BEST S SPECIAL REPORT

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1 BEST S SPECIAL REPORT Our Insight, Your Advantage. Market Review October 30, 2015 There has been an element of repricing as (re)insurers heighten their focus on the bottom line. European Insurance Markets Display Early Recovery Signs but Regulatory Issues Brew Europe s largest insurance markets have continued to show some signs of recovery, with many experiencing top-line growth. In general, the increases in total gross written premium (GWP) come following a number of years of muted development and even decline, and there is a sense of optimism that this momentum will continue. A.M. Best s in-depth analysis of the key European markets shows Italy has experienced a second consecutive year of double-digit growth with a 20.7% jump in total GWP in France posted a 6.1% increase, while Germany recorded a more modest 2.7% rise. Spain s total premium volume fell by 0.4% in 2014, although this was its smallest decline in three years and, despite its continued contraction, the country s insurance market remains very resilient and profitable. It is usual to see volatility with regards to the demand for life products, for example with significant growth in Italy and France, but a decrease in Spain. This is due to a combination of factors, including changes in tax treatment, marketing initiatives and competition from banks. The life sector has been the driver for top-line expansion as the prolonged low interest rate environment has caused investors to move away from traditional products (such as bank deposits and investment funds) and seek alternative investment solutions. For European life insurers, the biggest challenge remains legacy business with relatively high guaranteed investment returns, given the continued low interest rate environment. While new business is structured towards unit-linked products, portfolios of traditional products remain significant in particular in Germany. A.M. Best considers historic guaranteed business to represent a long-term potential issue, although there is a possibility of a secondary market emerging to take over these portfolios. This could include the sale or transfer of historic books to specialist companies, potentially backed by private equity firms. Analytical Contact: Carlos Wong-Fupuy +44 (0) Carlos.Wong-Fupuy@ ambest.com Writer and Researcher: Yvette Essen, London +44 (0) Yvette.Essen@ambest.com Editorial Manager: Richard Hayes +44 (0) Richard.Hayes@ambest.com SR Non-Life Sector Remains Competitive In comparison to a thriving life market, the non-life sectors in France, Germany and Spain have experienced more muted activity with a slight recovery. This reflects stabilisation in these economies and a consequent modest increase in demand for insurance products. There has been an element of repricing as (re)insurers heighten their focus on the bottom line, given their inability to rely on investment returns to support unprofitable underwriting. Italy s non-life sector stood out, with GWP contracting for a third consecutive year in 2014, reflecting pricing pressures for third-party motor and marine insurance its largest lines of business. Contents: German Insurers Enjoy Continued Strong Performance but Interest Rate Challenge Looms Sticking to the Basics Ensures Resilience of the Spanish Insurance Sector Italian Insurance Sector Maintains Strong Growth Despite Sluggish Economy The French Insurance Market Confirms its Recovery, Yet Challenges Remain Copyright 2015 by A.M. Best Company, Inc. ALL RIGHTS RESERVED. No part of this report or document may be distributed in any electronic form or by any means, or stored in a database or retrieval system, without the prior written permission of the A.M. Best Company. For additional details, refer to our Terms of Use available at the A.M. Best Company website:

2 Motor continues to be the dominant line of business in all four European markets and is generally the class most under pressure. In Germany, the motor combined ratio has improved in recent years although results have been deteriorating in France and corrective actions need to be taken. Despite pricing pressures in Spain, motor insurers are expected to benefit from an increase in car sales as the country s economy is forecasted to recover in A.M. Best expects technical results on non-life business to experience increased volatility owing to catastrophe exposure, although in the year to date there have been few major losses. The German property/casualty (P/C) sector achieved better underwriting results in 2014, primarily as a result of reduced losses for storms compared to In contrast, the total cost of weather-related claims in France in 2014 was significantly above the annual average incurred over the last 20 years. Natural catastrophes are less of an issue for Spanish insurers, which are protected by the Insurance Compensation Consortium, a public corporate entity which pays for losses from extraordinary events. Spanish insurance results have therefore historically been much more stable. Europe s Largest Insurers Centralise Resources A.M. Best notes that some of the largest European insurers listed in Exhibit 1 have increased their levels of retention in the last few years, trying to make their reinsurance programmes more efficient. This trend has continued in 2015, with the biggest groups centralising their reinsurance purchasing, even creating reinsurance captives. Exhibit 1 Europe Non-Life & Life Largest 10 European Insurers (based on Gross Written Premium) (EUR Billions) Rank AMB # Company Domicile Gross Written Premium Total Assets Capital & Surplus The largest European insurers are also attempting to realign their investment policies, and, given the low investment returns as a result of supressed interest rates, are becoming more involved in real assets. In addition to direct and indirect exposure to property and listed stocks, these may include infrastructure projects with government support through equity or debt. Discussions are ongoing as to whether these investments should receive favourable treatment under Solvency II, especially if they are used to back long-term liabilities such as annuities. European insurers continue to await approval for internal capital models submitted under Solvency II. A.M. Best expects some companies will hold capital in excess of minimum capital requirements (MCRs) to provide a significant buffer in the event of any economic AXA S.A. France Allianz SE Germany Assicurazioni Generali S.p.A. Italy Zurich Insurance Group Ltd. Switzerland Prudential plc United Kingdom CNP Assurances France Credit Agricole Assurances France Talanx AG Germany Aviva plc United Kingdom MAPFRE S.A. Spain Totals: , , Source: Best s Statement File - Global, A.M. Best data and research

3 uncertainty and volatility. For the largest European insurers, the new insurance directive has triggered some level of legal restructurings as companies attempt to allocate capital more efficiently. Surplus funds are being kept at holding company level, while some restructuring initiatives are clearly aimed at minimising the number of regulators involved in the oversight of these groups. Typically, this has led to the relocation or merging of subsidiaries. Regulatory Developments Key in 2016 Regulation will continue to play an important role in the prospects of European insurers for the remainder of 2015 and in In Spain, new legislation regarding the assessment of damages in personal injury claims ( baremo ) will provide greater certainty and clarity to these claims but at the same time could result in significant cost increases for insurers. France s Hamon law ( loi Hamon ) is expected to impact the home insurance, motor and loan insurance lines of business, leading to higher churn potential and increased competition whilst maintaining pressure on rates. On the health sector side, regulatory developments include the interprofessional national agreement (accord national interprofessionnel or ANI ) legislation in France, which will make it compulsory for companies to offer group health insurance to their employees starting January 1, However, the prospects offered by the ANI could result in aggressive competition, which would not be beneficial to the market. In Germany, there is currently a debate on how to increase the uptake of corporate Altersvorsorge (retirement/old age provision insurance, which mainly relates to pensions) and whether it should be made compulsory. 3

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5 Market Review Companies are altering product offerings and are cautiously adjusting their asset portfolios to obtain better yields. German Insurers Enjoy Continued Strong Performance but Interest Rate Challenge Looms German insurers are continuing to benefit from a strong domestic economy and the industry s results were supported by a return to a more benign catastrophe experience in 2014, although the low interest rate environment overshadows the sector. A.M. Best s analysis shows demographic factors, coupled with the country s strong economic fundamentals, are likely to result in ongoing demand for insurance over the long term. In 2014, insurance penetration was stable at 6.6% and there was a near 3% increase in total gross written premium (GWP) for a second successive year, driven by expansion across all the insurance sectors life, non-life and health (see Exhibit 1). Higher insurance premium rates have been a partial factor in the rise in GWP, combined with an uplift in gross domestic product (GDP) and a fall in unemployment. However, while the insurance market has continued to prosper, challenges remain. In particular, the difficult environment for generating investment returns is placing significant pressure on German life insurance companies, which must honour guaranteed high rates from legacy business. Companies are subsequently altering product offerings and are cautiously adjusting their asset portfolios to obtain better yields. Insurance Market Performance Robust In 2014, the German property/casualty (P/C) sector achieved better underwriting results compared to 2013, driving improved overall earnings for the insurance market. This was Analytical Contacts: Tim Prince +44 (0) Timothy.Prince@ambest.com Charlotte Vigier +44 (0) Charlotte.Vigier@ambest.com Writer and Researcher: Yvette Essen +44 (0) Yvette.Essen@ambest.com Editorial Manager: Richard Hayes +44 (0) Richard.Hayes@ambest.com SR Exhibit 1 Germany Non-Life & Life Key Facts Indicator Population (Millions) Gross Domestic Product (EUR Billions) 2, , , , , , ,903.8 Change in Real GDP (%) Inflation (%) Unemployment Rate (%) Insurance Penetration (%) Life Health Non-Life Total Insurance Premiums Written (EUR Billions) Life Health * Non-Life Total * Change in Total Premium Volume (%) * Provisional figures. Numbers may not add up due to rounding. Source: International Monetary Fund, World Economic Outlook Database, April 2015; Gesamtverband der Deutschen Versicherungswirtschaft (GDV) 5

6 primarily a result of reduced losses for natural catastrophes during the year, with hail and windstorm Ela the largest major loss in According to the insurance trade association, Gesamtverband der Deutschen Versicherungswirtschaft (GDV), Ela caused an estimated EUR 400 million of claims for property and EUR 250 million for motor. While it was the second most expensive storm for Germany in 15 years, losses were significantly lower than those of Andreas in In August 2015, the GDV stated that insurers expect a storm of Ela s severity to occur every two to three years. In addition, Europe was also impacted by thunderstorms, with German insurers paying EUR 340 million for losses related to lightning in Due to its exposure to natural catastrophe losses and the high retention of retail business risks, A.M. Best anticipates some level of volatility in the overall results of the German P/C sector over the long term. In 2013, Germany was the second largest contributor to worldwide natural catastrophe losses with an insured loss figure of USD 6.6 billion out of a total of USD 31 billion. In 2013, property claims were high as a result of catastrophe events resulting from extensive rainfall in June, which along with snowfall that melted added to rising water levels, resulted in the worst floods to hit Germany since The market has been hardening for personal lines, with motor and private property expected to post modest rate increases. In 2014, overall GWP for the motor sector increased for a fifth successive year, while domestic property benefitted from automatic inflation adjustments and stronger demand. In A.M. Best s opinion, the outlook for 2015 is promising, with insurance premium rates expected to remain at a good level. Insurers have been increasingly focused on their bottom line results ahead of the introduction of Solvency II and have adjusted their insurance portfolios accordingly. Furthermore, the low interest rate environment has led to a greater need for disciplined underwriting since investment returns remain challenging. A.M. Best s analysis of the development in shareholders capital plus equalisation reserves (based on the largest 20 P/C companies) shows that despite large natural catastrophe Exhibit 2 Germany - Non-Life - Capital & Surplus and GWP Leverage ( ) (Based on the results of the 20 largest property/casualty insurers) Capital & Surplus (EUR millions) 25,500 25,000 24,500 24,000 23,500 23,000 22,500 22,000 21, ,976 24,503 24, , Capital & Surplus (EUR Millions) Gross Written Premium Leverage 6 losses in recent years, the industry s overall level of available capital has remained robust (see Exhibit 2). However, for the same companies, there has been a modest increase in GWP leverage over the past five years as premium growth has outpaced the increase in available capital. According to GDV data, P/C GWP increased by 3.3% to EUR 62.6 billion in 2014 (see Exhibit 3). All lines of business experienced increases except for credit insurance. Motor, the largest non-life line of business, experienced a 4.8% increase to EUR 24.4 billion, while property (the second largest) rose by 3.4% to EUR 17.3 billion. In 2014, total claims decreased by 8.6% to EUR 45.4 billion. This was back in line with the loss experience of 2012 due to a more average year in terms of natural catastrophe claims, Exhibit 4 Germany Non-Life & Life Long-Term Interest Rates for Convergence Purposes ( August, 2015) Note: Gross Written Premium leverage is calculated as GWP divided by Capital & Surplus and Equalisation Reserves. Source: Best's Statement File - Global, A.M. Best data & research Gross Written Premium Leverage

7 Exhibit 3 Germany Non-Life Development by Line of Business ( ) Gross Written Premiums (EUR millions) and also reflected better underwriting results in motor. Total property claims were down 19.4%, while motor claims decreased by 5.1% from the prior year. The motor line of business had been loss making since 2008, largely due to highly competitive market conditions which has put pressure on rates. While the 2014 combined ratio decreased from the high 104.4% posted at year-end 2013 to 96.7%, Germany s largest line of business is expected to remain under some pressure. This is especially true if the more benign claims environment experienced in 2014 and 2015 to date results in softer rates as insurers continue to compete for business. In the life sector, data from the GDV show that premiums increased by 3.2% to EUR 93.7 billion in 2014, while paid claims rose by 6.3% to EUR 84.4 billion. As shown in Exhibit 1, since 2011, the sector has expanded, reflecting continued demand for traditional life and pensions products. The biggest challenge facing life insurers is the low interest rate environment, which is discussed in more detail later on in this report. The sector is expected to benefit from the Life Insurance Reform Act, passed in July 2014, which included a reduced obligation to share unrealised gains with policyholders upon expiry of their contracts. The act, which also has strict restrictions on dividend payments and enables a reduction of the minimum guaranteed rate on new contracts, is expected to have positive effects on the sector s solvency, according to simulations carried out by the Deutsche Bundesbank. Separately, there is a considerable industry debate on how to increase the uptake of corporate Altersvorsorge (retirement/old age provision insurance which mainly relates to pensions) and whether or not it should be made compulsory. Corporate pensions, the second pillar of the German old age provision system, currently only accounts for approximately 6% of the retired population s income while the state remains by far the largest contributor, providing just under two-thirds of a person s income in retirement. Corporate pensions are not currently compulsory in Germany but the bigger the employer, the more likely they are to provide their workforce with a corporate pension plan. The main issues with such schemes is that they are not currently regarded as attractive enough for employees and are cumbersome and too complex for many employers to manage. Whether these issues are addressed to make corporate pensions more appealing or whether this line of business is made compulsory, the insurance industry is likely to see an increase in corporate pensions in the medium term. 7 Claims (EUR millions) Combined ratio (%) % Change % Change Property Total: 16,728 17, % 15,109 12, % 116.2% 97.0% Private 8,917 9, % 7,605 5, % 115.6% 94.9% Commercial 7,810 7, % 7,504 6, % 116.8% 99.5% MAT 1,764 1, % 1,333 1, % 105.1% 91.4% Credit 1,582 1, % % 78.4% 68.6% General Liability 7,223 7, % 4,780 4, % 95.3% 94.2% Motor 23,260 24, % 21,770 20, % 104.4% 96.7% Accident Individual 6,411 6, % 3,092 3, % 79.4% 80.9% Legal Insurance 3,417 3, % 2,474 2, % 99.3% 102.4% Protection % % n/a n/a Total 60,558 62, % 49,653 45, % 103.5% 94.6% Source: Gesamtverband der Deutschen Versicherungswirtschaft (GDV) and A.M. Best data and research

8 Capital & Surplus (EUR Millions) Germany - Non-Life - Capital & Surplus and GWP Leverage ( ) Gross Written Premium Leverage Note: (Based on the results of the 20 largest property/casualty insurers) Surplus and Equalisation Reserves. Special 25,500 Report Gross Written Premium leverage is calculated as GWP divided by Capital & Source: Capital & Surplus (EUR millions) Best's Statement File - Global, A.M. Best 1.37data & 1.38 research Exhibit 24, , ,419 Germany 24,000 Non-Life & Life Long-Term Interest Rates for Convergence Purposes 1.32 ( August, 2015) 23, , ,500 22, , , Capital & Surplus (EUR Millions) 2 Gross Written Premium Leverage Note: Gross Written Premium leverage is calculated as GWP divided by Capital & Surplus 1 and Equalisation Reserves. Source: Best's Statement File - Global, A.M. Best data & research 0 Interest Rate (%) Exhibit Source: European 4 Central Bank Germany Non-Life & Life Long-Term Interest Rates for Convergence Purposes ( August, Low Interest 2015) Rates Overshadow Insurance Sector Exhibit 6 5Long-term interest rates continued to decline in 2014, with the 10-year German bund falling Germany significantly Non-Life & to Life 0.59% in Net December Investment This trend continued in 2015, driven by ongoing 5 troubles in the Eurozone, and in April 2015 the 10-year German bund stood at just 0.12% before Yields ( ) 5.0 rebounding slightly (see Exhibit 4). Demand for the country s debt resulted in Germany 4 selling more than EUR 3 billion of five-year bonds in February 2015 at a record low of minus 0.08%, the first time the country s debt had a negative yield. Interest Rate (%) % 3 25, , Supressed investment returns have, to an extent, overshadowed resilient company results, although on the positive side, the low bond yields have been a consequence of Germany s robust domestic economy. German GDP increased by 1.6% in 2014, following two years of relatively flat growth (2012: 0.6%, 2013: 0.2%). Furthermore, the unemployment rate fell further to 5.0% in 2014, compared to over 6.9% only five years prior (see Exhibit 1) Source: 3.5 European However, Central Bank a prolonged low interest rate environment is challenging as when older and higher yielding debt securities mature, insurers must replace them with lower yielding bonds. The Net Investment Yield (Largest 20 Life Insurers) alternative is for companies to invest in Net Investment Yield (Largest 20 Non-Life Insurers) Source: Exhibit 5 Best's Statement File - Global riskier assets which attract higher capital Germany Non-Life & Life Net Investment requirements. Whether due to lower Yields ( ) reinvestment rates or more capital intensive 5.0 investments, insurance companies face greater pressure. A.M. Best data shows a moderate reduction in the investment yield of Germany s 4.5 largest insurers over the past two years (see Exhibit 5). There are no signs at the moment of a reversal in that declining trend. % Gross Written Premium Leverage Source: Net Investment Yield (Largest 20 Life Insurers) Net Investment Yield (Largest 20 Non-Life Insurers) Best's Statement File - Global The low interest rate environment is negatively impacting the investment returns of all European insurers, but particularly those in the German life sector. This is a result of German life insurers holding significant legacy portfolios of saving products, some of which still offer minimum guaranteed rates of return 8

9 of 4.0% to 6.0% for their in-force books. This product was very popular with consumers and insurers alike prior to the 2008 financial crisis, and there are currently approximately 90 million such contracts in Germany. Companies have reacted by changing the features of new products to reduce guarantees and capital requirements, with the larger insurers increasingly marketing unit-linked policies. Despite the relative success of these initiatives, significant volumes of traditional products are continuing to be sold and although they promise much lower guarantees, usually between 1.0% and 2.0%, this is still high considering the low bund yields. According to the International Monetary Fund s Article IV Consultation report on Germany (published in July 2015), standard guaranteed rates products still represented about 80% of the flow of new contracts. However, companies are looking to increase the weight of nontraditional offerings in their new business mix. New products without embedded guarantees have had some traction and now account for a material proportion of new business volumes. A number of companies are changing their business mix. In May 2015, Generali announced the introduction of a new normal business model for its life insurance operations by focusing on products that are low capital intensive and high performance. The company plans to reduce the sale of pure traditional savings products while enhancing its unit-linked, hybrid savings and term life offerings. It will also selectively operate in corporate traditional life as it increases cross-selling in term life and professional disability. A.M. Best notes HDI Lebensversicherung Aktiengesellschaft has reduced the share of savings policies with investment guarantees from 47% of total business in 2009 to 39% in The Hannover-based insurer is just one of several companies that intends to cease selling traditional guaranteed products in the near future. In a statement made at the beginning of September 2015, Ergo, the direct writer subsidiary of Munich Re group, has announced to the Süddeutsche Zeitung that it is also withdrawing from the traditional guaranteed life insurance market by year-end The larger German insurers are currently sufficiently capitalised and have diversified portfolios that enable them to withstand low interest rates. However, in A.M. Best s opinion, smaller niche life companies will find it more challenging to alter their products and may not be able to withstand yields remaining low for an extended period. While German insurers continue to invest primarily in high-quality fixed-income securities, there has been a gradual shift into non-traditional commercial loans, infrastructure projects, mortgage books and equities as companies attempt to obtain greater returns by diversifying their portfolios. This has particularly been the case for the bigger insurers who have a larger volume of assets to invest, with liabilities of longer duration and with significant investment acumen. For example, during 2014, Allianz SE increased its allocation to these so called real assets across the group by EUR 6.9 billion. A.M. Best expects the trend of increased exposure to real assets to continue as large insurers and regulators start to become more comfortable with alternative investment classes, and as companies develop the necessary expertise. European insurance trade associations (including the GDV) have been putting pressure on the European Insurance and Occupational Pensions Authority (EIOPA) to loosen restrictions on infrastructure investments. While the risk charge for this asset class has already been revised from 60% to between 30% and 39%, German insurers believe a charge of between 20% to 25% would be more appropriate. German Insurers on Track for Another Strong Year Overall, German insurers have been resilient and in the past few years have absorbed the continued effects of a low yield environment. Significant changes are ongoing in the German life sector, with the emphasis on managing reserves related to traditional business with 9

10 Regulators Increase German Insurers Capital Requirements In 2011, Germany s federal insurance regulator, Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), reacted to the low interest rate environment by implementing additional reserve requirements called Zinszusatzreserve (ZZR). This assesses the risk to German life companies in the event of a prolonged low interest rate scenario and ensures companies can meet their guaranteed returns and is in addition to the standard provisions for setting reserves against life business. Since the ZZR was introduced in 2011, insurers have built up additional reserves of EUR 21 billion, of which EUR 9 billion was added in Insurers are lobbying for the rules regarding the setting up of the ZZR to be re-calibrated as the cost of these additional reserves is starting to impact companies overall profitability. While the ZZR adds a buffer to companies reserves as interest rates come down, there are some uncertainties over its longer term impact if interest rates ever go up materially. As interest rates reduce, companies generate unrealised gains as the value of bonds increases. These gains have helped finance ZZR over recent years. However, a rise in interest rates would result in a reversal of unrealised gains, yet companies may still need to finance additional ZZR, which is based on the interest rate average for the last ten years and not only the most recent year. A.M. Best expects BaFin to react quickly to market conditions and support the life sector where at all possible by relaxing some of the requirements. According to the findings of the second comprehensive life insurance survey ( Vollerhebung Leben ) conducted by BaFin, the German life insurance sector will be able to cope with the transition to the capital requirements under Solvency II. The survey stated transitional measures and volatility adjustment stipulated in the new European supervisory regime are achieving the desired effects and almost all life insurance undertakings showed the required level of own funds as at 31 Dec. 2014, despite the significant drop in interest rates. If insurers chose to apply for transitional measures, they could be permitted a 16-year period to strengthen their capital bases. According to Best s Capital Adequacy Ratio (BCAR), the impact of recent interest rate movements on German insurers risk-adjusted capitalisation has been mixed during Unrealised gains on companies bond portfolios have increased available capital. However, this has been offset to some extent by negative movements in companies embedded value, which has been driven by lower interest rates, higher volatilities and narrowing spreads. embedded guarantees, while changing features within new products. It is likely to take some time for the market as a whole to adopt less capital intensive life offerings, although some companies are making significant efforts. Long-term interest rates for the German bund increased during the first half of 2015 from 0.39% in January to 0.61% in August. Although the increase has partially eased the pressure on life companies, the rate remains exceptionally low and below the guaranteed features of some life products still being sold. The ratings of A.M. Best s German insurers are all secure (see Exhibit 6). This in part reflects the majority of rated entities being affiliates of large groups or substantial entities themselves, and the stable outlooks demonstrate their solid level of risk-adjusted capitalisation. Furthermore, Germany is a hub for some of global reinsurers, and despite the soft market conditions for international reinsurance business, Hannover Re and Munich Re are still performing well owing, in part, to their recent low natural catastrophe exposure. Should the benign loss environment continue, the German P/C sector is expected to enjoy another good year in 2015, with hard market characteristics being seen in many core lines, particularly property and motor. Impending Solvency II capital requirements and low investment returns are likely to result in management maintaining a focus on good underwriting performance. As investment returns are forecasted to stay low and under pressure, insurers have cautiously shifted towards real assets, but overall invested assets will remain focused on the German bund. Companies reinvestment rates are expected to remain low, and investment yields are likely to continue to decrease. 10

11 Exhibit 6 Germany Life & Non-Life A.M. Best-Rated Companies Ratings as of Oct 15, AMB # Company Name Best s Financial Strength Rating (FSR) Best s Long- Term Issuer Credit Rating (ICR) Best s FSR & ICR Outlook Best s FSR & ICR Action Rating Effective Date General Reinsurance AG A++ aa+ Stable Affirmed 17-Jun COSMOS Versicherung AG A a Stable Affirmed 10-Oct COSMOS Lebensversicherungs-AG A a Stable Affirmed 10-Oct AachenMünchener Versicherung AG A a Stable Affirmed 10-Oct Central Krankenversicherung AG A a Stable Affirmed 10-Oct Delvag Luftfahrtversicherungs-AG A a Stable Affirmed 13-Aug International Insurance Company of Hannover SE A+ aa- Stable Affirmed 25-Sep Allianz Global Corporate & Specialty SE A+ aa- Stable Affirmed 6-Aug HDI Lebensversicherung Aktiengesellschaft A a+ Stable Affirmed 21-May Allianz SE A+ aa- Stable Affirmed 6-Aug AachenMünchener Lebensversicherung AG A a Stable Affirmed 10-Oct Generali Deutschland Holding AG A a Stable Affirmed 10-Oct SCHWARZMEER UND OSTSEE Versicherungs-Aktiengesellschaft SOVAG B++ bbb Negative Affirmed 11-Sep Delvag Rückversicherungs-AG A a Stable Affirmed 13-Aug HDI-Gerling Industrie Versicherung Aktiengesellschaft A a+ Stable Affirmed 21-May HDI-Gerling Welt Service Aktiengesellschaft A a+ Stable Affirmed 21-May Munich Reinsurance Company A+ aa- Stable Affirmed 13-Nov Generali Versicherung AG A a Stable Affirmed 10-Oct HDI Haftpflichtverband der Deutschen Industrie V.a.G. A a+ Stable Affirmed 21-May Generali Lebensversicherung AG A a Stable Affirmed 10-Oct E+S Rückversicherung AG A+ aa- Stable Affirmed 25-Sep Hannover Rück SE A+ aa- Stable Affirmed 25-Sep-15 Source: Best s Statement File - Global, A.M. Best data & research 11

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13 Market Review The insurance sector continues to execute its business plans according to its traditional roots and remains relatively resilient. Sticking to the Basics Ensures Resilience of the Spanish Insurance Sector Spain s insurance market has continued to show resilience, with companies focusing on profitability as the country s economy showed further signs of recovery. While total gross written premium (GWP) contracted further in 2014, the pace at which the market has shrunk has slowed. The non-life sector in particular has been affected by competitive conditions for motor insurance, its predominant line of business, although a recovery in car sales is expected to assist this line of business in Insurance penetration in Spain remains below European standards, particularly in the life segment. In 2014, Spain s total insurance penetration was 5.3%, compared to 9.1% in Italy and 9.5% in France. Historically, domestic consumers have not had the incentive to save through insurance products and principal guaranteed long-term deposits have been the bread and butter of the risk-averse household in Spain. However, A.M. Best expects Spanish savers will continue to evolve towards a new reality in which long-term investment risk moves from state-guaranteed benefits to households own accounts, which, in turn, will create opportunities for life insurers. After enduring the worst recession in the last three decades, Spain s gross domestic product (GDP) expanded by 1.4% in 2014 (Exhibit 1). The economy performed well in the first half of 2015 and is forecasted to post a 2.5% growth in External tailwinds have included the European Central Bank s EUR 1.1 trillion quantitative easing programme, increased demand for Spanish products from European Union partners, and lower energy prices benefiting Spanish consumers. In recent years, the Spanish government has taken steps to Analytical Contact: Pablo Vasquez Tel: +44 (0) Pablo.Vasquez@ambest.com Writer and Researcher: Yvette Essen Tel: +44 (0) Yvette.Essen@ambest.com Editorial Manager: Richard Hayes Tel: +44 (0) Richard.Hayes@ambest.com SR Exhibit 1 Spain Non-Life & Life Key Facts Indicator Population (Millions) Gross Domestic Product (EUR Billions) 1, , , , , , ,058.5 Change in Real GDP (%) Inflation (%) Unemployment Rate (%) Insurance Penetration (%) Life Non-Life Total Insurance Premiums Written (EUR Billions) Life Non-Life Total Change in Total Premium Volume (%) Numbers may not add up due to rounding. Sources: International Monetary Fund, World Economic Outlook Database, April 2015; Dirección General de Seguros y Fondos de Pensiones; A.M. Best data and research 13

14 make structural reforms, helping to re-balance the economy. Changes to its fiscal stance have supported employment creation and heightened business and consumer confidence, which has resulted in higher retail consumption and private investment. Following six years of recession, household consumption is recovering with improved spending patterns evident in the first half of For example, low inflation has helped boost disposable income and has assisted a rise in car sales. The Spanish insurance sector experienced a slight 0.8% contraction in total GWP in 2014 and this continued in the first half of 2015 with a 4% fall when compared to the same period last year, according to Investigación Cooperativa entre Entidades Aseguradoras y Fondos de Pensiones (ICEA), which compiles and publishes industry statistics representing approximately 95% of the sector s premiums. Figures from the Spanish insurance regulator, Dirección General de Seguros y Fondos de Pensiones (DGSFP) estimated a 0.4% fall in total GWP in 2014; however, the decline was lower than that experienced in the previous two years, reflecting to some extent, the stronger economic backdrop (Exhibit 1). A.M. Best also notes that in the first six months of 2015, there has been a marked difference between the non-life sector, which increased year-over-year by 2.4%, and the life sector, which continued its correction in volumes endured during 2014 with a 12% fall in life premiums, according to ICEA. Economic Improvement to Assist Non-Life Insurance Recovery In 2014, the non-life sector grew for the first time since 2011, increasing by a modest 0.8% to EUR 30.5 billion, according to ICEA. DGSFP also estimated a rise, with a 1.2% increase in non-life premiums to EUR 30.7 billion. In A.M. Best s view, the non-life sector has been relatively resilient during a period of severe economic stress. Pricing dynamics have been very heterogeneous across different risk classes, with more cyclical lines of business such as motor insurance decreasing substantially in recent years, but other segments (like health) achieving positive year-over-year premium growth rates. With regard to distribution channels, non-life products continue to be sold predominantly by agents and brokers. A.M. Best considers that selling the majority of their general insurance products through a network of exclusive agents allows insurers to generate more stable Exhibit 2 Spain Non-Life Direct Premiums by Line of Business, 2014 Premiums (EUR millions), Market Share (%) Funeral Expenses EUR 2,077 7% Health EUR 7,115 23% Other Lines of Business EUR 5,243 17% Source: Dirección General de Seguros y Fondos de Pensiones Motor EUR 9,450 31% Multirisk EUR 6,810 22% 14 underwriting profits and helps them to build long-term relationships with customers. Motor insurance accounted for 23% of total non-life GWP during the first quarter of 2015 and overall in 2014, motor accounted for 31% of GWP (Exhibit 2), broadly unchanged when compared to previous years In 2014, rates for this line of business were flat, reflecting the intense competition among motor insurers. However, demand dynamics are recovering; car registrations increased by 18% during 2014 and they are expected to grow in double digits in 2015 in response to more favourable developments in households disposable income levels. Exhibit 3

15 Profitability remains challenging, and A.M. Best estimates that the combined ratio for this class of business has fluctuated between 98% and 104% since the second quarter of 2012 up to the first quarter of Spanish motor insurers have taken the opportunity to invest in operational efficiencies, focusing on streamlining claims processing, damage valuations and strengthening their car repair networks. In A.M. Best s view, these improvements will provide some support to technical performance, partially offsetting the likely rise in claims frequency as a result of the effect of new sales and the increased use of the car for long distance trips supported by the more buoyant economic situation and low fuel prices. However, A.M. Best considers that margins will remain narrow in this line of business for the foreseeable future. Widely anticipated new regulation for the assessment of damages in personal injury claims ( baremo ) will result in significant cost increases for insurers, with predictions of awards more than doubling in some particular cases from January In A.M. Best s opinion, insurers have long been expecting this development as they have participated in the drafting of the legislation since its conception. While increased costs will be unavoidable, A.M. Best considers the regulation to be a positive development that brings greater certainty and clarity to personal injuries claims. Increases in motor insurance prices are likely to be gradual and the high level of competition will naturally cap abrupt rate hikes. The second largest line of business in the Spanish general insurance market continues to be health insurance. During the first three months of 2015, health represented 23% of total GWP, which reflects seasonal purchasing trends and is in line with previous years. Health insurance premiums represented 13% of premiums in In a muted consumer price inflation environment, health insurance rates have increased in real terms each and every year since Profitability for health insurance has remained steady for a number of years. A.M. Best estimates that loss ratios remain anchored in the mid-80% range, demonstrating that health insurance providers have been able to increase premiums to support performance. A.M. Best considers that pharmaceutical product costs have been the main driver of claims inflation, which is continuing to push up rates in this segment; however, insurers have managed to keep rate hikes within levels supportive of growth in a number of policies. A certain degree of appetite for consolidation in the private hospital space remains, which is likely to lead to further cost pressures for insurers if service providers increase their bargaining power, that has been traditionally very low against the largest health insurers. Going forward, in A.M. Best s view, demand will continue to be supportive for the health sector on the back of improving economic conditions and the decreasing role of statesponsored social benefits in response to fiscal budget constraints. Funeral expenses outperformed other classes of business throughout 2014, although this remained a small part of the non-life sector, equating to 7% of total general insurance GWP. Decesos are a historical feature of the Spanish insurance market, providing a sum to pay for funeral services, and has benefited from consumers seeking the security it provides during uncertain times. A.M. Best expects decesos to continue to be an important part of the general insurance portfolio in the foreseeable future. Overall, premium volumes in the non-life sector have been slowly recovering during 2015, and increased by 2% in the first quarter, but still remain below pre-crisis levels. Growth is fundamentally supported by the improvement in household disposable income levels. Expectations for the remainder of 2015 are optimistic, in line with more robust economic conditions. 15

16 Life Insurance Market Continues to Decline Life premiums contracted by 12% in the first quarter of 2015 when compared to 2014, dragged down by low volumes of single premium business. This reflects consumer demand for higher yields than what insurers are able to offer in this low interest rate environment. On the other hand, regular premium contracts appear to be more resilient. Demand for savings and deposits are stronger due to higher contributions to pension plans, driven largely by public sector restructuring in recent years and demographic led changes contributing to the perception that government retirement income security is insufficient. Other factors behind the growth in savings and deposits products are improving equity market performance and lower benefits payments. Deposits and unit-linked products are also receiving a boost from a desire for riskier products that offer greater yield potential. Total life insurance premiums continued to decline during the first six months of After very positive growth in single premium savings products during 2011, the sector has been contracting in response to the effect of low interest rates hurting the attractiveness of life insurance as a guaranteed savings vehicle. Spanish households continue to show a preference for more traditional investments, such as bank deposits, and bancassurance is still the predominant distribution channel for life insurance products. The recent restructuring and consolidation of the Spanish banking sector has substantially changed the picture with regards to exclusive agreements and other third-party arrangements to sell through bank branches. New technologies have enhanced the ability to reach out to potential customers, but Spanish consumers seem to be very reluctant to transform price comparison searches into final purchases of both life and non-life insurance products. Although it will take some time to assess the effects of changes to the banking sector and their impact on distribution, in A.M. Best s view, life insurance product sales through bank branches will remain very important in the near future. Profitability in the life insurance sector has remained broadly in line with previous years during 2014 and in the first three months of 2015 has only shown a minor deterioration. Life insurers are issuing new products that transfer a significant amount of the investment risk to the policyholder. This is helping insurers offset the negative effects from low interest rates impacting mainly legacy books. Overall, A.M. Best considers Spanish life insurers well-placed to continue producing positive technical results. In the near future, significant demand pressures will remain and top-line levels will be depressed, in line with record low investment yields that will influence the value proposition of life insurance products. On the other hand, the fee business in which the investment risk is borne by policyholders, should benefit from the flight to yield and the growing belief among Spanish households of the need to start taking responsibility for their financial futures in light of the increasing challenges faced by public sector finances. Spanish Insurance Sector Performance While total GWP has contracted in the past few years, the Spanish insurance market has maintained its underwriting performance. According to A.M. Best s analysis, the sector had an average return on equity (ROE) of 14% between 2010 and 2014, fluctuating in a tight range of approximately 330 basis points. The traditional nature of Spanish management seems to be present in all domestic (re)insurers, and appears to be the reason behind what is fundamentally a risk-averse approach. In good times, prudence hurts margins and erodes competitiveness; meanwhile, in bad times, a cautious approach provides better rewards to all stakeholders involved. 16

17 In A.M. Best s view, the Spanish insurance sector continues to execute its business plans according to its traditional roots and remains relatively resilient. Although ROEs have come under pressure during the first half of 2015, Spanish insurers seem to avoid complicated formulas for growth or profitability, preferring the simplicity and reliability of a good wine over the paraphernalia of a fancy cocktail. The capitalization levels of the Spanish insurance sector remained broadly unchanged during Sustained earnings levels and stable dividends have been the tonic of the market. Aggregated capital and surplus increased by 8% during 2014 in the context of stagnant GWP levels. Capital generation has received additional support since the beginning of 2013 from fair value items (particularly unrealised gains in available for sale securities), which is the accounting treatment most Spanish insurers choose to use to classify their fixed-income holdings. Additionally, currency developments have been favourable during the last few months for Spanish insurers with consolidated entities in countries in which the exchange rate relative to the euro has increased as a consequence of monetary policy in the Eurozone and renewed geopolitical risks during the early summer of A.M. Best views these factors resulting in increases of risk-adjusted capitalisation levels, a natural consequence of the pro-cyclicality embedded into fair value accounting of fixed income holdings. Although the capital cushion is correctly valued, in A.M. Best s opinion, most insurers hold their fixed income investments until maturity and their investment decisions are largely driven by asset liability matching (ALM) and cash-flow matching considerations, which limit the real economic impact of swings in surplus accounting measures. Moreover, the vast majority of Spanish insurers are in the advanced stages of implementing Solvency II, and some have been able to publicly report estimated ranges for their Solvency II ratios at year-end Spanish insurers are, in general, well-prepared for the new directive that will come into force at the beginning of 2016, although at the same time, the smaller players face substantial cost burdens in implementation. Investment Portfolios Remain Conservative The Spanish insurance market s preference for sticking to the basics is also reflected in conservative investment profiles. The latest data from the DGSFP shows a continuation of existing trends, with insurers investing more than two-thirds of their assets in fixed income securities. Bank deposits and money market placements remain as the second choice, followed by equities and real estate. In A.M. Best s view, the rationale to invest in fixed income securities is in the majority of cases driven by ALM rather than by opportunistic trades looking to take advantage of certain views on credit spreads. In recent years, the preference of insurance companies for domestic corporate debt has shifted toward sovereign paper. This has been driven by better than expected total return profiles, fuelled by a narrowing of spreads in line with improved economic and fiscal prospects in Spain. Additionally, supply side effects have contributed toward this trend, with outstanding Spanish sovereign debt securities increasing consistently since In A.M. Best s view, the risk appetite of Spanish insurers as institutional investors remains stable and is not expected to change materially over the coming years. Domestic insurers are likely to explore alternative ways of increasing investment yield, but with a conservative approach. A.M. Best expects the weight of any alternative assets in investment portfolios will remain minimal. The allocation of assets backing life liabilities did not change dramatically during Sovereign debt represents approximately half of investments, followed by corporate paper (which accounts for 24%) and 17