European insurance companies may have been slow to warm to the idea of securitization.
However, over the last two years, activity in this sector has picked up. With regulations changing in favor of the use of this capital markets tool, securitization could one day become for the European insurance industry what it has been for the banking sector.
Such was the topic at last week's Fitch Ratings gathering in London on European insurance ABS. Philip Walsh, managing director of ABS at the rating agency, speculated on its growing role in the market. "Not in the next couple of years, of course, but seven to 10 years away," Walsh said. "In the 1970s, banking ABS invigorated the market. Until then, banks were locked into long-term transactions, such as mortgages, and ABS freed up financing to allow for greater growth."
However, it will not be a quick seven to 10 years, the Fitch team added, as challenges remain in aligning the interest of investors and sponsors, in addition to regulatory barriers and the fact that insurance ABS is in its relative infancy.
"The very heavy insurance regulatory environment is still a challenge for insurance securitizations in Europe, and even if this regulatory hurdle is cleared, the uncertainty surrounding the tax treatments of these instruments will slow down the market's development," said Franz Lathuillerie, a director in the insurance group at Fitch. "It must be dealt with by the tax authorities." Until then, Lathuillerie said, SPVs will continue to use offshore markets, such as those in the Cayman Islands or Bermuda, for insurance ABS.
But strides are being made on the regulatory front. The sector is set to receive an industrywide regulation overhaul under Solvency 2. According to the Financial Services Authority (FSA), these new requirements should help supervisors protect policyholders' interests more effectively by making prudential failure less likely - reducing the probability of consumer loss or market disruption.
The framework under development consists of three "pillars." Pillar 1 sets out the minimum capital requirements firms will be required to meet for insurance, credit, market and operations risk. Pillar 2 will be the supervisory review process - because of this, supervisors may decide that a firm should hold additional capital against risks not covered in pillar 1. The aim of pillar 3 disclosures is to harness market discipline by requiring firms to publish certain details of their risks and their capital and risk management.
"There are [still] transaction issues in some countries whilst Europe is moving from Solvency 1 to Solvency 2, [and] those countries need these rules outlined more precisely," said Luca Albertini, head of European insurance-linked securities at Swiss Re Capital Markets. "The rules are clear in some countries, like Switzerland, U.K. and Ireland [and] the rules are getting clearer in places like Holland, whereas in the other countries the rules are currently being developed."
Albertini said the growth of the market has been promising, with new players looking to tap the market. "If you look at insurance ABS four years ago and look at it this year, there has been extremely high growth," he said. "You have insurers starting to use this technology for the first time now. The investor base is well diversified-there are now hedge funds involved as well as institutional investors and specialized funds dedicated to the investment in insurance-linked securities. Even banks are involved in investment-grade investments that sometimes include double tranches. There is even greater investor demand in bonds, so the market will continue to enjoy high growth."
This growing importance of insurance securitization instruments has led to a change in Fitch's insurance companies rating methodology. Traditionally, the impact of insurance ABS deals was only treated qualitatively. With ABS in the mix, deals tend to bring greater financial flexibility and enhanced liquidity and risk management to the sponsor, which has led Fitch to apply a quantitative approach. This highlights the benefits and risks of these deals on the companies' key ratios and capital levels. Fitch believes that these new instruments will represent the "traditional" tools available to insurance companies within a decade from now.
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