It's results season again and 'capital' becomes a headline metric

It's results season again and 'capital' becomes a headline metric

It’s results season again and, as always, earnings differ significantly across the board. There are few trends or patterns to take away (so far) - though 2010’s list of costly catastrophes has clearly weighed heavily on many players.

One problem is that few firms have managed to marry strong underwriting with strong investment returns: RenaissanceRe, for instance, posted a combined ratio for the second quarter of 42% but saw investment income drop 76%; in contrast, an investment return up 48% to €5.1bn helped Munich Re post a group profit of €1.2bn and counterweigh a painful 106.4% combined ratio at its reinsurance division.

If there is one thread throughout, however, it is that capital - and efficient capital management with regards to balance sheet strength and regulatory solvency standards - has become as important a metric as profit, revenue and other traditional performance indicators.

Firms now shout at the top of their earnings report about their Solvency 1 ratio, their risk-based capital (RBC) value, their IGD surplus and so on. To be seen to be strong and well capitalised has clearly become very important.

And, judging by what the firms themselves say, most seem very well capitalised (to the point that the majority continue to talk about share buy-backs or, as in the case of Australia’s QBE, on an M&A led strategy to boost return on equity).

Swiss Re states that its estimated excess capital above AA capital requirement was more than $10bn at the end of the second quarter; Aviva says its IGD surplus is “robust” at £3.8bn and remains well above what it was before the crisis; AXA has raised its Solvency 1 margin to the highest level in five years (188%); and MetLife’s excess capital is estimated at around $2.8bn above an RBC ratio of 400%.

Stefan Lippe, CEO of Swiss Re, states that capital will “remain a key industry issue”, with a concomitant big potential for reinsurers to pick up more business. Higher solvency requirements, low investment returns and an increased focus on the economic costs of risk have the potential to fuel demand for (re)insurance capacity, he says. “Changes in regulatory, rating and accounting standards impose increasing constraints on investment strategies, often requiring insurers to hold additional capital. Consolidation among insurers is likely to stimulate demand for reinsurance”.

The truth is that there remains a great deal of uncertainty out there, and firms are stuck with the notion that it is better to have too much capital as opposed to too little. The next six months will be absolutely critical – and hence very interesting from an analytical point of view – for the global (re)insurance market, facing both a soft underwriting environment in many lines and volatile, hard-to-read investment markets as well.

Experts have said that only a $50bn event will move the market – statistically unlikely – while the regulatory heat is ratcheting up across the world. Europe’s insurers and regulators will spend much of the rest of 2010 digesting the European Commission’s QIS5 test, while the international market also now has tangible information on the IASB’s plans to standardise insurance accounting on a global basis.

We live, as somebody once said, in very interesting times.

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