M&A activity in the European insurance sector is likely to increase as firms make the transition to Solvency II regulations and profitability remains under pressure, Fitch Ratings says.

 

Saturated markets in most big European countries will make buying market share through consolidation an attractive option for some insurers. But Fitch believes deals are most likely among smaller insurers because the upcoming transition to Solvency II regulations is likely to be less problematic for bigger firms. Larger insurers are more likely to receive a benefit for diversification in the calculation of their capital charges, are generally likely to be better prepared for the new regulations, and have better access to capital if necessary. 

 

The rules do take account of an insurer's size using the principle of proportionality, which allows smaller, less complex firms to use approximations (for example to value their liabilities), but Fitch believes the sharp increase in costs associated with Solvency II will be a greater burden for smaller firms, which are also likely to be less well prepared. 

 

The rules will be phased in over 16 years from 2016, so insurers have time to change their business models, restructure and improve solvency, and they could benefit as interest rates start to recover. But the results show they are vulnerable to takeover and some may prefer that option. From a credit perspective, M&A can be positive if it increases diversification, market share and leads to economies of scale. But often execution risks such as failure to realise expected cost synergies, lower profits than forecast, poor integration of businesses and systems, and subsequent strategy changes leading to losses on disposal prove the overriding rating factors.

 

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