BEST S SPECIAL REPORT

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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 2014. 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.

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.

“There has

been an

element of

repricing as

(re)insurers

heighten their

focus on the

bottom line.”

Market Review October 30, 2015 Analytical Contact: Carlos Wong-Fupuy +44 (0) 20 7397 0287 Carlos.Wong-Fupuy@ ambest.com

Writer and Researcher:

Yvette Essen, London +44 (0) 20 7397 0322 [email protected] Editorial Manager: Richard Hayes +44 (0) 20 7397 0326 [email protected] SR-2015-092

B

EST’S

S

PECIAL

_{Our Insight, Your Advantage.}

R

EPORT

Contents:

German Insurers Enjoy Continued Strong Performance but Interest Rate Challenge Looms . . . .5

Sticking to the Basics Ensures Resilience of the Spanish Insurance Sector . . . .13

Italian Insurance Sector Maintains Strong Growth Despite Sluggish Economy . . . .21

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Special Report European Non-Life & Life Insurers 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 2015.

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 2013. 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.

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

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

2014 2013 2014 2013 2014 2013

1 085085 AXA S.A. France 86.3 85.5 840.1 755.4 56.0 45.1

2 085014 Allianz SE Germany 73.9 72.1 805.8 711.1 60.7 50.1

3 085124 Assicurazioni Generali S.p.A. Italy 66.2 62.7 501.3 449.7 23.2 19.8

4 086976 Zurich Insurance Group Ltd. Switzerland 45.1 39.8 334.5 301.5 28.6 23.6

5 085925 Prudential plc United Kingdom 42.0 36.5 471.8 390.4 15.1 11.6

6 086056 CNP Assurances France 30.6 27.5 395.4 365.4 16.7 14.6

7 093310 Credit Agricole Assurances France 29.4 25.7 329.3 291.4 12.6 10.5

8 084651 Talanx AG Germany 27.9 27.0 147.3 132.8 8.0 7.1

9 085909 Aviva plc United Kingdom 27.7 26.4 365.1 337.4 14.2 11.4

10 085419 MAPFRE S.A. Spain 22.4 21.8 67.2 56.8 9.2 7.8

Totals: 451.4 425.1 4,257.8 3,791.9 244.2 201.6

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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 2016. 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, 2016. 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.

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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

“Companies

are altering

product

offerings and

are cautiously

adjusting their

asset portfolios

to obtain better

yields.”

Market Review Analytical Contacts: Tim Prince +44 (0) 20 7397 0320 [email protected] Charlotte Vigier +44 (0) 20 7397 0270 [email protected]

Yvette Essen +44 (0) 20 7397 0322 [email protected] Editorial Manager: Richard Hayes +44 (0) 20 7397 0326 [email protected] SR-2015-390

Exhibit 1

Germany Non-Life & Life – Key Facts

Indicator 2008 2009 2010 2011 2012 2013 2014

Population (Millions) 82.0 81.8 81.8 80.3 80.5 80.8 81.1

Gross Domestic Product (EUR Billions) 2,558.0 2,456.7 2,576.2 2,699.1 2,749.9 2,809.5 2,903.8

Change in Real GDP (%) 0.8 -5.6 3.9 3.7 0.6 0.2 1.6 Inflation (%) 1.1 0.8 1.9 2.3 2.1 1.2 0.2 Unemployment Rate (%) 7.4 7.7 6.9 5.9 5.4 5.2 5.0 Insurance Penetration (%) Life 3.11 3.47 3.51 3.22 3.18 3.23 3.23 Health 1.19 1.28 1.29 1.28 1.30 1.28 1.25 Non-Life 2.14 2.23 2.14 2.10 2.13 2.16 2.16 Total 6.43 6.98 6.94 6.60 6.60 6.67 6.63

Insurance Premiums Written (EUR Billions)

Life 79.6 85.2 90.4 86.8 87.3 90.8 93.7

Health 30.3 31.5 33.3 34.7 35.6 35.9 36.2*

Non-Life 54.6 54.7 55.2 56.6 58.6 60.6 62.6

Total 164.5 171.4 178.8 178.1 181.6 187.3 192.4*

Change in Total Premium Volume (%) 1.0 4.2 4.3 -0.4 2.0 3.1 2.7

* 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)

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Special Report European Non-Life & Life Insurers

primarily a result of reduced losses for natural catastrophes during the year, with hail and windstorm Ela the largest major loss in 2014. 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 2013. 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 2014. 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 2002.

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 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 2

Germany - Non-Life - Capital & Surplus and

GWP Leverage (2011-2014)

(Based on the results of the 20 largest property/casualty insurers)

Exhibit 4

Germany Non-Life & Life – Long-Term Interest Rates for Convergence Purposes

(2000 - August, 2015)

22,976 24,503 _24,419 25,053 1.29 _1.28 1.35 1.37 1.24 1.26 1.28 1.30 1.32 1.34 1.36 1.38 21,500 22,000 22,500 23,000 23,500 24,000 24,500 25,000 25,500 2011 2012 2013 2014 Gr os s W rit te n Pr em iu m L ev er ag e Ca pi ta l & S ur pl us (E UR m ill io ns )

Capital & Surplus (EUR Millions) Gross Written Premium Leverage

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

0 1 2 3 4 5 6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 In te re st R at e (% )

Source: European Central Bank

Exhibit 5

Germany Non-Life & Life – Net Investment

Yields (2011-2014)

3.5 4.0 4.5 5.0 2011 2012 2013 2014 %

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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.

Exhibit 3

Germany – Non-Life – Development by Line of Business (2013-2014)

Gross Written Premiums

(EUR millions) (EUR millions)Claims Combined ratio (%)

2013 2014 % Change 2013 2014 % Change 2013 2014 Property Total: 16,728 17,291 3.37% 15,109 12,177 -19.41% 116.2% 97.0% Private 8,917 9,334 4.68% 7,605 5,931 -22.01% 115.6% 94.9% Commercial 7,810 7,958 1.90% 7,504 6,246 -16.76% 116.8% 99.5% MAT 1,764 1,765 0.06% 1,333 1,110 -16.73% 105.1% 91.4% Credit 1,582 1,561 -1.33% 893 668 -25.20% 78.4% 68.6% General Liability 7,223 7,442 3.03% 4,780 4,814 0.71% 95.3% 94.2% Motor 23,260 24,380 4.82% 21,770 20,656 -5.12% 104.4% 96.7% Accident Individual 6,411 6,471 0.94% 3,092 3,167 2.43% 79.4% 80.9% Legal Insurance 3,417 3,486 2.02% 2,474 2,600 5.09% 99.3% 102.4%

Protection 173 185 6.94% 202 190 -5.94% n/a n/a

Total 60,558 62,581 3.34% 49,653 45,382 -8.60% 103.5% 94.6%

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Low Interest Rates Overshadow Insurance Sector

Long-term interest rates continued to decline in 2014, with the 10-year German bund falling significantly to 0.59% in December 2014. This trend continued in 2015, driven by ongoing troubles in the Eurozone, and in April 2015 the 10-year German bund stood at just 0.12% before rebounding slightly (see Exhibit 4). Demand for the country’s debt resulted in Germany

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.

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).

However, 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

alternative is for companies to invest in riskier assets which attract higher capital requirements. Whether due to lower reinvestment rates or more capital intensive investments, insurance companies face greater pressure. A.M. Best data shows a moderate reduction in the investment yield of Germany’s largest insurers over the past two years (see

Exhibit 5). There are no signs at the moment

of a reversal in that declining trend. 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

Exhibit 2

Exhibit 4

(2000 - August, 2015)

Note:

0 1 2 3 4 5 6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 In te re st R at e (% )

Exhibit 5

Yields (2011-2014)

3.5 4.0 4.5 5.0 2011 2012 2013 2014 %

Net Investment Yield (Largest 20 Life Insurers) Net Investment Yield (Largest 20 Non-Life Insurers)

Source: Best's Statement File - Global

Exhibit 2

Exhibit 4

(2000 - August, 2015)

Note:

0 1 2 3 4 5 6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 In te re st R at e (% )

Exhibit 5

Yields (2011-2014)

3.5 4.0 4.5 5.0 2011 2012 2013 2014 %

Net Investment Yield (Largest 20 Life Insurers) Net Investment Yield (Largest 20 Non-Life Insurers)

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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 non-traditional 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 2014. 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 2015.

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

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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.

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 2014. 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 2014. 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.

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Exhibit 6

Germany – Life & Non-Life – A.M. Best-Rated Companies

Ratings as of Oct 15, 2015.

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

85310 General Reinsurance AG A++ aa+ Stable Affirmed 17-Jun-14

85382 COSMOS Versicherung AG A a Stable Affirmed 10-Oct-14

85304 COSMOS Lebensversicherungs-AG A a Stable Affirmed 10-Oct-14

85302 AachenMünchener Versicherung AG A a Stable Affirmed 10-Oct-14

85303 Central Krankenversicherung AG A a Stable Affirmed 10-Oct-14

85437 Delvag Luftfahrtversicherungs-AG A a Stable Affirmed 13-Aug-15

86486 International Insurance Company of Hannover SE A+ aa- Stable Affirmed 25-Sep-15

87997 Allianz Global Corporate & Specialty SE A+ aa- Stable Affirmed 6-Aug-15

85842 HDI Lebensversicherung Aktiengesellschaft A a+ Stable Affirmed 21-May-15

85449 Allianz SE A+ aa- Stable Affirmed 6-Aug-15

85761 AachenMünchener Lebensversicherung AG A a Stable Affirmed 10-Oct-14

84112 Generali Deutschland Holding AG A a Stable Affirmed 10-Oct-14

84710 SCHWARZMEER UND OSTSEE Versicherungs-Aktiengesellschaft SOVAG B++ bbb Negative Affirmed 11-Sep-15

84019 Delvag Rückversicherungs-AG A a Stable Affirmed 13-Aug-15

77779 HDI-Gerling Industrie Versicherung Aktiengesellschaft A a+ Stable Affirmed 21-May-15

78321 HDI-Gerling Welt Service Aktiengesellschaft A a+ Stable Affirmed 21-May-15

85011 Munich Reinsurance Company A+ aa- Stable Affirmed 13-Nov-14

85076 Generali Versicherung AG A a Stable Affirmed 10-Oct-14

85259 HDI Haftpflichtverband der Deutschen Industrie V.a.G. A a+ Stable Affirmed 21-May-15

85074 Generali Lebensversicherung AG A a Stable Affirmed 10-Oct-14

85064 E+S Rückversicherung AG A+ aa- Stable Affirmed 25-Sep-15

85070 Hannover Rück SE A+ aa- Stable Affirmed 25-Sep-15

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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 2015.

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 2015. 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

“The insurance

sector

continues to

execute its

business plans

according to its

traditional roots

and remains

relatively

resilient.”

Market Review Analytical Contact: Pablo Vasquez Tel: +44 (0) 20 7397 0311 [email protected]

Yvette Essen Tel: +44 (0) 20 7397 0322 [email protected] Editorial Manager: Richard Hayes Tel: +44 (0) 20 7397 0326 [email protected] SR-2015-392

Exhibit 1

Spain – Non-Life & Life – Key Facts

Indicator 2008 2009 2010 2011 2012 2013 2014

Change in Real GDP (%) 1.1 -3.6 0.0 -0.6 -2.1 -1.2 1.4 Inflation (%) 1.5 0.9 2.9 2.4 3.0 0.3 -1.0 Unemployment Rate (%) 11.3 17.9 19.9 21.4 24.8 26.1 24.5 Insurance Penetration (%) Life 2.46 2.71 2.53 2.78 2.53 2.47 2.39 Non-Life 2.94 2.97 2.87 2.90 2.94 2.89 2.90 Total 5.40 5.68 5.40 5.68 5.47 5.36 5.29

Life 27.45 29.20 27.40 29.86 26.71 25.91 25.32

Non-Life 32.78 32.10 30.97 31.20 31.04 30.35 30.70

Total 60.23 61.30 58.37 61.05 57.75 56.26 56.02

Change in Total Premium Volume (%) 7.98 1.78 -4.77 4.59 -5.42 -2.57 -0.44

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

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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 2015. 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

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 2

Spain Non-Life – Direct Premiums by Line of Business,

2014 Premiums (EUR millions), Market Share (%)

Source: Dirección General de Seguros y Fondos de Pensiones

Exhibit 3

Spain Non-Life & Life - Investments

As of Dec. 31, 2014. 0% 10% 20% 30% 40% 50% 60%

Stocks Funds Money Market Loans Other Lines of Business EUR 5,243 17% Funeral Expenses EUR 2,077 7% Health EUR 7,115 23% _Multirisk EUR 6,810 22% Motor EUR 9,450 31% Fixed Income (Sovereign) Fixed Income (Corporate) Real

Estate StructuredCredit &

Derivatives Total Life Non-Life

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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 2015. 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 2016. 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 2014.

In a muted consumer price inflation environment, health insurance rates have increased in real terms each and every year since 2011. 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 state-sponsored 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.

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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 2015. 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.

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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 2014. 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 geo-political risks during the early summer of 2015.

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 2014. 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 2008. 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 2014. Sovereign debt represents approximately half of investments, followed by corporate paper (which accounts for 24%) and

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Ratings Environment for Spanish Insurers Is Stable

Spanish insurers rated by A.M. Best display financial indicators that continue to exhibit signs of robustness. Operating margins in the sector contracted in the first three months of 2015, reflecting the effect of the challenging environment in life technical results. Overall, however, insurers have demonstrated the ability to withstand demand pressures on the back of a recessionary economic environment and pricing challenges coming from increased competition. Although risk-adjusted capitalization decreased during 2014, Spanish insurers’ surplus levels are generally strong and debt leverage is not substantial.

A.M. Best rates a range of entities in Spain, with all Financial Strength Ratings (FSRs) and Issuer Credit Ratings (ICRs) comfortably within the investment grade range (Exhibit 4).

Financial flexibility levels are generally good across all rated entities, with low or nil debt on the balance sheet and supportive majority shareholders.

Limited rating actions were taken by A.M. Best in Spain during the double-dip recession that started in 2008 and then again in 2011, which demonstrates the excellent capitalization of rated domestic participants. However, risk-adjusted capitalization levels after stress tests did decrease by the end of 2012, as a direct result of the exposure of Spanish insurers to domestic corporate and sovereign fixed income securities. Concerns related to the credit quality profile of The Kingdom of Spain have substantially dissipated in the last two years and the weighted average yield of 10-year sovereign bonds has contracted from 6.7% in July 2012 to historical lows of 1.0% in March 2015, according to data from the Bank of Spain. In A.M. Best’s view, the investment exposure of domestic insurers to sovereign paper will continue to be substantial in the foreseeable future, driven by the local nature of the liabilities of the majority of Spanish insurers.

A.M. Best’s country risk methodology analyses country-specific factors that influence the credit quality of insurers. A.M. Best has classified Spain as CRT-2 (Country Risk Tier 2) – the same as Ireland and Italy. There are five different CRT categories, with CRT-5 representing the countries with more risk and CRT-1 denoting the lowest degree of risk. Central to A.M. Best’s rating methodology is the ability to differentiate levels of risk exposure among competing insurers in a given market. For this reason, rather than money market instruments that make up 15%

of the overall investment portfolio. Equity holdings represent 4% and real estate accounts for 2.3% of life insurance investments.

The different cash flow pattern of non-life insurance liabilities permits a slightly riskier allocation of assets backing non-life provisions, compared to life companies. However,

Spanish insurers continue to demonstrate a low appetite for market risk. Fixed income (sovereign and corporate) remains the predominant asset class, adding up to more than half (54%) of investments (Exhibit 3).

Equities, funds, money market instruments and real estate each represent slightly more than 10% of total non-life investments.

Exhibit 2

Spain Non-Life – Direct Premiums by Line of Business,

2014 Premiums (EUR millions), Market Share (%)

Source: Dirección General de Seguros y Fondos de Pensiones

Exhibit 3

Spain Non-Life & Life - Investments

As of Dec. 31, 2014. 0% 10% 20% 30% 40% 50% 60%

Stocks Funds Money Market Loans

Source: Dirección General de Seguros y Fondos de Pensiones Other Lines of Business EUR 5,243 17% Funeral Expenses EUR 2,077 7% Health EUR 7,115 23% _Multirisk EUR 6,810 22% Motor EUR 9,450 31% Fixed Income (Sovereign) Fixed Income (Corporate) Real

Estate StructuredCredit &

Derivatives Total Life Non-Life

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applying a blanket sovereign ceiling to all insurers in a country, a stress-testing approach is used. In A.M. Best’s opinion, Spain has low levels of economic, political and financial system risk. The economy recovery is expected to strengthen into 2015 at a rate of 2.5%, driven largely by improved business and consumer sentiment, lower commodity prices and accommodative monetary policy.

Exhibit 4

Spain – Life & Non-Life – A.M. Best-Rated Companies

Ratings as of Oct.15, 2015.

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

83556 Bilbao, Compañia Anonima de Seguros y Reaseguros S.A.1 _A- _a- _Stable _Affirmed _20/2/2015

56998 Casiopea Re S.A.2 _A- _a- _Stable _Affirmed _7/10/2015

83565 Compañía Española de Seguros y Reaseguros de Crédito y _{Caución, S.A.U.}1 A a Stable Affirmed 3/10/2014

86801 MAPFRE GLOBAL RISKS, Compania Internacional de _{Seguros y Reaseguros S.A.} A a Stable Affirmed 14/10/2015

86277 MAPFRE RE, Compania de Reaseguros, S.A. A a Stable Affirmed 14/10/2015

85481 Nacional de Reaseguros, S.A. A- a- Positive Affirmed 22/9/2015

85823 Ocaso, S.A. Seguros y Reaseguros A a+ Stable Affirmed 1/5/2015

84142 Seguros Catalana Occidente, S.A. de Seguros y Reaseguros1 _A- _a- _Stable _Affirmed _20/2/2015

86153 Solunion Seguros de Crédito, Compañía Internacional de _{Seguros y Reaseguros S.A.} A- a- Stable Assigned 22/9/2015 Notes:

1_{Owned by Groupo Catalana Occidente S.A.}

2_{Captive based in Luxembourg, owned by Spanish company Telefónica}

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Italian Insurance Sector Maintains Strong

Growth Despite Sluggish Economy

Italy’s insurance market remained buoyant in 2014 and is well-placed to continue to grow in 2015, driven by demand for life products. A second consecutive year of double-digit expansion in gross written premium (GWP) came despite a difficult economic environment, although the Italian government is gradually making headway with its reforms to stimulate productivity. In 2014, total GWP rose 20.7% to EUR 143.3 billion, building on the 13% increase achieved in 2013 (Exhibit 1). This was driven by demand for life insurance, with low interest rates

pushing investors away from traditional products (such as bank deposits and investment funds) and towards alternative investment solutions. In particular, according to the insurance trade association, the Associazione Nazionale fra le Imprese Assicuratrici (ANIA), new products derived from the combination of segregated funds and unit-linked investment funds gained momentum. While an increase of GWP in the region of 20% or above may be harder to achieve in 2015, A.M. Best expects another year of double-digit growth.

Since the global financial crisis of 2008, Italy’s economy has been struggling and gross

domestic product (GDP) has contracted for five out of seven years. In 2014, the decline slowed with a 0.4% fall in GDP, reflecting governmental reforms and the strength of exporters (many of which are family-owned small-to-medium enterprises).

The International Monetary Fund (IMF) predicts real GDP growth will be 0.7% in 2015 and 1.2% in 2016, although political instability, high debt and a large shadow economy are contributing to the slow recovery. Furthermore, low labour productivity, which is significantly below most of the major economies in the Organisation for Economic Co-operation and Development (OECD), is a key structural problem. According to the IMF July 2015 country report for Italy, there is a causal link between the inefficiency of the public sector and low labour productivity. The research adds that government spending could be made more

“A.M. Best

expects

another year

of double-digit

growth.”

Market Review Analytical Contact: Alvise Argenton +44 (0) 20 7397 0293 [email protected]

Yvette Essen +44 (0) 20 7397 0322 [email protected] Editorial Manager: Richard Hayes +44 (0) 20 7397 0326 [email protected] SR-2015-391

Exhibit 1

Italy Non-Life & Life – Key Facts

Indicator 2008 2009 2010 2011 2012 2013 2014

Change in Real GDP (%) -1.1 -5.5 1.7 0.6 -2.8 -1.7 -0.4 Inflation (%) 2.4 1.1 2.1 3.7 2.6 0.7 -0.1 Unemployment Rate (%) 6.8 7.8 8.4 8.4 10.6 12.2 12.8 Insurance Penetration (%) Life 3.34 5.15 5.61 4.51 4.32 5.29 6.84 Non-Life 2.29 2.33 2.22 2.22 2.19 2.09 2.03 Total 5.64 7.49 7.83 6.73 6.51 7.38 8.87

Life 54.6 81.1 90.1 73.9 69.7 85.1 110.5

Non-Life 37.5 36.7 35.6 36.4 35.4 33.7 32.8

Total 92.02 117.80 125.72 110.23 105.13 118.79 143.32

Change in Total Premium Volume (%) -7.14 28.02 6.72 -12.32 -4.63 12.99 20.65 Source: International Monetary Fund, World Economic Outlook Database, April 2015; Associazione Nazionale fra le Imprese Assicuratrici; A.M. Best data and research

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Special Report European Non-Life & Life Insurers efficient if legislation and the public administration reform agenda were accelerated. In 2014,

Italy moved into deflation, while unemployment continued to rise to 12.8%.

Outside Italy’s borders, a mild recovery has so far been driven by a weaker euro, lower

commodity prices and easy monetary policy that allows for refinancing. Concerns remain over the geopolitical situation in and around the Eurozone, and in September, the European Central Bank (ECB) maintained interest rates at a record low level of 0.05%.

Life Sector Buoys Insurance Market Growth

A large proportion of the insurance market is dominated by life products, representing 77.1% of total GWP in 2014. Life premiums amounted to EUR 110.5 billion, growing by 29.9% since 2013, compared to non-life GWP of EUR 32.8 billion (a decline of 2.7% from 2013). As Exhibit 1 shows, life insurance penetration is high at 6.8%. Data from ANIA for 2014 confirmed

a consolidated trend observed since 1998, with a widening gap between life and non-life premium growth (Exhibit 2).

Long-term life insurance (“Ramo I” – as per the Italian categorisation) and life insurance unit-linked products (“Ramo III”) are the biggest segments in the Italian life market, representing 75% and 20%, respectively, of life premium income in 2014. In light of the low returns offered by fixed-income instruments, investors and Italian families divested their savings from Italian government and corporate bonds, reducing them by EUR 63.3 billion in 2013 and EUR 112.9 billion in 2014. If interest rates increase in the near future, A.M. Best expects bonds to be in demand again.

The appetite for more diversified investment and higher returns sustained the top-line growth in premiums in 2014, consistent with 2013 trends. In 2014, unit-linked products allocated the largest share of assets on corporate bonds (36.0%) and equity investments (35.1%) with the remainder distributed between government bonds (23.5%) and short-term investments (5.3%). While the Italian insurance sector has committed more than a third of investments into equities, two of the largest competitors, Allianz S.p.A. and Assicurazioni Generali S.p.A., which are rated by A.M. Best, tend to have more conservative portfolios that are reflective of their presence outside of Italy.

As cited above, non-life GWP continued to decline in 2014, decreasing for the third consecutive year. This contraction was reflected through its largest segment – third-party motor and marine insurance (representing 46.4% of non-life premium income) – and which continued to remain under pressure with a decline of 6.5% following a decrease of 7% in 2013 as prices fell due to the high levels of competition in the market.

Market Performance Positive

The net result after tax for the insurance market as a whole for 2014 was EUR 6 billion, up by EUR 800 million, or 15.4% in 2014, with positive contributions from the life and non-life sectors (both posting a EUR 400 million increase). The life sector achieved a positive technical result for 2014 of EUR 2.8 billion, albeit declining from 2013 levels of EUR 3.3 billion, according to data from ANIA (Exhibit 3). This was a result of an adverse

Exhibit 2

Italy – Non-Life & Life –

Gross Written Premium Growth (1998-2014)

Source: The Associazione Nazionale fra le Imprese Assicuratrici (ANIA) 0 20,000 40,000 60,000 80,000 100,000 120,000 1998 2000 2002 2004 2006 2008 2010 2012 2014 EU R (m ill io n) Non-Life Life

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development of technical reserves – following the rise in premiums level – and expenses both in terms of acquisition and administrative costs (increasing 7.7% from 2013). The ratio between technical profit and GWP was 0.6%, compared to 0.8% in the previous year. Claims losses remained at levels comparable to 2013.

A.M. Best notes that while the non-life segment outperformed the life sector in 2014, the life segment has been more volatile, as illustrated by Exhibit 3. This

in part reflects the investment performances of life insurers, which have been very poor during periods of financial difficulties – notably in 2008 and 2011.

Among the two main life segments, unit-linked policies reported underwriting profit on a calendar-year basis between 2010 and 2014. In particular, in 2014 this segment recorded its highest technical profit (EUR 723 million), up by 47.9% compared to 2013. In contrast, long-term life insurance reported technical losses in 2010 and 2011 but produced significant profits over the last three years.

The 2014 combined ratio for the non-life sector remained consistent with 2013 at 90.1% as an increase in the expense ratio was balanced by an equal decrease in the loss ratio (Exhibit 4). This translated into a technical profit of EUR 3.6 billion, up by EUR 126 million from

2013, as shown in Exhibit 3. The ratio of technical profit over GWP was 10.7%, unchanged

from the prior year.

The loss ratio fell largely due to a reduction in third-party motor and marine insurance losses, with these two lines of business representing 53% of total non-life GWP in 2014. The decrease in the loss ratio was offset, for these same products, by a corresponding increase in the expense ratio. According to data from ANIA, this brought the combined ratio up to 90.5% from 88.2% in 2013 for this line of business.

Exhibit 3

Italy – Non-Life & Life –

Technical Performance (1998-2014)

Source: The Associazione Nazionale fra le Imprese Assicuratrici (ANIA)

-4,000 -2,000 0 2,000 4,000 6,000 8,000 1998 2000 2002 2004 2006 2008 2010 2012 2014 EU R (m ill io n) Non-Life Life

Exhibit 4

Italy – Non-Life – Combined Ratio (1998-2014)

Source: The Associazione Nazionale fra le Imprese Assicuratrici (ANIA)

111.0 108.1 107.4 102.0 97.3 95.1 93.3 92.7 94.0 94.7 98.7 103.7 100.2 97.9 95.9 90.1 90.1 0% 20% 40% 60% 80% 100% 120% 1998 2000 2002 2004 2006 2008 2010 2012 2014 Co m bi ne d Ra tio (% )

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Special Report European Non-Life & Life Insurers A.M. Best expects the motor market could benefit from the improving economic conditions,

with the Automobile Club Italia reporting new car and motorbike registrations rising by 9% on a year-on-year basis as of August 2015. Furthermore, according to the Italian National Institute of Statistics (L’Istituto nazionale di statistica - ISTAT), 2013 saw a further decrease in car accidents and casualties, down by 3.7% and 9.8%, respectively. A.M. Best notes this trend has been observed over the last few years; however, regulatory developments in the motor market could negatively affect insurers. In April 2015, the Italian Parliament commenced the validation process for a bill relating to competition in the insurance market – “D.d.l. Concorrenza”. The legislation includes measures to improve transparency, tackle fraud and further facilitate competition, with particular reference to the motor insurance market. The bill’s ultimate aim is to bring current rates closer to levels observed in other European countries (see panel below,

“Italian Regulatory Developments”).

As at the end of 2014, total insurance market investments amounted to EUR 568.5 billion, of which 85% was attributable to the life segment. For both non-life and life, net unrealised gains were EUR 59.3 billion, up from EUR 20.8 billion at the end of 2013, due to the reduction in interest rates. The result is largely attributable to the considerable amount of fixed-income securities in the portfolio (80% of total investments). The investment in Italian bonds has steadily increased between 2009 and 2014, moving from EUR 179 billion to EUR 336 billion and from 48% to 59% of total investments (excluding real estate, intercompany loans and participations). A.M. Best believes this shift is partly due to the higher yields granted by Italian bonds, which have become increasingly attractive in a low interest rate environment.

In terms of profit and loss, overall net investment income and realised gains amounted to EUR 25 billion in 2014, up from EUR 22 billion in 2013. Consistent with the portfolio composition, the largest share of income was derived from corporate and government bonds (53%).

From a solvency standpoint, the Italian insurance market looks solid. The buffer on the regulatory margin increased to EUR 46.7 billion, or 3.5% as of the end of 2014, with an excess of almost 90% over minimum requirements in Italy. Furthermore, according to the results of a stress test conducted by the European Insurance and Occupational Pensions Authority (EIOPA) and published in November 2014, the Italian insurance market was deemed adequately capitalised under Solvency II requirements.

Overseas Insurers Engage in M&A Activity

The Italian insurance sector has seen some merger and acquisition (M&A) activity in recent years, increasingly involving overseas market participants. As of 31 December 2014, there were 226 insurance companies or branches established in Italy, of which 125 were domestic and 101 were representatives of overseas companies. Out of these, there were 124 non-life insurers, 69 life insurers, 26 composites and 7 were operating as reinsurers. In 2013, there were 232 registered insurers or branches in the country.

Since 2012, M&A transactions within the Italian market have included the integration of the Unipol and Premafin/Fondiaria-Sai groups, which aimed to address solvency deficiencies of the latter. Unipol Assicurazioni, Milano Assicurazioni and Premafin later were merged into Fondiaria-Sai, which subsequently assumed the name UnipolSai Assicurazioni S.p.A and became operative in January 2014. Following these deals, the Italian non-life market has become dominated by three main players – UnipolSai Assicurazioni, Generali Italia and Allianz, representing 53% of the total market size in terms of GWP in 2014.

Transactions have continued in 2014, f