Fitch recognises in its ratings that insurers have strengthened their balance sheets and reduced their exposure to equity markets. Direct shareholder exposure to the sovereign debt of Greece, Ireland, Portugal, Spain and Italy is generally minimal. However, the agency expects earnings in the medium term to be below pre-crisis levels as a consequence of lower interest rates and insurers' more cautious investment portfolios, despite the cost cutting that many insurers are undertaking to bolster profitability.
"Although sales volumes do not generally drive ratings in the short term, they are a barometer of consumer confidence in the life insurance industry," says David Prowse, Senior Director in Fitch's Insurance team in London. "Sales are likely to be held back as lower wage growth and higher price inflation squeeze disposable income, consumers continue to deleverage at the expense of saving, and demand for mortgage-related protection products continues to suffer from the slow housing market. However, the bulk annuity market looks set to grow, giving insurers an avenue to bolster otherwise flagging sales."
Fitch expects business generated by pensions auto-enrolment to be low-margin, with limited prospects 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 2016, the minimum required contribution will be only 2% of qualifying earnings.
UK life insurers are preparing for an unprecedented wave of reforms that will transform how they are regulated and how their products are distributed. Solvency II, the new risk-based regulatory regime for European insurers, and the Retail Distribution Review (RDR), which will bring about a step-change in how investment advice is paid for, are due to take effect on 1 January 2013. Fitch expects these reforms to cause some short-term disruption to the UK life market but expects major insurers to adapt successfully to the new landscape, with no significant implications for credit ratings in the near term.
Fitch expects Solvency II capital requirements to be manageable for most major UK life insurers. However, the ultimate impact will depend on several major decisions still to be made, including the capital treatment of expected profits in future premiums and the length of transitional measures to ensure a smooth transition to Solvency II - notably for hybrid capital, discount rates for provisions (particularly important for annuity business), and equivalence with third countries.
"The RDR is likely 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," says Prowse. "However, many customers may be deterred by explicit fees and shift towards cheaper, restricted advice or no advice at all, with the IFA channel contracting as a result."
Fitch considers the main risks to UK life insurers' ratings in the next 12-24 months to be lower-than-expected GDP growth, the threat of 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.
