S&P’s 2006 Report on European Insurance Highlights a “Good Year”

December 18, 2006

In a recently published report Standard & Poor’s Ratings Services said it “considers that the insurance sector in Europe has enjoyed a very good year in 2006, aided by the absence of the large losses that characterized 2005. Insurers’ strong results have been driven by peak-of-the-cycle underwriting profits in the non-life sector, and solid investment performance. In the life sector, meanwhile, an increase in interest rates has helped to ease pressures over contract guarantees.”

S&P noted: “At present, 79 percent of insurance ratings are assigned a stable outlook or developing CreditWatch listing, 16 percent a positive outlook or CreditWatch listing, and just 5 percent a negative outlook or CreditWatch status. Factors that might upset this stable environment include poor execution of acquisitions and investment market volatility. Equally, further positive outlook revisions could occur if insurers are able to demonstrate that favorable earnings trends are sustainable through the cycle.

“The ratio of rating upgrades to downgrades in the 11 months to Nov. 30, 2006, was 1.2 to 1.0, compared with 2.1 to 1.0 for the same period in 2005,” the bulletin noted.

S&P cited Gerling’s operations as being among “notable upgrades,” as follows:
— Gerling-Konzern Allgemeine Versicherungs-AG (GKA; to A+/Stable/– from A-/Watch Pos/–)
— and HDI Gerling Lebensversicherungs AG (HDI-Gerling; formerly Gerling-Konzern Lebensversicherungs-AG; to A/Positive/– from BBB/Watch Pos/–).

S&P also indicated “notable downgrades among the leading insurers” as including:
— Standard Life Assurance Ltd. (formerly Standard Life Assurance Co.; to A/Stable/A-1 from A+/Negative/A-
— Core entities of the Swiss Re group (to AA-/Stable/– from AA/Watch Neg/–).

A “notable new rating was the ‘AA’ long-term ratings assigned to the largest French life assurer, CNP Assurances.”

S&P also indicated that “after the return of M&A to the insurance sector in 2005, there have been a number of sizable deals announced in 2006. These include: the acquisition of AmerUs Group Co. (A/Stable/–) by Aviva PLC (A+/Stable/–); the acquisition of Winterthur Swiss Insurance Co. (A-/Watch Pos/–) by AXA (A-/Stable/a-1); and Eureko B.V.’s (A-/Positive/–) purchase of Interpolis BTL N.V. and N.V. Interpolis Schade (both rated A+/Positive/–). In addition, SCOR S.A. (foreign currency A-/Stable/–, local currency A-/Stable/A-2) acquired Revios Rückversicherung AG (A-/Stable/–), while Old Mutual PLC acquired Skandia Insurance Co. Ltd. Swiss Re’s acquisition of GE Insurance Solutions Corp. (A/Stable/–) and Talanx AG’s (A-/Stable/–) acquisition of GKA and Gerling-Konzern Lebensversicherungs-AG (now HDI-Gerling) were announced in late 2005 and completed this year.”

Three of Europe’s major insurance groups took steps to address reserving issues, another important development. Singled out in S&P’s report were: Converium AG (BBB+/Watch Pos/–), Lloyd’s (insurer financial strength rating A/Positive), and
Royal & Sun Alliance Insurance Group PLC (core operating entities are rated A-Stable/–). Each one as “announced proposed solutions to legacy U.S. reserving issues in recent months, and any upside has accordingly been factored into their ratings,” said S&P.

The rating agency also said it expects “2007 to be another good year for the sector, although the primary and reinsurance markets may be beyond their pricing peak. Any decline in pricing is likely to be less steep than in previous cycles due to more disciplined management, lower investment returns, improved risk management, and better pricing tools.

“Sub-100 percent combined ratios are expected in the European primary non-life markets in the foreseeable future. Most Continental European non-life markets appear to be holding firm. In the U.K., however, motor and commercial lines rates are bordering on the uneconomic.”

There may, however, be some storms (literally) ahead. S&P said that the “quiet 2006 U.S. hurricane season leaves unanswered crucial questions that emerged in the aftermath of the Katrina, Rita, and Wilma storm losses, as well as potentially damaging the pricing environment going forward.”

S&P also noted: “A year after launch, our enterprise risk management (ERM) analysis is now firmly embedded in our ratings. So far, 3 percent of Europe’s insurers have been assessed as excellent, 11 percent as strong, 82 percent as adequate, and 4 percent as weak. Moreover, European insurers emerge favorably from our analysis. This is partly because there are already regulatory incentives in place in certain countries to demonstrate ERM, and the remainder of the EU should follow suit when Solvency
II is implemented in 2010.”

S&P characterized the implementation of the Solvency II rules as a “genuinely revolutionary change for the insurance industry in Europe and means a complete overhaul of insurance supervision within the EU.” It explained that the “project will introduce a new solvency regime with an integrated risk approach that reflects the risks being taken by insurers far more effectively than the current Solvency I regime.

“Improvements in risk management are leading to greater appreciation of the costs of offering options and guarantees on traditional life products. Where guarantees remain, they are increasingly being priced and hedged out at the inception of the policy.”

S&P also said it is in the process of “updating the way we assess the capital adequacy of insurance companies worldwide. This update has taken the form of a proposed new risk based capital model. All the asset and liability charges within the model have been reviewed and updated. Standard & Poor’s is currently soliciting comments from market participants about the revised charges and the model overall.”

In another sector, S&P’s report notes that 2006 “witnessed a record period for insurance-linked securities (ILSs), with a particularly strong issuance of catastrophe bonds (over 100 percent growth on 2005) and sidecars (that is, limited-purpose reinsurance vehicles), as well as a number of new ILS asset classes such as trade credit insurance securitization (introduced by Swiss Re). AXA’s motor securitization was also the first of its kind. The coming year is expected to see continued strong growth in ILS issuance in Europe and the possibility of the first large securitizations of life embedded value brought to the European market since 2004. Much effort is being placed in developing new asset classes and innovative structures: the provision of new capital market solutions to answer the problem of longevity risk experienced by insurers and pensions funds, for instance, features high on the agenda. Further strong issuance is also expected in non-life asset classes, including both catastrophe bonds and securitizations of risks such as motor insurance.”

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