Solvency II will increase insurers’ demand for reinsurance products as they seek to strengthen their capital positions via risk transfer, according to a report published by Fitch Ratings.
Reinsurance can help reduce volatility or improve the certainty of cash flows, which will have the greatest influence on more generic, short tail, commoditized reinsurance products, such as property, “where cost and price considerations are more sensitive,” said Fitch.
Fitch expects the main beneficiaries of new reinsurance business to be the financially strongest reinsurers in the European Union as well as those in jurisdictions whose regulatory regime is considered fully equivalent to Solvency II (S2).
“Higher reinsurer ratings mean lower capital charges for ceding companies under the solvency capital requirement (SCR) calculation,” said the Fitch report titled “Reinsurance in a Solvency II World.”
Full S2 equivalence also is an important advantage because it simplifies the process of transacting reinsurance with carriers domiciled in countries that are designated equivalent to EU regulations for reinsurance supervision.
Currently, Switzerland and Bermuda are the only two countries deemed to be fully equivalent, Fitch said, while Australia, Brazil, Canada, Japan, Mexico and the U.S. have been granted provisional equivalence in respect of the solvency calculation.
For the six countries granted provisional equivalence, the report said, there are no conclusions yet on equivalence for reinsurance and group supervision as these elements have not yet been assessed, although Japan has been granted temporary reinsurance equivalence.
A more complete picture of S2’s influence on reinsurance demand “will emerge as the regime beds down,” Fitch noted, but S2 has already contributed to a marked increase in longevity reinsurance, particularly among UK life insurers with bulk annuity business.
“Longevity risk significantly increases the capital requirements for new annuity business while interest rates are very low because of the S2 risk margin,” the report said. “This increased capital requirement has made insurers keen to reinsure longevity risk, as the associated capital charges for counterparty risk with large, financially strong reinsurers are much lower than those for retained longevity risk.”
Major European Reinsurers Have Strong SCRs
Fitch noted that S2 began to apply to leading European reinsurers – Hannover Re, Munich Re and SCOR – on Jan. 1, 2016, and each company achieved strong SCR coverage.
Swiss Re, which operates under the Swiss Solvency Test, or SST, also achieved a significantly higher level of SCR coverage, compared with the SST, the report affirmed. This confirms the market’s impression that the SST is more conservative than Solvency II, Fitch said.
“The introduction of a supervised economic risk-based regime, which represents a key change under S2, has been less of a change for these companies as they already managed their businesses through internally developed risk-based economic capital models,” the report said.
Each of these reinsurers maintained strong capital under the previous regulatory regime, Solvency I, which was non-risk based, Fitch affirmed.
The entire Fitch report on reinsurance and Solvency II, can be accessed through the rating agency’s website.