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European insurers 'extremely stretched'

European insurers' pure solvency ratios are "extremely stretched" and 2009 will be an acutely difficult year for some of Europe's largest market participants, particularly in the life sector ? warned Jean d'Herbécourt, the recently appointed head of CA Cheuvreux's insurance research team.

At a London presentation last week, d'Herbécourt said solvency deterioration will be a key feature of financial reporting and ratings actions.

"Most insurers are close to or even below minimum solvency levels" d'Herbécourt said, adding that investors and analysts may not be alerted to the true extent of the problem due to the methods some insurers have employed to calculate their solvency ratios.

"The bad news for investors and analysts is that most of the solvency ratios that will be published in the coming weeks will not be comparable to what was published last June or, to an even greater extent, at the end of 2007. There has been considerable relaxation of the methodology by which these ratios are calculated across Europe. In France, for example, the regulator now recognises part of the excess of reserves in general insurance, and also part of the in-force value, as capital '.

CA Cheuvreux estimates that the majority of European (re)insurers will publish their solvency 1 ratios at between 100 and 150 percent. Most insurers are close to the break-even target ratio of 100 percent, compared to the benchmark ratio of between 150 and 200 percent at the same point last year.

"It is also important to stress that solvency ratios for bigger European insurance companies are also supported by a very significant level of perpetual and subordinated debt which is an element of risk and not always clearly communicated. If you remove debt from the calculations", explained the analyst, "the most stretched insurers in terms of solvency are not surprisingly Aegon, Allianz, AXA, Aviva, Generali, Swiss Life and CNP. These groups are the most at risk in terms of solvency today."

Accounting adjustments "will barely hide the difficulties to close a terrible year" d'Herbécourt said of 2008, adding that CA Cheuvreux predicts a 64 percent drop in profitability on a consolidated basis throughout the insurance sector in 2009, with earnings estimates 42 percent below consensus.

Financial flexibility has vanished and CA Cheuvreux estimates that the majority of insurers will decide not to maintain their 2008 dividends at the same level of 2007.

Meanwhile, the hard market still lies in the future for reinsurers, according to d'Herbécourt, with just the most cyclical lines of businesses demonstrating the turn so far in reaction to a difficult year in terms of costly natural catastrophes.

2009 will see "a complete turnaround for pricing in risk insurance, reinsurance, commercial lines and natural catastrophes," with prices anticipated to more than double in business lines such as excess of loss covers for credit insurance.

"Insurance rates are going to be multiplied by 10 in some segments such as credit insurance" d'Herbécourt said, as soft capacity vanishes under the strain of the financial market collapse.

The likely winner is the reinsurance industry, which has the strongest balance sheets in terms of quality. Decreased capitalisation of primary insurers will lead to increased demand for reinsurance covers, while the decreased capital base of reinsurers will lead to a reduced supply of reinsurance capacity, according to the report.

CA Cheuvreux highlighted Munich Re as a main beneficiary in 2009 renewals, "as it offers superior security to clients - a 'flight to quality'".

Munich Re is in a position to provide its full capacity in the 2009 renewals and at the same time be selective about where it sources business. As a result it can demand higher prices than competitors.

CA Cheuvreux predicts Munich Re's prices to increase overall by 2-5 percent in 2009, which will lead to an improvement in its combined ratio of 2-3 percent.

However he added that one of the key elements to watch for in 2009 is the fall of reinsurers' investment income, in the context of generally stretched solvency across the industry.

"All the excess reserves of the reinsurers has been consumed in the last year, they were quite rich in 2007. They must adjust the cost of their liabilities, by increasing insurance rates and cutting their cost bases,"d'Herbécourt concluded.

Meanwhile, European life insurers are set to suffer a dismal year as business volumes plummet and insurers find they must continue to honour high interest rate guarantees they granted to policyholders in the ongoing low interest rate environment.

"The main risk, which has not yet materialised or even been quantified, would be savings withdrawals that would force insurers to sell assets and realise losses," the report said.

Balance sheets in the sector are "very fragile" and d'Herbécourt expressed doubt as to whether life insurers could smooth losses on assets this year.

The CA Cheuvreux report also predicts that most of Europe's largest insurers will be at risk of a need for recapitalisation as they face a combined shortage of financial capacity and huge potential losses on assets while governments are reluctant to come to their aid.

While public authorities do not want to see bail-outs or rescue plans like those in the banking industry, "all European insurance regulators are working on such scenarios" according to d'Herbécourt.

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