Rousseau. "We still view capital adequacy as in the 'BBB' category on average, based on our criteria, but thanks to this improvement, we assess it at the higher end of this range, a level consistent with a "moderately strong" capital adequacy."
Improved investment markets rebuilt capital buffers, such as unrealized gains and present value of future profits, while resilient 2013 earnings allowed for higher retention and reserve rebuilding. However, the 2013 return to growth for life insurers has dampened the overall improvement in capital adequacy due to the associated growth in capital requirements. More generally, balance-sheet and asset-risk growth has contained further improvements.
"Although we believe such higher capital adequacy levels position the French insurers we rate well in light of the implementation of Solvency II, we expect capital adequacy's sensitivity to investment market conditions to remain an area of long-term concern and a key risk factor in our view," said Rousseau. "This is because the capital improvements of the past two years were largely because of soft capital items, such as unrealized capital gains on investments and the present value of future profits from life insurance business, which are more subject to volatility."
"The sharp decline in long-term interest rates of over 100 basis points (bps) in the eurozone (European Economic and Monetary Union) in 2014 tempers our views on the sustainability of capital adequacy improvements. This is because lower rates can dampen future earnings and result in a higher cost of options and guarantees in traditional savings products."
"As such, increased unrealized gains on non-life bonds may not be sufficient to offset a lower present value of future profits from the life business and a reduced non-life reserve discount. Finally, evolving investment strategies seeking higher returns are likely to lead to increased capital requirements for asset risk, particularly credit risk."
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