Solvency II to increase reinsurance (and ILS) demand in Europe: S&P

As the new European regulatory standards’ adoption moves ever closer, with Solvency II regulation set for January 1st 2016, S&P has said that it should result in higher reinsurance demand, which could mean more opportunity for insurance-linked securities (ILS).

The approaching implementation of Solvency II regulation and guidelines has been a long time coming for insurers and reinsurers across Europe, providing firms with ample time to adapt and prepare for the upcoming changes.

And, while some uncertainties still loom surrounding certain guidelines and new parameters for re/insurers that operate out of Europe, some of which are still under review and perhaps won’t be fully realised until after implementation, ratings agency Standard & Poor’s (S&P) feels certain changes will likely result in an increased demand for reinsurance, which should result in a rise in the use of ILS solutions across the continent.

“Capital charges under the standard formula or under internal or partial internal models remain under review, and could lead to higher capital requirements. Therefore, we believe reinsurance will remain an important source of short-term and long-term capital as it is fully recognized under Solvency II,” advises S&P.

And example of this, notes S&P, can be seen outside the dominant property/casualty insurance and reinsurance sector, and in the expanding life re/insurance market.

“Certain products carrying longevity risk, for example, are more punitive in terms of capital requirements under Solvency II than others. We have seen, particularly in the U.K., a large portion of primary insurers’ defined-benefit pension scheme transactions completed with the support of longevity reinsurance agreement,” says S&P.

The longevity reinsurance market is poised for rapid growth according to industry experts and analysts, as the growth witnessed in the U.K. is predicted to spread to the U.S., Canada, the Netherlands and beyond.

And, as highlighted by S&P, certain longevity products will demand higher capital requirements under Solvency II, revealing an opportunity for ILS, cat bonds and other alternative risk transfer mechanisms to offer additional capacity and grow its support of the transfer of longevity risks.

As the larger, more diversified reinsurance entities adapt and get used to the new requirements and regulations from the launch of Solvency II, it’s expected that varied reinsurance purchasing and distribution mechanisms and avenues will be adopted, which includes the increased utilisation of alternative risk transfer tools, such as catastrophe bonds, sidecars and collateralized reinsurance agreements.

Increased capital retention requirements will likely drive European reinsurers to further diversify their risk portfolios, seeking new, innovative, bespoke structures and solutions to take advantage of the geographical and peril diversification the ILS space can offer.

Furthermore, claims the ratings agency, in a more-complex Solvency II operating landscape, “large and more-sophisticated reinsurers can offer both significant capacity and bespoke solutions.”

Something S&P feels “provides them (larger and more sophisticated reinsurers) with a competitive advantage over less-diversified and smaller reinsurers.”

According to S&P as reinsurance becomes fully recognised under Solvency II regulations its demand from European entities will rise, which, we at Artemis feel will likely result in a rise in the use of ILS, and alternative risk transfer solutions, an element of the global reinsurance space that has been developing and expanding at a fairly rapid pace in recent times, without the need for higher capital retention guidelines.