Solvency II rules could result in less long-tail capacity: Fitch

European insurance buyers likely will find less capacity available for long-tail lines of business if the European Commission adopts the latest set of capital charges suggested for Solvency II, the planned capital adequacy regime for Europe's insurance industry, according to Fitch Ratings.

The Committee of European Insurance and Occupational Pensions Supervisors—the Frankfurt, Germany-based group that advises the European Commission on the new regime—recently published details of its latest set of Level 2 advice on Solvency II that it has given the Commission. This latest advice and subsequent third and final round of consultation on the planned regime represented a significant strengthening in the capital requirements compared with the framework directive that was adopted in May.

A quantitative impact study, QIS4, was carried out to assess the likely impact on insurers of the directive on the ultimate capital requirements, according to insurers.

Lyuba Tarnopolosky, director, insurance at Fitch in London, said Tuesday in at a meeting in Frankfurt that the risk charges, which are based on standard deviations—a measure of volatility based upon a set factor that is multiplied by premium volume—for property/casualty risks, had been significantly enhanced.

Ms. Tarnopolosky said the risk charge for property premium risks, based on annual premium written, had risen to 12.5% from 10%, based on the latest advice compared with QIS4. For the same line of business, the reserve risk, based upon the likelihood that reserves for that business has been underestimated, has risen to 15% from 10%, she said.

For third-part liability, the premium risk charge has risen to 17.5% from 12.5% and the reserve risk has risen to 20% from 15%. Reinsurance has experienced the biggest increase rising to 30% under the latest guidelines from 15% under QIS4 for premium risk and the same percentages for reserve risk.

The overall impact of these increases, when coupled with similarly healthy increases for motor, marine, aviation and transport and credit and surety lines, results in a total increase in capital needs for property/casualty premium and reserve risks of 35%, Ms. Tarnopolosky said.

Other charges, such as for market risk calibrations, correlations and diversification and those proposed for hybrid debt, also have been tightened. But the property/casualty risk charges represent some 50% of the total for property/casualty insurers and therefore would have the biggest effect on insurer capital requirements, she said.

“On the basis of the charges for nonlife risks proposed over the last couple of weeks, the largest tightening has been seen in long-tail and reinsurance lines of business. There has been a substantial tightening for these lines, and if they are adopted in this form then they will be most severely impacted,” said Ms. Tarnopolosky.

Ms. Tarnopolosky said one impact on the insurance market could be a decision to shift capital from more capital-intensive lines of business to less capital-intensive lines of business.

The proposed new charges for long-tail risks and reinsurance were described as “punitive” by one insurance manager for a major German company who preferred to remain anonymous.

The manager said CEIOPS “clearly had bowed to political pressure” caused by the recent financial and economic downturn and opted to introduce these “illogical” charges to “cover their backs.”

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