What is the appropriate risk-to-capital balance?
SCOR’s most recent report digs into the best solvency ratio for insurance businesses, focussing on the essential balance of risk and capitalisation.
The research investigates how insurers might manage this balance effectively, using data from over 2,100 insurance companies in 30 European nations.
According to the SCOR analysis, the median solvency ratio is 225%, suggesting that these companies have more than double the capital required by law. This level of solvency has been consistent since the commencement of Solvency II in 2016, with variations from the median gradually decreasing over time.
The capital need for life insurance firms is mostly driven by market risk, but for property and liability (P&C) insurers, it is primarily determined by net premium after reinsurance cession.
SCOR’s findings illustrate the various objectives that influence capital adequacy choices in insurance businesses. Regulators frequently advocate for increased capital reserves, although shareholders may wish to see capital returned as dividends. Meanwhile, firm management focusses on long-term growth, combining capital requirements with business expansion objectives.
The report underscores that most insurers prioritize achieving their target solvency ratio before addressing other business objectives, such as growth and profitability. The solvency ratio, which compares eligible own funds (EOF) to the Solvency Capital Requirement (SCR), typically hovers around 225%. While the range of solvency ratios can be broad, the majority of companies fall close to this median value.
SCOR’s investigation demonstrates that the solvency ratio distribution remains similar across risk profiles and calculation methods, whether for life or non-life enterprises. However, the allocation varies greatly based on the company’s domicile.
Insurers can manage their solvency ratios by growing their own money, such as raising equity or debt, or by lowering their capital requirements, generally through the use of reinsurance to reduce retention while maintaining business growth.
Non-life insurance businesses, notably those in the P&C sector, rely heavily on the underwriting risk module to determine capital requirements. SCOR defines this risk as premium risk, reserving risk, catastrophe (CAT) risk, and lapse risk, with premium and reserve risks being the most prevalent.
According to SCOR research, P&C businesses require around €7 million in capital, plus 42% of the net written premium. This requirement varies according to the areas of business, diversification, risk to catastrophic events, and reinsurance coverage.
Including capital requirements for additional risks and diversification impacts, the correlation with net written premium is normally between 30% and 35%, though this varies based on asset management strategies and risk profiles.
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