European re/insurers operating under Solvency II regulations have the flexibility to issue further hybrid capital if needed, according to a new report by S&P Global Ratings, but doing so could put credit ratings at risk.
Analysts noted that access to hybrid capital is an important element of a re/insurer’s financial strength, as it can provide additional loss-absorbing capacity and enhance solvency or liquidity positions.
On average, 60% of Solvency II hybrid capacity is unused, with relatively more capacity for restricted tier 1 (RT1) (35%) than for both tier 2 and tier 3 (25%).
However, S&P believes that most companies are likely to continue using more of their tier 2 than RT1 capacity because it is cheaper and a more classic option for investors.
In general, the rating agency found that insurers more focused on acquisitions or optimising their return on equity have used a greater proportion of their Solvency II hybrid capacity than others.
Analysts suggested that the flexibility to issue additional hybrid instruments could provide an insurer with about 60 percentage points of additional Solvency II coverage on average.
Currently, S&P views Solvency II coverage as healthy, and does not expect many insurers to further leverage their balance sheets through incremental hybrid issuances
While having available hybrid capacity provides financial flexibility, an insurer’s creditworthiness could be affected if the size and cost of debt become difficult to absorb using profits alone, S&P cautioned.
The firm typically takes a negative view in its credit rating analysis if an insurer’s indebtedness measured by the financial leverage ratio exceeds 40%.
Additionally, there are restrictions on the extent to which hybrid capital may be used as part of available capital, both within the Solvency II framework and our credit ratings analysis.
