Insurance industry's capital position strong in 2016; Solvency II disclosures not clear enough for investors

3 May 2017 — Daniela GHETU
From the investors' perspective, Solvency II disclosures fall short, not providing a clear and easy to understand picture of the re/insurers' financial performance, reads a recent report by Autonomous Research and Willis Towers Watson.

The report titled "Solvency II, One Year On", reviews the European insurance industry's year-end 2016 disclosures based on the Solvency II statements of 31 European top insurers.

The main findings of the report are:
  • Insurance sector performance reporting has become more complicated as a result of Solvency II, and IFRS 17 proposals are unlikely to help;
  • Solvency II has led to a reduction in life supplementary embedded value (in particular free surplus movement) disclosures with no replacement;
  • Solvency II prescribed disclosures (to be published for the first time this May) will not address investor gaps, as there is no requirement to produce a movement analysis from one balance sheet date to the next, nor sensitivities;
  • In order to aid the investor community, the report's authors propose standardized templates for the insurance industry disclosing, inter alia, a movement in Solvency II free surplus, Solvency II sensitivities, and an explanation of whether Solvency II or IFRS or something else is the dividend paying biting constraint.
The primary purpose of Solvency II, reads the report's conclusions page, is to provide a clearer picture of capital adequacy for European insurers. In this it has been successful. For investors, the framing of current coverage ratios within the context of upper/ lower bounds provides guidance as to when dividends may be at risk or additional capital might be returned.

As a profit performance and cash generation measure current Solvency II disclosures fall short. This is a live issue given the rapidly shrinking publication of useful EV data in Europe and the fact that the reformation of IFRS (new proposals in May) is unlikely to help for many years. Two substantive issues need addressing:
  • Because there is no requirement under Solvency II to produce an in-period movement analysis, nor sensitivities, investors do not have a clear picture of free capital generation;
  • Solvency II has forced apart the accounting and solvency reporting, making it harder to understand the dividend paying biting constraint.
With an aggregate Solvency II coverage ratio of 187% at the end of 2016, the industry's current capital position is comfortable. None the less the industry would do well to address the shortcomings of Solvency II before a crisis. In 2008/09 lack of transparency on cash and capital contributed to the sector's implied cost of equity hitting 20%. The peripheral sovereign crisis (2011) and Brexit concerns (mid-2016) support the view that investor confidence in insurance is febrile. Improved transparency should help.

The full report is available on the Willis Towers Watson's website.

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