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Last month, see Chase Cooper News of 16th July, the European Commission released its Level 1 draft for the new capital adequacy directive, Solvency II. It should be no surprise therefore that the level of activity in the merger and acquisition field has increased considerably.
Solvency II requires insurers to allocate capital in sufficient quantities to match the risks that they carry, a process that is already being implemented for banks and other financial institutions through the New Basel Capital Accord (Basel II) and its European Union equivalent, the Capital Requirements Directive (CRD). Solvency II will require insurers to specifically allocate many billions of sterling or euros – but equally it also allows insures that are seen as being well risk managed to free up billions in capital. Munich Re have recently reported that they will need 6 billion euros less in risk reserves. Solvency II will also facilitate cross–border insurance sales with national presence being of little importance.
Joerg Schneider, chief financial officer, in announcing these savings, said that it was due to the level of business diversification found in Munich Re. Diversification allows insurers to offset risks against other activities in the company and favours large and diverse global insurers. Conversely, smaller insurers may find themselves having to allocate more capital as they have limited offsetting capability. How do firms use excess capital? They look for acquisition opportunities. And how do they justify these acquisitions? By identifying greater savings in the merged entity – savings such as reducing total risk capital reserves.
In the UK market, Friends Provident are looking to merge with Resolution. Pearl are also looking to acquire Resolution, and Zurich and Axa are waiting to pounce on Friends Provident. L&G and the Pru are both under pressure and Royal and Sun Alliance could benefit from a merger to diversify their portfolio. Insurance has always favoured the big players – now Solvency II looks to increase this trend.
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