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Euro Insurers Balance Sheets Hit By Sovereign Debts

Posted on Nov 22, 2011 by Sergio Ulloa ()

A new special report released this month by Standard & Poor's (S&P), the world's foremost insurance rating and information agency, has examined how recent financial developments, including the slumping share and bond prices resulting from the ongoing eurozone sovereign debt crisis, have negatively affected the balance sheets of Western European insurers through the third quarter 2011 and how this has placed further pressure on the international insurance industry at large. In S&P's report, released November 4 and titled 'European Insurance Credit Trends: Third-Quarter 2011 Market Movements Take Their Toll On Insurers' Capital Adequacy,' the ratings agency describes how the ongoing recession conditions, volatile financial markets and the eurozone sovereign debt crisis have all affected the performance of Europe's insurance industry. While many of the continent's largest insurance players had been able to largely rebuild their balance sheets from their previous low in the aftermath of the 2008-9 financial crisis by the middle of 2011, in light of recent events S&P expects greater financial oversight from company executives to be required going forward in order to better navigate the difficult market conditions sure to come as a result of European bailouts. "In our opinion, the European insurance industry's nervousness has grown," S&P surmised in the report, adding that insurance company losses on bonds issued by the largest eurozone debtor nations would not pose direct threat to their financial positions but will likely be a damper on profitability for the foreseeable future. "In the past quarter, we have seen the credit quality of certain sovereigns and banks decline, and the economic outlook deteriorate. The effect has been amplified by a sharp fall in interest rates, depressed equity markets, and increased volatility. All these factors helped weaken insurers' third-quarter economic earnings and balance sheets," S&P said. In general, Europe's insurance companies should be better able to deal with systemic failures like the eurozone debt crisis than banks, as they would be able to share losses mutually with policyholders without necessarily turning to shareholders or even governments for fresh capital. However, as S&P noted, the insurance industry has developed closer ties with the banking sector over the past few decades through derivate contracts and bond portfolios, and this in turn has left them more deeply exposed to the ongoing eurozone sovereign debt crisis than need be. These ties could also adversely affect their bancassurance distribution network, as many insurers now depend on banks to sell their life and general insurance products through their associated branch networks. This is all occurring while a soft pricing market and stubbornly low interest rates persist, and this keeps rates low, putting downward pressure on insurer profitability going forward. Attempts to increase premiums levels are met with resistance in a weak economic climate, as consumers are unwilling to pay higher rates, if in fact they can afford insurance at all. Stagnant economic growth in Europe's principal markets have both increased the possibility of a double-dip recession and exacerbated the sovereign debt crisis in a number of peripheral eurozone countries, including Portugal, Italy, Ireland, Greece and Spain. According to S&P, European insurers now cumulatively hold roughly €60 billion (US$83 billion) in sovereign debt issued by the most risky nations (Greece, Ireland, Portugal), with a further €190 billion (US$255.7 billion) in bonds held for the larger debtor countries of Italy and Spain, both of whom have replaced their respective governments within the past few weeks. In addition to persistent widespread economic and political uncertainty, Western European insurance companies are also finding themselves stretched in order to meet the changing solvency and industry-wide accounting rules, which are coming into force relatively soon across the continent. S&P noted that the uncertainly surrounding the introduction and execution of Solvency II's updated risk-based financial frameworks and enlarged capital requirements has proven to be a particular impediment for many European insurers. Short term concerns persist for analysts that Solvency II could lead to insurers increasing their capital position at the expense of tackling new business ventures, and thus damaging their competitiveness in the overall global insurance marketplace. The slow-moving implementation of Solvency II, now delayed to 2014, has already proven costly and could also further strain insurers with potentially stricter risk-based capital requirements. The overall cost of introducing Solvency II across Europe is already thought to have exceeded the European Union's estimated EUR 3 billion. In addition to this expense, there remain significant implementation details that still need to be figured out, including premium provision and risk margin. At the same time that these updated capital requirements kick in, a new International Financial Reporting Standard (IFRS) for insurance practices will also occur and this could cost companies valued staff time and resources when they can least afford it. "These trends are compounded, in our view, by the potential impact of industry-wide projects, such as implementing the EU's Solvency II directive on insurance supervision, the International Accounting Standards Board's Phase 2 insurance accounting project, and the Financial Stability Board's designation of globally systemically important financial institutions, now expected in 2012," S&P said. Despite all these industry-wide concerns however, S&P has kept the ratings for the 125 individual European insurers it monitors unchanged, with an average long-term issuer credit classification of 'A' negative. Overall, the ratings agency indicated that while it has a pessimistic outlook on the European insurance sector in general, it of course remains strong in comparison to the other rated businesses active in the Eurozone marketplace. Fortunately for those outside of Europe, there remains considerable business potential for those interested in closing the trillion dollar gap in coverage between the West and the emerging Eastern economies, and this could present sufficient business opportunity for multinational insurers looking to re-capitalize and offset any further calamitous developments occurring in their mature home markets. Ratings Company Mentioned Standard & Poor's Standard and Poors Standard & Poor's (commonly referred to as S&P) is a business branch of publishing house McGraw-Hill. Operating out of 20 countries, S&P provides the investment community with independent credit ratings on important financial vehicles such as stocks, municipal bonds, corporate bonds and mutual funds. In addition to its risk management, investment research and credit rating services, Standard & Poor's is known for its indexes, in particular the S&P 500 index.
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