Articles - The new tactic to cope with Solvency II

Grappling with Solvency II requirements has not been an easy task for insurance firms over the last 20 months. Whether from a resource, technology or writing business perspective, insurers are continuing to jump through several hoops to ensure compliance with this regulation. This is largely down to the Solvency Capital Requirement (SCR), or the amount of capital which insurers are required to hold.

 By Simon Bittlestone, Managing Director of Metapraxis

 Ultimately, the regulation is in place to make sure insurers have 99.5% confidence that they could cope with the worst expected losses on an annual basis – which means they need to have a large proportion of capital within the business at any one time.

 In order to meet these necessary SCR figures, many firms are considering selling large chunks of their written business to balance out the capital on their books. This requires a great deal of planning before, during and post-sale to ensure that the process runs smoothly.

 Who is already doing this?

 Several large insurance firms are selling off sizeable portions of their business to competitors, to keep their solvency returns at an optimum rate.

 The most recent example of this is Prudential, who has sought a buyer for a section of its £45 billion annuities division. Having run a search for investment bankers to advise on the divestment, it is now looking for buyers for £10 billion of its annuities back-book. With such a valuable piece of the Prudential pie on the market, there are already buyers circling – Legal & General and Rothesay Life are already reported to have put their hats in the ring.

 This is by no means the first instance of this type of sale. Purchasing back-books of others’ business can be a sure-fire growth strategy for an insurance firm, which is undoubtedly a positive for those looking to sell these on.

 Annuities are an especially capital-heavy area for insurance firms, so as Solvency II’s requirements rumble on, it’s likely that there will be more of these large sales hitting the market in the future. Industry heavyweight Aegon most recently announced the sale of its Dutch financial advisory business, UMG, which increased its solvency ratio by 6% alone. Whilst this wasn’t an annuities sale, it’s clear that these sales can have an immediate impact on compliance with this regulation.

 What are the challenges?

 For the finance team in particular, a key barrier to selling off a book of business is being able to model the impact that this sale would have, across a number of different elements. This runs from the impact on a firm’s earning profile, ceded premium, reinsurance treaties and reserves required, all the way through to the financial statements of any affected legal entities.

 To model this effectively, the finance team will need to view the numbers in the context of the firm’s historical data, and consider whether any trends appear regarding the performance of the book they wish to sell.

 It’s all about the planning

 Planning for any major decision within a business’ corporate lifecycle is crucial, but especially when it comes to a sale. This preparation needs to take the form of data analysis, in addition to scenario modelling, to assess the impact that a sale – or any other strategic decision for that matter – will have on the organisation in the immediate and longer term.

 As part of the planning process, businesses across a variety of sectors undertake ad hoc analyses on their books of business as opportunities to divest their portfolio arise; the insurance sector is no different. This analysis can be difficult for others outside the modelling team to understand, however, which can lead to deals completing with worse terms than the firm may have originally wanted. To combat this, insurers need to invest in modelling tools which place their data analysis in the context of historical, actual and planned financial metrics.

 Another factor to consider is engagement from senior leadership and other key stakeholders. Engaging executive board members with financial metrics can be a tricky process at the best of times, so utilising a tool which makes this data easy and quick to understand is vital for refining the deal and getting the best possible terms for the business.

 As we approach the two-year anniversary of Solvency II’s implementation, it is clear that insurers are taking great steps to comply with this regulation, including changing the very structure of their organisations. Undoubtedly, more of these sales will be on the horizon, so when considering selling a book of business to keep their Solvency Capital Requirements at an appropriate level, insurance firms must consider the barriers to effective planning, and the importance of executive level engagement to the success of deals of this nature.

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