European insurers must rebuild capital while seeking growth opportunities in 2010

According to Ernst & Young’s Global Insurance Center 2010 European Insurance Outlook, as insurance companies wait for the world economy to slowly recover, they must work to rebuild capital, reassess risk management, integrate changing regulations and aggressively seize opportunities for growth, both via acquisition and new product development. For both the general and life-and-pensions sectors, 2010 will be a challenging year for raising capital and building reserves, complicated by a changing accounting and regulatory environment and the impending implementation of Solvency II.

Ernst & Young identified the seven most significant challenges for European insurers in 2010:

1. Rebuilding capital and re-evaluating core businesses. Insurers are reacting to recent investment losses by focusing on restoring, replenishing and protecting capital. Many who have been battered by falling sales and rising claims are embracing a “back-to-basics” strategy and exiting less profitable lines. As insurers seek out new capital, they need to examine the roles played by reinsurance and alternatives such as captives and securitization. They also need to allocate capital effectively among different product lines and business units. Pending regulatory changes, such as Solvency II, also drives this move.

2. Developing an enterprise-wide approach to risk management. Enterprise risk management (ERM) models are required to recognize and manage the overall level of risk borne by an insurer. ERM can also provide a more effective substitute to “de-risking” so as to reduce exposure. European insurers have forged ahead of competitors in other regions, in part due to the link between enhanced risk management and capital management inherent in the Solvency II framework. Insurers that successfully improve their risk management processes are better situated to attract capital and stakeholder support.

3. Preparing for Solvency II implementation. With the 2012 implementation deadline approaching, insurers must work diligently to prepare for Solvency II. These new standards will probably exacerbate capital constraints, while also driving changes in product and distribution strategies. Encompassing much more than capital requirements, Solvency II marks a fundamental call to connect governance, risk control and wider risk management into an integrated framework.

4. Addressing significant stakeholder concerns. In general, financial services suffered reputational damage and a loss of consumer confidence as a result of the global economic crisis. Insurers and their distributors need to surmount this image problem by spotlighting products and processes, recapturing the trust of consumers and renewing financial transparency.

Because insurance is an intangible product, consumers expect clear policy documentation and uncomplicated claims processes. However, many insurance contracts continue to be perceived as complex documents. In an era when consumers are increasingly using technology to evaluate products from different insurers, pricing transparency is becoming more important.

5. Handling increasing complexity in a changing regulatory environment. The use of International Financial Reporting Standards (IFRS), embedded value and market-consistent embedded value accounting regimes produce different views when it comes to valuing assets and showing profitability.

Some rating agencies continue to question the quality of information and data supplied under IFRS concerning the valuation of assets and product classifications. These challenges may complicate the process of rebuilding capital in 2010. New compliance issues and opportunities will also emerge as European insurers continue to shift away from fragmented, protected markets to an integrated one. But the emergence of new pan-European regulatory bodies that are introducing new compliance requirements for insurers bring increasingly complexity to the regulatory landscape.

6. Reprioritizing investment in expansion. M&A activity should revive in 2010, as the global economy rebounds. Certain opportunities may materialize for financial firms as they jettison insurance businesses to divest themselves of non-core operations and make up for capital deficiencies. If the Euro maintains its strength, European insurers could find acquisitions even more tempting. Consolidation in the crowded European insurance market may also resume in 2010. European insurers that find limited growth prospects in their home nations or in other heavily penetrated markets in the region, will actively seek targets in emerging markets such as Eastern Europe and Asia.

7. Capitalizing on opportunities for retirement products and health insurance. The aging of Europe’s population will continue to present insurers with product opportunities in 2010. Simultaneously, the withdrawal of non-European insurers from the EU retirement market enables resident insurers to pursue larger market share. Insurers will create more guaranteed-rate products in 2010 to meet consumer demand for financial stability. However, these products increase the investment management risk borne by insurers. Thus, they will need to further develop hedging and other risk-mitigation techniques, taking into account Solvency II requirements.