Based on the analysis of the reporting statements of 31 European insurers, the report finds Solvency II has forced apart the sector’s accounting and solvency reporting, making it harder for investors to have a clear picture of how individual insurers are performing.
The report finds that Solvency II falls significantly short as a profit performance and cash generation metric that can replace embedded value (EV). The urgency of this issue is further underlined by the rapidly shrinking publication of useful EV data in Europe and the fact that the reformation of IFRS (new proposals expected to be published in May) is unlikely to help for many years.
Andrew Crean, Managing Partner at Autonomous Research, said: “Solvency II has helped provide a clearer picture of capital adequacy for European insurers, providing some guidance as to when dividends may be a risk or additional capital may be returned. However, Solvency II disclosures have not always considered the investor perspective, creating issues for external users in understanding performance and the dividend paying capacity.”
A clear explanation of the ‘investor story’ in cash terms with a more coherent link between IFRS, EV and Solvency II is essential to sustaining the sector rating, according to the report.
Kamran Foroughi, Director at Willis Towers Watson, said: “Solvency II is obscuring the transition from IFRS earnings, to cash and on to dividends. This risks driving up the sector’s cost of equity, particularly if markets dislocate and concerns emerge about the capital security. In 2008/09, lack of transparency on cash and capital contributed to the sector’s implied cost of equity hitting 20%.”
In order to address the current lack of transparency, the report’s conclusions stress the need for the insurance industry to aid investors by disclosing Solvency II free surplus and sensitivities and an explanation of whether Solvency II or IFRS is the biting constraint when it comes to cash remittances and dividend paying capacity.
Kamran Foroughi commented: “Unfortunately for the insurance industry, the Solvency II and IFRS projects are heading in different directions for the foreseeable future and on their own will not meet investor requirements. In response, we have developed standardised templates for the insurance industry which should help address this gap.”
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