S&P Examines Europe’s Insurers Exposure to ‘Credit Crunch’

November 6, 2007

Standard & Poor’s has published an “Industry Report Card” on Europe’s insurers, which examines their situation “in the aftermath of the subprime credit crunch,” the findings of an European Commission (EC) inquiry into business insurance, and moves toward a global financial reporting standard.

In relation to the first concern S&P’s report concludes that, “stable outlooks predominate among Europe’s largest insurers. European insurer liquidity remains strong in the aftermath of subprime credit crunch.”

S&P’s analysis notes that “European insurers are resilient to the liquidity conditions that have prevailed since the credit crunch precipitated by concerns over U.S. subprime mortgage lending.”

While the report indicates that an “insurer’s liquidity is typically considered by us as a rating strength for most insurers, stresses tend to “emerge only in the aftermath of major natural catastrophes or with high levels of life insurance surrender activity, neither of which applies currently, and for which there are a number of mitigants.”

S&P also explained that “Europe’s insurers are conservative investors (partly due to regulatory constraints) with the vast majority of their investments deployed in government and highly rated corporate debt, bank deposits, and equities. The resulting credit risk is moderate, except for those groups with large U.S. life insurance subsidiaries.”

S&P concludes that “outside the U.S. such exposure is immaterial.
Insurers are financed by equity and hybrid capital (again subject to regulatory constraints) with very little short-term finance. Only eight of Europe’s pure insurers issue CP, but the amounts concerned are small and are backed by committed bank lines. CP issuance tends to be for financial flexibility purposes rather than for recurring funding requirements.

“There is some pent-up demand from insurers to issue hybrid capital, but investor appetite for these instruments appears to have returned to some extent. Nevertheless, the capital adequacy of the sector as a whole is at a cyclical high. Cash flows are similarly strong. Insurers are typically investment-grade issuers.”

However, S&P said that its “greatest concern arising from the subprime issues relates to the cost of possible investor litigation, since some of that cost may be recovered from the offending institutions.”

S&P also examines the possible impact of the recent report by the European Commission on anti-competitive practices and broker remuneration (See IJ web site Sept. 26). Initially S&P concludes that the “inquiry findings could favor Europe’s leading reinsurers, as it’s expected to “add further impetus to the trend toward differential pricing within the reinsurance sector. While this is expected to be beneficial for the sector as a whole over the long term, it could have a mixed impact over the short to medium term, likely favoring those players able to offer lead capacity.”

The report further noted that, although “no hard evidence” of anti-competitive practices has been found,” that may not be in the best interests of a (re)insurer’s clients. In a reinsurance context, principal among these is the prevalence of harmonized (that is,undifferentiated) pricing, i.e. clients pay the same price for ‘A’ rated reinsurance, as they do for all of the other reinsurers, who sign on to the coverage through subscription.

The EC has strongly indicated that where such “harmonized premiums” are involved, the customers must be fully informed. It has also indicated that requiring premiums to be paid on this basis may contravene the EU’s rules prohibiting anti-competitive practices.

S&P said it “expects that the specter of heightened regulatory scrutiny will provide further impetus to the recent trend toward the increased incidence of differential pricing within the reinsurance sector.”

In conclusion S&P made reference to a report it published, on Oct. 15, 2007, which commented on the International Accounting Standards Board’s (IASB’s) discussion paper (DP) on moves to harmonize global insurance accounting procedures. S&P’s highly favorable comments on the initiative characterized “its implementation to be long overdue,” and adding “we strongly support the development.”

The report – “Toward A Global Financial Reporting Standard For Insurance: Standard & Poor’s Comments On The IASB’s Preliminary Views On Insurance Contracts -” may be accessed on the S&P web site at: www.standardandpoors.com; for further information on S&P’s view of the European insurance market go to: http://www.europeinsurance.standardandpoors.com.

Source: Standard & Poor’s

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