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Fitch Ratings says in a new report that the EMEA insurance sector is strongly capitalised, a key credit positive. Following the launch of its Prism Factor-Based Model (Prism FBM) in September 2014, Fitch has carried out a capital analysis of its EMEA insurance portfolio. The portfolio is strongly capitalised, with 82% of entities scoring 'Extremely Strong', 'Very Strong' or 'Strong', typically above or in line with their ratings. Most ratings are constrained by factors other than capital, e.g. low profitability, high financial leverage, sovereign constraints, limited scale or lack of business diversification.
Net equity is the largest component of Fitch-calculated Total Available Capital (TAC). However, it accounts for only 47% of TAC across the portfolio, as there are several other important components. Capital buffers, e.g. funds for future appropriation, account for 14% of TAC, subordinated debt accounts for 15%, and value of in-force business accounts for 13%.
For life insurers, Target Capital (TC) is dominated by asset risk, which accounts for 65% across the life portfolio. For non-life insurers and reinsurers, the largest components of TC are asset, catastrophe, motor, property and liability risk, reflecting the business mix in the portfolio. Asset risk is the largest component, accounting for 24% of TC, but it is significantly lower than for life insurers because non-life insurers and reinsurers generally focus on taking insurance risk and tend to minimise asset risk.
Prism FBM gives credit for diversification between product lines, asset types and types of business. Diversification benefit across Fitch's EMEA portfolio ranges from 5% to 35% (as a percentage of TC), with composite insurers having the largest benefit, typically around 25%-30%. Even monoline insurers have some diversification benefit, reflecting the diversification between asset and insurance risks and between asset types.
To assess capital adequacy, Fitch considers Prism scores, regulatory solvency, leverage metrics and insurers' own capital models. The Prism score is the main focus, because, unlike most other metrics, it is both risk-based and comparable across markets. It also factors in certain risks and sources of capital that may not be reflected in regulatory metrics. For example, it allows directly for asset risks that vary by rating and duration, and capital buffers such as funds for future appropriation are fully factored into TAC.
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