This week SCOR released a report benchmarking the solvency positions of more than 2,100 insurance companies in Europe, based on their 2023 SFCRs. The author of the report, Jacky Mochel, CTO of the SCOR P&C “Alternative Solutions” business unit, highlights a few of the key findings of the report including the strong correlation between non-life underwriting risk and net premiums.
Managing capital requirement and business objectives
The strategic business priorities of insurance companies typically centre around premium and top-line growth, as well bottom-line profitability and dividend payment. In our discussions with insurance company executives, it is evident that any major decision relating to these objectives is also assessed in terms of the impact on the firm’s solvency. We also find that companies first consider adequate capital levels to obtain their target solvency ratio, and pursue growth and profitability within that framework.
Convergence of solvency ratios over time
The SCOR study is based on the 2023 Solvency II disclosures (SFCR and QRTs) of 2,200 solo EEA insurers provided in the Solvency II Wire Data database.
The solvency ratio of the sample is typically around 225%. Although the range of values is quite wide, most companies are fairly close to the median value: half of the companies are between the first quartile ratio of 175% and the third quartile of 312%.
The median solvency ratio has remained stable since Solvency II went live in 2016 (see table below), ranging between 211% and 224%. It is more than double the regulatory requirement and corresponds to an optimal value for most companies as it is sufficiently high to manage the sensitivity of the ratio to the short-term volatility in market conditions and to face a 1-in-200-year worst case scenario without falling below the regulatory level. And it has become the gold standard for solvency ratios in the market.
Extended scope of companies, as per availability in Solvency II Wire Data database for Europe (including UK),between 2,100 and 2,500 companies considered each year.
The dispersion around the median is shrinking over time, as can be observed by the narrowing of the 25%, 50% and 75% quantiles of the solvency ratio. This would indicate that companies tend to adjust their ratio to be as close as possible to the median value on their market. The study found that insurers with a solvency ratio below the 225% level tend to increase their solvency position, whereas companies that have a higher solvency ratio tend to reduce their surplus.
Non-life underwriting risk driving the solvency ratio
The solvency ratio is defined as the own funds divided by the capital requirement. To manage their solvency ratio, companies often think about increasing the numerator: increasing equity capital, issuing subordinated notes and reducing the dividend. They can also work on the denominator by reducing the capital requirement.
The report shows that for non-life insurers, the main driver of the ratio is usually the capital requirement for the underwriting risk. This risk relates to “P&C” business, and consists of so-called “Premium Risk” (risk related to future occurrence), “Reserving Risk” (risk related to outstanding claims), “CAT Risk” (consequences of extreme events) and “Lapse Risk”.
Scope: companies writing more than 95% of their premium in the “Non-Life” category, and writing over EUR 1 million of NL premium; size of the sample: 1,127
Many case studies illustrate the predominance of the “premium and reserve” risks, which are calculated as a standard coefficient multiplied by the net premium and net reserve on their balance sheets.
The findings of the report also confirm a strong correlation of non-life underwriting risk to the net premium after reinsurance.
All amounts in EUR million, log scale. Scope: All companies doing P&C business above EUR 10 million
premium, standard formula. Sample size: 795 companies
Reinsurance as a tool for non-life underwriting capital management
The strong correlation between ceded premium and capital relief lays the foundation for capital management reinsurance. Our research found that 25% of the premium written by the companies is ceded to reinsurers.
Very often, reinsurance programs are based on a risk cartography and aim to manage peak risks. However, reinsurance can be considered not only from a pure risk viewpoint but also from a financial viewpoint.
By reducing the volumes of net premium and net reserves, reinsurance reduces the risk as captured by the standard formula, which in turn reduces the capital requirement.
For example , ceding for instance EUR 1,000,000 of premium reduces the capital requirement for underwriting risk by EUR 420,000. After diversification and deferred tax, the total capital requirement of the company would be reduced by around EUR 325,000. When targeting a solvency ratio of 225%, this relief provides the same benefit as raising EUR 730,000 in equity or subordinated debt.
Reinsurance under Solvency II
Reinsurance, namely proportional reinsurance for companies using the standard formula, constitutes a powerful capital management tool that has proved to be more flexible than equity or sub-debt solutions, and provides actual protection in adverse scenarios.
Reinsurance as a capital management tool is particularly cost-efficient on portfolios for which the actual risk – as measured by actuarial modelling – is lower than the regulatory risk coefficient, calibrated on a market average. In such cases, where reinsurance would sometimes not be considered for risk management purposes (e.g., large net portfolios or certain niche portfolios), the cost of reinsurance, which reflects the cost of the modelled risk, will be very competitive.
The author is CTO of the SCOR P&C “Alternative Solutions” business unit. Views expressed are the author’s own.
Click the link to access the SCOR report: Solvency & Reinsurance in Europe – Review of Solvency II reports.
