European insurers must rebuild capital while seeking growth opportunities in 2010, according to Ernst & Young
London, Moscow, 16 February 2010 – While many European insurers weathered the financial crisis better than their bank counterparts, many were shaken by investment losses and capital constraints that are expected to present additional challenges in 2010, according to Ernst & Young’s Global Insurance Center 2010 European Insurance Outlook.
As insurance companies wait for the world economy to slowly recover, they must work to rebuild capital, reassess risk management, integrate changing regulations and aggressively seize opportunities for growth, both via acquisition and new product development, according to Ernst & Young. For both the general and the life-and-pensions sectors, 2010 will be a challenging year for raising capital and building reserves, complicated by a changing accounting and regulatory environment and the impending implementation of Solvency II.
“While insurers hope that they are through the worst of the crisis, the industry will be working hard to reassess and test the destruction to its risk management plans,” said Lex Van Overmeire, Ernst & Young’s Insurance leader for Europe, Middle East, India and Africa. “The past 18 months have taught them, however, that the impossible is possible and that they must be well-positioned for turbulence to ensure success.”
Ernst & Young identified the seven most significant challenges for European insurers in 2010:
1. Rebuilding capital and re-evaluating core businesses
Insurers are reacting to recent investment losses by centering on restoring, replenishing and protecting capital. Many who have been battered by falling sales and rising claims are embracing a “back-to-basics” strategy and exiting less profitable lines. As insurers seek out new capital, they need to examine the roles played by reinsurance and alternatives such as captives and securitization. They also need to allocate capital effectively among different product lines and business units. Pending regulatory changes, such as Solvency II, also drives this move.
2. Developing an enterprise-wide approach to risk management
Enterprise risk management (ERM) models are required to recognize and manage the overall level of risk borne by an insurer. ERM can also provide a more effective substitute to “de-risking” to reduce exposure. European insurers have forged ahead of competitors in other regions, in part due to the link between enhanced risk management and capital management inherent in the Solvency II framework. Insurers that successfully improve their risk management processes are better situated to attract capital and stakeholder support.
3. Preparing for Solvency II implementation
With the 2012 implementation deadline approaching, insurers must work diligently to prepare for Solvency II. These new standards will probably exacerbate capital constraints, while also driving changes in product and distribution strategies. Encompassing much more than capital requirements, Solvency II marks a fundamental call to connect governance, risk control and wider risk management into an integrated framework.
The financial crisis underlines the fact that insurers relied too much on quantitative models, external ratings and benchmarks. In 2010, insurers will explore new quantitative risk-capital requirements under Solvency II – framed by an appropriate risk management infrastructure, with the proper internal processes and controls at all levels.
4. Addressing significant stakeholder concerns
In general, financial services suffered reputational damage and a loss of consumer confidence as a result of the global economic crisis. Insurers and their distributors need to surmount this image problem by spotlighting products and processes, recapturing the trust of consumers and renewing financial transparency.
Because insurance is an intangible product, consumers expect clear policy documentation and uncomplicated claims processes. However, many insurance contracts continue to be perceived as complex documents. In an era when consumers are increasingly using technology to evaluate products from different insurers, pricing transparency is becoming more important. Moreover, how insurance companies handle policyholders during the claims process is a vital opportunity for positive exchange between insurer and consumer, a critical “moment of truth.”
5. Handling increasing complexity in a changing regulatory environment
In 2010, insurers must enhance their compliance processes and oversight in light of the growing intricacy of European insurance regulation. In the wake of the financial crisis, consumers, rating agencies, and regulators will be demanding more transparency around insurance companies’ financial positions. The use of International Financial Reporting Standards (IFRS), embedded value and market-consistent embedded value accounting regimes produce different views when it comes to valuing assets and showing profitability.
Some rating agencies continue to question the quality of information and data supplied under IFRS concerning the valuation of assets and product classifications. These challenges may complicate the process of rebuilding capital in 2010. New compliance issues and opportunities will also emerge as European insurers continue to shift away from fragmented, protected markets to an integrated one. But the emergence of new pan-European regulatory bodies that are introducing new compliance requirements for insurers bring increasingly complexity to the regulatory landscape.
6. Reprioritizing investment in expansion
European insurers have primarily expanded through acquisitions. Merger and acquisition (M&A) activity should revive in 2010, as the global economy rebounds.
Certain opportunities may materialize for financial firms as they jettison insurance businesses to divest themselves of non-core operations and make up for capital deficiencies. If the Euro maintains its strength, European insurers could find acquisitions even more tempting. Consolidation in the crowded European insurance market may also resume in 2010. European insurers that find limited growth prospects in their home nations or in other heavily penetrated markets in the region, will actively seek targets in emerging markets such as Eastern Europe and Asia.
7. Capitalizing on opportunities for retirement products and health insurance
The aging of Europe’s population will continue to present insurers with product opportunities in 2010. Simultaneously, the withdrawal of non-European insurers from the EU retirement market enables resident insurers to pursue larger market share.
Recent economic turmoil made consumers more aware of the asset risk embedded in their supplementary pensions. Bulk, unit-linked buy-outs have slowed due to concerns about pricing among corporate consumers. Even so, insurers still play an important role in managing retirement assets and longevity risk. Insurers will create more guaranteed-rate products in 2010 to meet consumer demand for financial stability. However, these products increase the investment management risk borne by insurers. Thus, they will need to further develop hedging and other risk-mitigation techniques, taking into account Solvency II requirements.
"Interestingly, that Russian insurers are facing many of these challenges as well," says Alex Korogodsky, Ernst & Young Partner and Insurance and Actuarial Advisory Services (IAAS) Group Leader in the CIS. "Many of our clients ask for our advice when they need to restructure their portfolio, rethink their underwriting guidelines or develop agile tariffs. Furthermore, almost all insurers are undercapitalized, and it is clear that shareholders will need to raise capital for their businesses, hence - they will require adequate risk and capital management solutions. Automating key processes in the CFO domain (as opposed to manual spreadsheets), such as preparation of the IFRS and triangulating it with the Russian statutory and management book, is viewed by our clients as a way to transparent and manageable organization. Pensions - is another area of focus for us. Recent legislative changes (August 2009) provide Pension Fund Administrators with greater opportunities for adopting a more aggressive investment strategy, and this means, they will need more robust tools to manage assets and to administer plans."
"Our insurance advisory group is ready to help with answers to these and other questions," Alex continues.
The full version of the 2010 European Insurance Outlook is available at: www.ey.com/insurance.
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