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1 Potential Rating Implications of Solvency II London 15 March, 2012 Catherine ThomasDirector, Analytics.

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Presentation on theme: "1 Potential Rating Implications of Solvency II London 15 March, 2012 Catherine ThomasDirector, Analytics."— Presentation transcript:

1 1 Potential Rating Implications of Solvency II London 15 March, 2012 Catherine ThomasDirector, Analytics

2 2  Key Issues: –Diversification benefits –Investment strategies –Available regulatory capital –Use of internal capital models

3 3 Diversification benefits enhanced BEST’S PERSPECTIVE  Well diversified groups will be able to realise substantial reductions to their capital requirements  Larger groups more likely to seek internal model approval – potential for even greater diversification benefits  Internal models increasingly used to support strategic decisions  Diversification benefits from acquisitions that increase product offering or extend geographical reach RATING IMPLICATION  Diversification benefit applied consistently across the global insurance market through BCAR  Credit in BCAR for line of business diversification and economies of scale  Correlations increase during periods of extreme financial stress  Diversification for diversification’s sake viewed unfavourably  M&A - underwriting, execution and integration risk are key rating drivers

4 4 Investment strategies BEST’S PERSPECTIVE  Individual asset classes will be examined to determine if returns support cost of capital  Equities, as well as longer dated and lower rated corporate bonds, are relatively capital intensive  EEA government bonds currently classified as risk free  Shift from long term to short term debt and towards higher rated corporate and government bonds  Alternative assets incur fixed 49% charge unless possible to “look through” to underlying assets RATING IMPLICATION  Continue to independently assess the risk profile of each rated insurer’s investment portfolio  Required capital to support investment risk calculated using BCAR  Capital charges based on risk of default, illiquidity and market-value declines  Do not differentiate between government and corporate bonds  Additional stress testing owing to European economic uncertainty

5 5 Available regulatory capital BEST’S PERSPECTIVE  3 tiers based on 5 criteria: –subordination –loss absorption –permanence –perpetuity –interest deferral  Tier II and III capital will allow insurers to increase financial leverage RATING IMPLICATION  AM Best has its own methodology on equity credit for hybrid securities  Key characteristics – permanency of capital, ability to defer interest or dividend payments and subordination in an insurer’s capital structure  No change in methodology – allows for global consistency  Will monitor how companies respond to guidelines, in particular if this leads to further innovation in respect of hybrid instruments

6 6 Credit for economic capital models BEST’S PERSPECTIVE  Customised model fit to company’s unique risk profile  Regulator reviews and approves the model  Development of an internal ECM generally viewed positively – company is exploring another way to quantify and manage its risk  Concerns regarding over-reliance RATING IMPLICATION  Difficult to compare company ECMs because of little standardisation  Insurers encouraged to share ECM output  Credit for ECM versus BCAR required capital  No change in methodology  Proven strong ERM + ECM capability = lowering of capital requirement over time

7 7 Risk Management and BCAR – Best’s Approach LOWHIGH EXPOSURE TO EARNINGS and CAPITAL VOLATILITY BCAR BCAR Guideline Weak Risk Management Strong Risk Management Enhanced ERM

8 8 Conclusion  Rating implications will depend on the final structure and calibration of Solvency II  Uncertainty remains –timing of implementation –transitional arrangements –final capital charges –equivalence –group supervision –internal capital model approval  Response of management will determine the impact on an insurer’s credit worthiness

9 9 Catherine Thomas Director, Analytics A.M. Best Europe – Ratings Services Ltd

10 10 © AM Best Company (AMB) and/or its licensors and affiliates. All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT AMB’s PRIOR WRITTEN CONSENT. All information contained herein is obtained by AMB from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. Under no circumstances shall AMB have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of AMB or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if AMB is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor does it address the suitability of any particular financial obligation for a specific purpose or purchaser. Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due. Credit ratings do not address any other risk, including but not limited to, liquidity risk, market value risk or price volatility of rated securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY AMB IN ANY FORM OR MANNER WHATSOEVER. Each credit rating or other opinion must be weighed solely as one factor in any investment or purchasing decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security or other financial obligation and of each issuer and guarantor of, and each provider of credit support for, each security or other financial obligation that it may consider purchasing, holding or selling. Disclaimer

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