Insurers ride high on rising premiums

Investors can probably tolerate Europe’s insurance chief executives taking the occasional champagne bath, after the opening salvoes of the insurance reporting season revealed a uniform picture of rising rates for all parts of the industry from Lloyd’s syndicates, reinsurers and personal insurers to life insurers and catastrophe specialists.

Average rates across a host of different lines from personal to catastrophe and cyber attack insurance have doubled over the past year as the sector experiences an upswing. Life, in short, is good for the man from the Pru. A few of those toasts might also be directed at the government and the Bank of England’s Prudential Regulation Authority (PRA) after a mooted reform of the Solvency II regulations inherited from the European Union came a step closer to being implemented, in the first tangible sign that the UK will adopt significant regulatory divergence as part of its post-Brexit economic strategy.    

A question of solvency

One of the most contentious aspects of the original regulations was a change in how life insurers calculated their solvency ratios. In many cases, this required companies to boost their sustainable capital generation and hold more assets for longer on their balance sheets. The impact was immediate and felt most severely at smaller companies that faced several years of balance sheet restructuring to meet the new requirements. While life insurers were universally affected, long-term buy idea Just (JUST) suffered more than most during this process – it is still a major factor in the company’s comparatively low share rating as it ups its sustainable capital generation.

The reforms to Solvency II could see the risk margin for annuities significantly reduced by either 56 per cent or 21 per cent, depending on which option the PRA ultimately decides to implement. The risk margin is the difference between technical provisions and the best estimate of liabilities should the business need to run-off and be transferred to another entity.

The Association of British Insurers (ABI) argues that the risk in Solvency II was far too wide for the operations and structures of UK-based insurers, which makes the calculation uniquely sensitive to interest rates. The ABI reckons that a side-effect of such a large risk margin is that many British insurers have “offshored” the longevity risks in their balance sheets to jurisdictions with a more liberal allowance. The association reckons that a cut of at least 75 per cent in the risk margin would be needed to reverse this disparity.

Other regulatory changes may have inadvertently benefited the personal insurance sector. The ban on so-called “price walking”, where loyal customers are charged increasingly higher rates in preference to acquiring cheaper new business, seems to have had the unintended effect of improving margins. Insurers are offering fewer discounts to chase new business and a resulting increase in customer retention is improving the stability of cash flows. Investors will get a better idea of the impact of the adapted personal insurance business model when Direct Line (DLG), the best-performing insurance share in Europe so far this year, reports its results on 8 March. 

Natural inflation hedge

The other reason that investors have noticed insurers is the paradox that the capital requirements of Solvency II have meant insurers matching their long-term liabilities better with inflation-resistant assets such as infrastructure and property. In fact, the crossover for the MSCI Euro Insurance indices and the Stoxx Euro 600 index came at the point where inflation expectations started to rise (see chart) which, combined with high dividend yields, has put the sector firmly on the radar of income investors as well as benefiting from the value rotation that has taken place since tech stocks peaked just before Christmas.

It seems that anyone wishing to defend at least a portion of their income from inflation is looking to bag the yields the insurance sector offers.