Solvency II is driving a marked increase in transaction activity as insurers look to change their business model in response to the new regulations. Speaking today at a seminar attended by leading insurers, Nigel Masters, Head of Actuarial at Grant Thornton, said: “The received business wisdom that has held in the insurance industry for the last 20 years has broken down – with the advent of Solvency II, the game has changed. Historically, companies thought that it was best to specialise but under the new rules that position is going to be much less capital effective.
“The old adage says that there is no such thing as a free lunch. However, by aggregating a number of different risks, the capital required is lower and the return commensurately higher – proving that, in fact, risk diversification really is the only free lunch.”
Companies moving quickly
“Working with our clients it is clear that the market is moving much faster than anticipated as companies look to divest or acquire lines of business to optimise their risk capital position under the new regulations,” said Masters.
Companies that are considering a transaction are likely to act within the next 12 to 18 months. “There is no real upside to a ‘wait and see’ approach,” Masters noted. “Those companies that move quickly to restructure their business models will gain a significant first-mover advantage.” The types of restructuring under consideration include:
* A Part VII transfer – the number of notifications received by the FSA has doubled in the last six months; half the attendees at the seminar said they are considering a Part VII transfer in the coming year
* Entering or exiting a line of business through an acquisition or a sale – the volume of transactions in the Lloyd’s markets has jumped back almost to pre-2008 levels due in part to regulatory pressures and the drive for capital efficiency
* Entering into a reinsurance arrangement – quota share arrangements retain their attraction for insurers looking to diversify risk
* Changing risk profile through the use of derivatives such as cat bonds or industry loss warrants – Swiss Re issued a $50 million longevity cat bond in December 2010, paving the way for more widespread life securitisation.
Focus on risk capital
Other impending changes to business models resulting from Solvency II include a reduction in equity portfolios and an increase in outsourcing of certain functions – such as sales and information technology – as companies adapt to new statutory capital requirements for operational risk.
“The treatment of investment assets under Solvency II will require insurers to deleverage their equity portfolios down to AA-rated bond risks and their return will fall accordingly,” explained Masters. “The logic of putting risk capital behind investment management is gone.”
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