Vol 5 (2008) - Issue 4

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Recent Developments in the Insurance Sector

Introduction

When looking at the insurance sector there is a wide spectrum of business types which includes life insurers, non-life insurers and reinsurers. Life insurers are best categorised as ‘asset’ businesses usually linked in some way to the provision of savings, pensions or annuities of some kind. Non-life (or Property & Casualty) insurers are by contrast predominately ‘liability’ businesses where premiums are received now to provide cover for claims (i.e. liabilities) that might arise at some point in the future.

Life and non-life insurance companies both operate in a highly regulated environment and the typical balance sheet will have very substantial cash and investments so liquidity is generally not an issue. As a consequence, the ability of these entities to meet the liabilities as they fall due in the short term is invariably not the critical factor but rather the overall assessment of the balance sheet position which can include some very material and significant assumptions. As a consequence restructuring in the insurance arena, common with other areas of financial services, has different pressure points and therefore there is a tendency for insurance restructuring assignments to follow a very different path to other business sectors requiring specialist industry specific expertise.

The restructuring need is predominately balance sheet driven often through some increase in liabilities (e.g. new reported losses on a catastrophic event.) such that the assets are insufficient to discharge the liabilities. Alternatively there may be some decrease in the value of assets with a similar balance sheet outcome. A significant, and common, exception to this is a restructuring that may be required where financing (debt or equity) is structurally subordinated in non-regulated holding companies or some intermediate holding company. The structural subordination protects policyholders in a regulated vehicle but can give rise to liquidity issues in servicing the debt if there is insufficient dividend funds flow from the regulated vehicle to service debt structures at the holding company level. This very issue can be observed in a number of recent situations such as Goshawk, Quanta and PXRE where the companies ceased underwriting new business following hurricanes Katrina, Rita and Wilma in 2005 and regulatory intervention impeded the release of capital to the holding company vehicles.

Over the last few years the international insurance market has seen a relatively benign environment from a restructuring perspective with a ‘hard’ market (one where premium rates are high) and an absence of any major claims event. This coincided with a time when investment performance was generally very good and the major insurers around the world have been reporting record profits for the 2007 calendar year.

By contrast, at the most recent year end renewal, premium rates have softened considerably and coupled with the deteriorating investment environment the situation may be about to change. Many of the earnings announcements from the insurer have directly commented on this changing landscape.

Legal and regulatory developments (Solvency II)

The EU is currently in the process of developing a comprehensive new framework for insurance supervision and regulation. This new framework is referred to as Solvency II and is scheduled to be implemented in or around 2012. The change in approach is a significant one with the development of a comprehensive risk based approach to regulation. Insurance groups are upgrading their capital modelling in anticipation of the new regime and at the same time using this as an opportunity to assess capital efficiency and ways in which that can be improved.

For some groups the spotlight has turned on the capital cost of discontinued lines of business. Discontinued lines of business arise where business has been underwritten in the past but the obligation to pay claims may continue to run for many years after the last receipt of premiums. Historically the focus for capital measurement has been on future premium income. Capital modelling also considers the volatility in claims reserves and where such reserves relate to discontinued business this can be a significant capital drain.