We have changed our credit outlook for the UK life sector to stable from negative. The change in outlook primarily reflects three factors (1) our expectations of earnings stability supported by increasing cash generation; (2) the industry’s strong and resilient capitalisation, which we expect to continue, sustained by conservative capital management; and (3) the strong performance of captive asset managers. However, these factors are counterbalanced by a degree of short-term disruption likely to arise from the Retail Distribution Review (RDR), the risks posed by insurers’ expansion into “new” investment areas and the UK's weak economic growth outlook.
» The profitability of the UK life industry is stable and supported by growing cash generation. We expect the industry’s earnings to remain healthy overall, whilst earnings quality will improve given the focus on cash generation. The low interest-rate environment will gradually reduce profitability, but only marginally, given the industry’s relatively low sensitivity to interest rates.
» Capitalisation has improved and we expect continued conservative capital management. The introduction of Solvency II, although postponed, has kept capital in check. Capitalisation has rebounded from its lows according to various capital metrics and is higher than pre-financial crisis levels. In addition the exposure to peripheral Eurozone investments is minimal.
» Captive asset managers have helped insurers to capture significant growth. Captive asset managers have provided income diversity and helped some UK life insurers to expand and partially offset the historical erosion of cash flows in the life insurance market. Over 2013, we expect this trend to continue.
» Short-term disruption is likely to arise from the RDR. The introduction of RDR at the end of 2012 will reduce the number of Independent Financial Advisors (IFAs) and, consequently, life sales are likely to decline over the outlook period.
» Insurers are increasing their credit exposure to “new” asset classes, albeit in modest amounts thus far. The retrenching of the banking system and the low interest-rate environment has meant that insurers are increasingly expanding their investment activities into the realm of banks. We believe that risks arise from the insurance sector’s often limited investment experience in these “new” assets and the need to develop specific expertise that companies might currently lack.
» UK economic growth remains weak, albeit long-term growth prospects for the UK life sector are strong. The operating environment for UK insurers remains challenging, given the weak economic growth prospects and high level of household indebtedness, albeit some pockets of growth exist, particularly in the annuity and protection lines. We also expect long-term growth from the expanding pensioner
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