The European Union’s new insurance regulatory regime, known as Solvency II, is likely to have significant effects on the industry, possibly curbing risk taking, raising some prices, and boosting M&A activity, says Fitch Ratings.

In report published Wednesday, Fitch says that the new regime, which is expected to take effect in 2012, is expected to have far-reaching effects on insurers, with both positive and negative credit rating implications.

“Fitch expects Solvency II to reshape the insurance landscape with some fundamental shifts to lower-risk product mix, more cautious investment strategy and, for certain products, higher premiums,” says Clara Hughers, associate director in Fitch’s insurance team.

Additionally, it notes that as insurance companies hold large amounts of corporate and government bonds and equities, changes in their investment strategies could significantly shift demand between these asset classes, with implications for asset prices and yields.

For product lines with increased capital requirements under Solvency II, Fitch expects insurers to pass the associated extra costs onto policyholders wherever possible. For example, it points to the UK’s annuity market, where it is already seeing annuity rates being cut in direct response to Solvency II.

“People retiring are facing lower annuity rates than five years ago,” says Hughes. “This has been due to increasing longevity and diminishing returns but now it is being exacerbated by Solvency II. Many insurers are preparing for the new regulation by moving to much more cautious asset strategies driven by the new rules. However, this means lower expected returns and therefore lower pensions for pensioners.”

Solvency II may also result in an increase in merger and acquisition activity, which could provide opportunities for larger insurers but which would also bring integration risks to the insurance sector, it adds.

Any rating action due to the new regime will be driven by the characteristics of each insurer and its management of the transition to Solvency II, Fitch says. The main drivers of ratings are likely to include exposure to risks that require significantly more capital under Solvency II such as equities, low-grade corporate bonds, products with high guarantees, and marine, aviation and transport insurance.

IE