Question 1 – Capital or complexity?
The insurance sector in Europe is not suffering from a lack of capital. It is, however, suffering from a lack of profits and profitability. I am not aware of any company that is not undergoing significant transformation, and we see three strategic priorities manifesting within the sector:
- Redefining purpose and strategic direction
- Transforming the business to be more agile, digital and customer centric
- Optimising the business through cost management and capital allocation
We see a sector with a clear wish to serve its customers and modernise its estate. There is a need to negotiate the investment for that change agenda so that businesses can achieve an appropriate and sustainable return for all stakeholders. Insurance is in the middle of significant change, with the focus on re-organisation and re-platforming, moving from non-life business into the life sector.
To fund those investments and realise operating capacity, we see significant re-organisation of groups, externalisation of long term guarantees through reinsurance and in the limit disposal. Much of that new money, whether for reinsurance or for acquisition, is not coming from within the EU but from the outside. It is solely predicated on the ability to shift the capital frictions outside of the EU. The global market price for such risks are being set outside of Europe, and sometimes significantly lower than Solvency II assumes.
As such, there is a market signal that we have not got the right balance currently and that the appetite for incumbents is more likely to de-risk portfolios seeking better matching of market to market regulatory capital than “risk on” projects where the short term mismatches are held. The resolution of that tension for those seeking to hold those longer term positions are often associated with a transfer of risk out of the EU regulatory context.
The hierarchy of issues and considerations has been well articulated and for posterity if not completeness I can share a personal reflection and view based on client and wider industry insights with specific focus on the Technical Provisions;
- First on the European hit list is the Risk Margin; In this the reforms make a move but it is also worth noting there is a trend away from the Cost of Capital model for risk margin globally; The arguments over its construction are well made with a specific attention on the level of the cost of capital; For sure there is something of an inconsistency where we are reducing productivity gains in the future but not adjusting for costs of capital; But the particular perspective to share is a move to abandon the cost of capital model for valuation purposes and bring back PADs based on percentile. More by note than advocacy it is instructive to note a significant shift of non-European companies to look at a percentile approach for IFRS17 risk adjustments and to note the application of such an approach under the ICS basis.
- Next most favoured topic appears to be the volatility adjustment and this is perhaps a specific area of enhanced complexity with an attendant program of controls that moves the current VA towards a better matching position. This basis is starting to shift in the direction of a matching adjustment and that in turn brings with its considerations of cost benefit and of application and oversight. The feedback that is coming back up the way is that the cost of making it very bespoke will only add to the supervisory burden for the same for larger organisations it is not clear where that balance of benefit will end up in particular for the smaller organisations.
Stepping back from the technical matters, there is also the risk of ending up where the surgery has been a success but the patient had died. In medicine, the reference is iatrogenic, in regulation we reference cost benefit analysis and impact analysis. This is no simple act and is fraught with tradeoffs within and between the actors.
EIOPA has applied diligence in the pursuit of its mandate to provide advice but there is an attendant need for the users of the advice to test and challenge the accompanying cost benefit analysis. From my own review, it appears the costs and impacts underappreciate their effect, and there is the risk of unintended consequences.