Anthony Hilton: Insurers are quaking over Solvency II

The dinosaurs of 60 million years ago, perfectly evolved for the conditions of the age, presumably had no advance notice of the meteor which hit their world so hard it changed the climate and made them extinct.

And of course if they had known, there was nothing they could have done about it. So one imagines they munched away happily in blissful ignorance right to the end.

Not for them the employment of teams of actuaries and thousands of consultants to debate where the meteor will hit, what its impact will be, and which part of the world would optimise their chances of survival.

Not for them the creation of board committees and committees of those committees, and committees of committees of committees, to see if they can discover a new form of life, which might be more suited to the new conditions, whatever they might be.

Not for them a lingering hope that the missile would burn up in the atmosphere, or that some benign deity would intervene at the last minute to save their world.

And not for them the preparations of pleadings running from 8000 pages in the case of small companies right up to 100,000 pages for the giants in the industry, to establish that whatever happened to the others, they at least deserved to survive.

All this means that the dinosaurs were spared the current agonies of Europe’s insurance industry, whose world will very soon be so changed that extinction beckons for some of them, too.

But this meteor is not so much an act of fate as an act of man — launched not from outer space but from Moorgate and the offices of the Prudential Regulation Authority.

For those who have not already guessed, it is Solvency II, and it is a Europe-wide regulatory framework, initially conceived with the laudable intention of making all of Europe’s insurers operate on a comparable basis, which has evolved into something so removed from the original concept that some insurance industry chiefs are wondering whether they can ever be profitable again.

So it does promise to be the ultimate cosmic accident.

Trying to explain why, without making the world’s eyes glaze over, is a bit of a challenge, but in effect, it seeks to do two things.

First, it wants insurers to separate their different lines of business and allocate capital to each in accordance to riskiness, so that the policies are priced correctly and there will always be money there to pay the claimants.

Second, it wants the companies to be similarly clear and disciplined in how they invest their premium income. Different classes of assets will require a different buffer of capital in proportion to their perceived riskiness when the baby boomers — those born in the surge just after the war — entered the labour force for the first time, to offset the likelihood of the investment losing money.

Then if everyone in Europe works to the same rules, we will be able to see which companies are efficient, and — by extension — whose policies are the best buy.

Such good intentions! But of course it has not worked out like that.

First, no one can agree on what is risky and what is not risky, and arguably it is impossible anyway, because insurance contracts and investments are in place for 20 years and more, and who knows how the world will change in the meantime. Arguing the toss between the companies and the regulator over what should be allowed and at what price has cost literally hundreds of millions of pounds for big companies, and billions for the sector as a whole.

And for what? Though it was designed as a Europe-wide model, it is being implemented country by country.

Each regulator interprets the rules differently, so the ability to compare — which was the point of the exercise — has already been lost.

Third, the regulatory climate of the times is one of reckless prudence, meaning that everything has to be ultra-safe, regardless of the cost.

In insurance terms, this means backing every bit of the business with as much capital as possible.

But these additional capital allocations threaten to make whole lines of business hopelessly unprofitable, so insurers will either have to put their prices up dramatically, or leave the market to a foreign competitor whose regulator has been more lenient, and who has therefore delivered to his constituency an unassailable price advantage.