Solvency II Directive (2009/138/EC) and Insurance Business Consolidation: Part 1

Insurance and reinsurance undertakings (Firms) are set to witness a surge of activity within the European insurance markets in 2016. The EIOPA review of the methodology to derive ultimate forward rates, discussions on countercyclical buffer rates, the looming 20 May 2016 Solvency II Day 1 returns deadline for December year-end solo firms, and the launch of a Europe-wide stress test for the insurance sector on 31 May 2016, are just some of the highlights on offer. Set amidst economic volatility, low-interest rates, and the race to increase capital returns, firms must now also navigate a regulatory storm to restructure and adapt existing business models to the new Solvency II capital regime. Patchy deal activity in the European Union (EU) since 2014, a cloud of uncertainty, and a ‘wait and see” attitude[1] may now give way to a wave of reform and a surge in mergers & acquisitions (M&A) and divestments.

All about Solvency II and Insurance Business Consolidation:

Under the Solvency II framework, well-diversified Firms benefit from lower capital requirements. Consequently, it is anticipated that smaller Firms may struggle to compete as new Solvency II capital charges will likely increase aggregate capital requirements. They may also find it difficult to adapt effectively to the onerous data analysis, capital modeling, and reporting requirements. High compliance costs, weak solvency ratios, and capital deficiencies may lead to smaller, specialized, and monoline firms being pressured into divesting themselves of capital-intensive units, disposing of non-core units, developing more balanced portfolios, or entering new markets. Whilst larger Firms may seek to increase their diversification across products and geographies further, smaller and medium-sized Firms may fail to realize the full potential of diversification if they fail to develop an Internal Model, and are instead forced to rely on the Standard Formula. Larger insurers with strong capital reserves may aim to cut prices to increase market share further strategically.

It has already been seen that there is now increased interest in legacy portfolio disposals across Western Europe, and risk margin requirements for annuity businesses may in turn lead to increased disposal of annuity books. Under Solvency II, owing to guarantees, the life insurance market will be particularly affected, which means that many German life insurers, which run large books of guaranteed business, will seek to mitigate capital charges under Solvency II. A 2016 Fitch Ratings Report pronounced a negative outlook on the Dutch life insurance market owing to a continuing contraction of the individual life market.[2] Taken together with predicted significant disparities between solvency ratios for Dutch Firms, this could trigger further consolidations in the Dutch life insurance market.  In France, bank subsidiaries (bancassurance) account for approximately 60 percent of the life insurance market. The envisaged increased capital requirements and the challenge of implementing a forward-looking risk assessment under the Own Risk and Solvency Assessment (ORSA) for French Firms may ultimately lead to further consolidations and a contraction of the insurance marketplace.

Under Solvency II, Firms will be forced to reassess internal structuring, strengthen capital positions, mitigate risk, employ diversification strategies, and achieve new efficiencies and cost savings. The likelihood then, is that the EU will witness a shift in the insurance landscape precipitated by increased strategic M&A activities.

If you would like to discuss any of the implications of Solvency II on your business or for more information on our Solvency II reporting solutions and prices, please email DataTracks at:

[1] In 2014 134 transactions were reported as being completed, and only 61 in the first half of 2015. Clyde & Co (2015). Insurance M&A activity A global overview, Clyde & Co Ltd, p.25.

[2] Fitch Ratings’ Report (2016). 2016 Dutch Insurance. Fitch Ratings Limited.

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