Fitch Ratings says in a new report that the rating outlook for the UK life insurance sector remains stable, indicating that the vast majority of UK life insurer ratings are likely to be affirmed over the next 12-24 months. Fitch's outlook assumes a weak, economic recovery, with modest GDP growth. The outlook does not take into account potential exogenous shocks to the economy but will be updated to reflect such events if they occur.

Fitch says in its report that it recognises in its ratings that insurers have strengthened their balance sheets and reduced their exposure to equity markets. "In contrast to several European insurers, most UK life insurers have negligible direct exposure to the sovereign debt of Greece, Italy, Ireland, Portugal and Spain – typically less than five per cent of shareholders' equity," says David Prowse, senior director in Fitch's Insurance team. "The notable exception is Aviva, with significant exposure to Italian sovereign debt supporting its sizeable operations in Italy."

"Fitch's prognosis for UK life insurers' earnings is less positive," says Prowse. "Earnings are likely to remain below pre-crisis levels as a consequence of lower interest rates and insurers' more cautious investment portfolios, despite the cost cutting that many companies are undertaking to bolster profitability."

Solvency II, the new risk-based regulatory regime for European insurers, is now postponed until 2014. Fitch expects Solvency II capital requirements to be manageable for most major UK life insurers but the ultimate impact will depend on several key decisions still to be made.

"A feature of the UK life sector is the relatively large use of hybrid debt as a material part of insurers' capital structures," says Clara Hughes, senior director in Fitch's Insurance team. "Confirmation of Solvency II transitional arrangements for hybrids will be important for the sector."

Another feature is the large volume of annuity business. "Under Solvency II, capital requirements for annuities stand to be more onerous," says Hughes. "The European Commission is conducting an assessment of the likely impact of Solvency II on products such as annuities that have long-term guarantees, with results due in March 2013. Ultimately, the requirements seem likely be eased by the inclusion of a matching premium, the use of internal models and transitional arrangements."

Pension auto-enrolment is being phased in from 1 October 2012. Fitch expects this to generate premium growth for UK life insurers that provide corporate pension schemes. However, the agency expects the business to be low margin for insurers because they will be in competition with the government's low-cost NEST scheme and contributions amounts are likely to be small: until September 2017, the minimum required contribution is only two per cent of qualifying earnings.

The Retail Distribution Review (RDR), which will bring about a step-change in how investment advice is paid for, comes into effect on 1 January 2013. Fitch expects the RDR to lead to reduced distribution costs for insurers and, through the scrapping of commission, to better standards of financial advice, with less mis-selling and lower policyholder surrender rates. These factors could improve profitability for insurers, even if the introduction of explicit fees causes the loss of some potential customers.

Fitch considers the main risks to UK life insurers' ratings in the next 12-24 months to be deterioration in credit markets, prolonged low interest rates, and potential disruptions from Solvency II, the RDR and other regulatory reforms. In the longer term, the large, diverse insurers, which are typically best-placed for the transition to Solvency II and the RDR, stand to benefit relative to the market and their credit profiles may improve as a result.

Share Story: