Insurers' results highlight Solvency II differences - Fitch

Results from UK insurers have highlighted the impact that different investment and underwriting risk strategies have on Solvency II capital ratios, according to Fitch Ratings.

The varying impact of Solvency II on Esure, Admiral and Direct Line reflects differences in diversification, investment and risk transfer strategies, according to Fitch associate director insurance, Ekaterina Ishchenko.

Esure reported a Solvency II coverage ratio of 123% for end-2015, at the lower end of its peer group. Admiral’s coverage was 206% and Direct Line’s was 147%. Ishchenko said all three companies use the standard formula for calculating these ratios.

“We believe that Esure’s lower capital coverage ratio is driven by its less diversified business risk profile and the greater credit risk in its investment portfolio,” she said.

“It was hit the most out of the peer group by SII requirements,” she said, pointing out that Esure’s Solvency I ratio was 390%.

Esure’s business is concentrated in UK motor, which accounts for 83% of its premiums, while about 10% of its fixed income investment portfolio is invested in non-investment grade bonds, higher than its peers. High-yield bonds attract a high capital charge under Solvency II.

Admiral has a conservative investment strategy concentrated in highly-rated investments. Ishchenko added that Admiral’s substantial use of co-insurance and reinsurance to transfer risks and obtain capital relief also helps achieve a higher Solvency II ratio.

Admiral is also focused on UK motor, but only 25% is retained because Admiral has a 40% co-insurance agreement with Munich Re as well as quota share reinsurance agreements in place with major international reinsurance groups, Ischenko said.

Direct Line is more diversified, with motor accounting for 45% of gross written premiums, which would likely reduce the capital hit, offsetting the effect of the company’s riskier investment portfolio.

“We expect these insurers’ SII coverage ratios to be relatively stable on the underwriting side, but Esure’s and Direct Line’s ratios could be exposed to greater volatility from their higher risk investments including high yield bonds, equities and infrastructure,” Ishchenko said.

She added that DLG’s and Admiral’s move to using internal models, which they target for 2016/17, may reduce their Solvency II capital requirements and better reflect the risk in their business models, she said. Esure is also considering the move to an internal model in the future.