A rebound in the solvency ratios of European insurers, while welcome, largely reflects the recovery in sovereign bond markets, rather than any underlying improvement to insurers' balance sheets. Insurers targeting high investment-grade ratings may need to improve the quality of the capital they hold to reduce volatility in their solvency ratios, Fitch Ratings says.
Insurers reporting results over the last few weeks have generally noted that solvency ratios have strengthened significantly since the end of 2011, when the deterioration in sovereign bond markets sent ratios lower across the board. While stronger ratios are clearly preferable, we believe volatile ratios are not in keeping with the highest ratings, as they indicate that an insurer has a limited ability to shield itself from significant market moves.
Insurers with big operations in Italy, Spain or other markets where sovereign spreads widened in 2011 have tended to see the most volatility in solvency ratios, because the desire to match assets and liabilities led to them holding large portfolios of these sovereigns' bonds. Differences in the implementation of Solvency I rules between different countries within the EU can make comparisons difficult and may also have added to volatility in the ratios.
In particular Italy's rules for calculating the solvency ratio are more prudent than those of France and Germany. This means ratios are generally lower and that, in a market downturn, restrictions on assets that can be counted towards capital kick in earlier, resulting in a sharper drop in the solvency ratio and inducing forms of regulatory forbearance. Conversely, as markets recover, ratios may also rebound faster.
In the case of Italy's Assicurazioni Generali SpA, the insurer's solvency ratio rebounded to 132% at the start of March from just 117% at the end of 2011. This ratio and level of volatility is consistent with the group's 'A-' Insurer Financial Strength rating. We downgraded Generali's IFS from 'AA-' in December, along with other Italian and Spanish insurers. This followed stress tests assessing the sensitivity of insurers' capital adequacy to stressed assumptions over the credit quality of their Italian and Spanish government and bank debt holdings.
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