From 1 January, 2016, European insurers will have to comply with the Solvency II rules. In addition, Internationally Active Insurance Groups (IAIGs) and Global Systematically Important Insurers (G-SIIs) will be subject to additional capital requirements from 2019. While the details of all these new regulatory frameworks have yet to be finalised, Moody's anticipates that calibrations of required capital and definitions of eligible capital under the future regimes will differ significantly from Solvency I, the current regulatory regime.
Because hybrid instruments issued by European insurers include clauses which refer to a breach of regulatory capital requirements, to regulatory intervention or to non-eligibility of the instruments as regulatory capital, Moody's says that the significant changes in regulations will also change the likelihood that these clauses will be activated.
Moody's has identified three main risks for holders of existing debts issued by European insurers.
Firstly, a breach of regulatory capital requirements that triggers a coupon suspension could be more likely under the future regulatory regimes. Secondly, regulatory intervention prompting a mandatory or optional suspension of coupons could become more frequent. Lastly, the possibility for the issuer to unilaterally vary the terms and conditions or exchange debts in the case of non-eligibility for regulatory capital could allow insurers to introduce loss absorption features into existing debts.
"We think that the significant changes in insurance regulation increase the risk for holders of existing hybrid debt instruments," says Benjamin Serra, Vice President -- Senior Credit Officer and author of the report.
"However we do not expect that Solvency II will lead to a significant and generalised increase in risk for noteholders in the short to medium term because transitional measures will help smooth the impact of the introduction of the new regime."
The transitional arrangements included in the Solvency II legislation will reduce the volatility of Solvency II regulatory ratios and reduce the risk for insurance companies of not being able to meet the Solvency II requirements in the near-term. Moody's expects that most outstanding hybrid instruments with coupon suspension mechanisms triggered by a breach of solvency capital requirements will be called either before, or at the time of, the expiry of the transitional measures.
However, Moody's mentions that there could be downward pressure on insurance hybrid ratings if, over time, as the benefits of the transitional measures diminish, insurers' Solvency II ratios drift much closer to 100% and if Moody's believes hybrid instruments with mandatory coupon suspension mechanisms will remain outstanding.
"The impact of regulations for IAIGs and G-SIIs remains more uncertain at this stage", adds Serra. "However, we expect capital requirements for G-SIIs to be tougher than for non-systemic insurers, which will further increase the risks for bondholders of instruments issued by systemic insurers".
Moody's new report highlights the main risks that future insurance regulations (Solvency II and regulations for IAIGs and G-SIIs) will pose to bondholders of existing insurance hybrid instruments and discusses the likelihood of these risks to materialise.
The report, "European Insurance: Moving regulatory frameworks create risks for hybrid bondholders", is now available below
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