How product innovation helps insurers win Solvency II battle

For several years, ‘Solvency II’ was a byword for delays and uncertainty. Now, much of the blanks have been filled in, with insurers assured of the 1 January start date and the overall content of the legislation. 

But while much is shored up about Solvency II, there is still uncertainty about whether some European insurers can meet the new regulatory requirements in time.  

For example, this May the German regulator Bundesanstalt für Finanzdienstleistungsaufsich (BaFin) said that many German insurers would struggle to meet their minimum capital standards due to low rates. 

In the face of this, many smaller and medium-sized insurers are turning to external companies to help. Fortunately, the ongoing innovation around products and services can help these insurers better handle their Solvency II requirements.  

One example comes from investment manager Twelve Capital, which has a scheme that lets small and medium-sized insurers sell off their subordinated debt to investors and thus help them comply with Solvency II regulations. 

Solvency II rules take a dim view of insurers having too much subordinated debt on their books. To count as regulatory capital, tiered subordinate debt is only allowed to make up 20% of an insurer’s tier one capital. The remaining 80% should be equity. 

Twelve Capital managing partner John Butler says that Solvency II has changed the insurance investment landscape by opening up debt restructuring to smaller companies.  

“You have a large group of smaller-sized companies who, at least in the European context, have not traditionally accessed debt as an instrument in their balance sheets,” he explains. 

“They have traditionally managed their capital structure with just equity and reinsurance, largely, or have been mutuals with a very different financial structure. Solvency II has made debt more understandable and available to them. It is opening a market that wasn’t there for investors before.” 

The pool of insurers currently doing this is small, according to Twelve Capital executive director Marcus Rivaldi: “The issuer universe is probably 100, or even less,” he says. “But I think for the largest companies use of debt in their capital structures has been a well-trodden path.”  

Some insurers are more likely to be interested in selling their subordinated debt than others, though Butler notes that “the need for the capital is to some extent across the board”. 

He adds: “There have been some territories and sectors, ahead of others, that have been more willing to face up to the facts of what Solvency II means to them and prepare. For me, the level and duration of denial in the minds of some insurance CFOs in certain sectors has been remarkable.” 

Rivaldi adds that the most likely insurers to want to sell debt are those in northern Europe, life insurance firms and insurers without a very diversified operation. 

This is because these companies have the characteristics that Solvency II capital restrictions punish, he says: “What comes out badly from an Solvency II perspective are companies that have been sold and have a big back book of heavy guarantee business and your investment policy, for whatever reason, has allowed large asset liability duration mismatches to develop on your balance sheet. 

“Solvency II does not like these mismatches and charges you for that. So that leads us to northern Europe, markets such as Germany and Austria and life companies.” 

The main parties interested in investing are European institutional investors, says Butler. 

But not all Solvency II compliance innovation comes from selling debt. Another example comes from software houses. For instance Tagetik sells a product that helps insurers with the reporting needed to meet the new regulations, as this compliance requires robust reporting to the local regulator.  

Other Solvency II compliance software is created by firms including SAS, Oracle, Sungard and Towers Perrin. 

Tagetik Benelux managing director Marco Van der Kooij says: “Solvency II is just another way of reporting, from a market value point of view. It is just a lot of reports required by a regulator that need to be supplied in a certain form.” 

Van der Kooij adds that software can let insurers capture their data in a structured way with clear audit trails, then create reports, giving an alternative to more traditional spreadsheet-based methods. 

Those reports can also be used for purposes outside Solvency II, such as making company accounts, he adds. 

According to Van der Kooij, the countries currently most interested in this are the Netherlands and Italy, followed by the Nordic countries, Slovenia and the UK. 

Van der Kooij says that medium-sized insurance companies are the ones most likely to use this sort of software.  

“I see that small insurance companies tend to keep using their Excel spreadsheets,” he explains. “In my opinion medium-sized insurance companies are moving the most.”  

How prepared insurers are for Solvency II varies. With the start date just a few months away, it is unlikely that some insurers will be entirely ready in time. Many smaller and medium-sized insurers have already sought outside assistance, but the imminent arrival of Europe’s new solvency regulations is likely to drive many more to do the same.