Solvency II (S2) will increase demand for reinsurance products as under the new regulatory regime insurers can strengthen their capital position through risk transfer, Fitch Ratings says. We expect the main beneficiaries of new business to be the financially strongest reinsurers in the EU and the jurisdictions whose regulatory regime is considered fully equivalent to S2.
A complete picture of the impact on reinsurance demand will take time to emerge. 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. 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.
Reinsurers based in the EU or a country that has been granted equivalence for reinsurance supervision under S2 are likely to have an advantage over those domiciled in non-equivalent countries when competing for business from EU insurers, because transactions should be simpler to execute. Reinsurers outside these regions could be required to post collateral or liaise with a local European regulator, adding costs or delays. Only Switzerland, Bermuda and Japan (temporarily) have been granted this equivalence.
These benefits are likely to have the greatest influence on more commoditised reinsurance products such as property. Other factors could be of greater importance for more complex risks, such as longevity. For example, the value added by a reinsurer’s technical expertise and the potential for a lower price due to diversification benefits for the reinsurer may be more important than the advantages provided through equivalence.
Diversification benefits can be achieved in relation to other exposures, particularly mortality risk, and typically lower the reinsurer’s longevity capital charges. This reduction is often significant compared to the charges faced by the ceding life insurer, even when both companies are operating under the S2 framework.
For more information on the impact of S2 on the reinsurance sector, including the solvency capital requirement coverage reported by Europe’s major reinsurers, see the report “Reinsurance in a Solvency II World”, available from www.fitchratings.com or by clicking the link above. – BusinessNewsAsia.com