The news for EMEA insurers during 2020 is likely to be dominated by COVID-19-related insurance claims and the revaluation of investments. As the capital markets react to the daily COVID-19 updates, S&P Global Ratings has maintained a stable outlook on most rated insurers based in EMEA. We consider EMEA insurers' solid capital positions and broad diversification will continue to protect many of them, and that volatility in their investment exposures will prove a greater risk than increases in insurance liabilities over the next 12 months.

In light of the changing conditions, we have already revised our outlooks for some insurers, partly because they have less robust balance sheets and partly because of their greater exposure to financial market volatility. We predict that insurance losses in EMEA will be concentrated in industrial lines such as event insurance, D&O, and business interruption (see "COVID-19 Will Test Insurers' Resilience," published on March 25, 2020).

Insurance Losses Look More Controllable Than Economic Risks

Pandemics are excluded from most business interruption insurance contracts, and in EMEA, we see limited risk that authorities will make retroactive legal changes to these agreements. Such a move risks bringing contract law into question (see "Credit FAQ: How COVID-19 Risks Factor Into U.S. Property/Casualty Ratings," published on April 27, 2020). That said, in less clear-cut cases, or where policy wording is less definitive, we could see regulatory or legal pressure to pay claims, which could increase capital pressure on individual insurers. Travel insurance might increase insured losses for a wider group of specialist insurers that focus on this line of business but, in most cases, we assume the losses will not be material. Despite the many tragic COVID-19 cases, the numbers are not material enough to weigh on life and health liabilities for EMEA insurers.

Given that GDP in Europe is expected to plummet by 5.9% as a result of the measures to curb the spread of the pandemic, we expect gross written premium to take a hit (see "Credit Conditions Europe: The Lowdown On Lockdowns," published on April 27, 2020). Nevertheless, many insurance lines are mandatory in much of EMEA. Therefore, while gross revenue in lines such as motor third-party liability may be flat, we anticipate that much of the top line will prove persistent, despite the predicted recession. In addition, our earnings forecasts incorporates the rebates we have already observed in selected cases, for example, where vehicles are driven less than the insurer assumed when underwriting the motor insurance. Typically, recessionary environments lead to lower claims frequency. Not only do people drive private vehicles less, but also corporate machinery is not used to its maximum capacity, improving the loss experience for some corporate insurance lines.

We forecast that banks' loan-loss provisions will spike this year, meaning insurers that have material banking activities and exposure could be more affected than other insurers. The same holds for core insurance subsidiaries of banking groups, where our rating on the insurer is closely tied to that on the parent banking group. Such links triggered our rating actions on PZU in Poland, and on BNP Paribas Cardif and Sogecap (both in France). A list of all COVID-19-related rating actions can be found here: "COVID-19: Coronavirus- And Oil Price-Related Public Rating Actions On Corporations, Sovereigns, And Project Finance To Date").

For 2020, Rating Analysis Will Focus On Balance Sheets

Given this background, we expect to continue to focus on analyzing how COVID-19 and related risks and opportunities affect insurers' balance sheets in 2020 and beyond. Capital market movements are likely to erode some unrealized investment gains, and an additional burden could arise from the rating migrations so far, combined with the expected corporate defaults (see "Default, Transition, and Recovery: Recession Likely Will Spur The European Speculative-Grade Default Rate To Rise Toward 8%," published on March 31, 2020).

We recognize that supervisory authorities have been urging insurers to postpone dividends and share buy-backs. These moves are understood to be precautionary measures that will safeguard capital adequacy in light of the current situation (see "Insurers' Dividend Pause Amid COVID-19 Concerns Likely Indicates Caution, Not Credit Risks," published on April 15, 2020). However, access to capital markets will remain crucial to refinancing many EMEA insurance groups (see chart 1).

As described, the risk factors are part of our prospective analysis and are incorporated in the ratings. The main factor supporting our ratings on EMEA insurers is their solid capital adequacy, as measured by our risk-based capital model. There are material buffers at the different confidence levels (see chart 2; estimates shown for 2020 and 2021 predate the COVID-19 stress). In our prospective view on capitalization, we assume some insurers will display capital within the 'AA' level going forward, and that the sector as a whole will have a buffer of about 5% above the benchmark expected at the 'AA' level. Although we have some flexibility in our prospective view to look through a short-term capital drop, a tendency to maintain lower redundancy indicates potential for a negative rating action if external stress factors reoccur. Ratings may still be affirmed, even at a lower capital level, but we reassess the rating, balancing the capital level against other rating factors.

Chart 2

Chart 2 uses aggregate numbers, so that metrics at some groups could be stronger or weaker than the aggregate. Nevertheless, it is notable that insurers that report capital at the 'AAA' level also show a material capital redundancy. The aggregate buffer is much lower for insurers rated in the 'AA' and 'A' categories. Where we assume capital at the 'BBB' level supports the rating, we also observe that some insurers display a material redundancy. Strengths and weakness in capitalization are not uniformly distributed, even within one confidence level. Many of our recent rating actions linked to COVID-19 have been linked to a weakened prospective view on capitalization.

Quality Matters

In assessing the strength of an insurer's total adjusted capital (TAC), we pay attention to the quality, as well as the absolute size, of its capital. Two insurers might report the same absolute amount of capital, but one might only include shareholders' equity in that amount; the other might reach the same level through a mix of shareholders' equity, off-balance sheet unrealized capital gains, hybrid debt, and life embedded value value-in-force (VIF).

We typically regard hybrids, discount on P/C reserves, and VIF as softer forms of capital, and where material, this affects our assessment of the rating scores and anchor. In such cases, we may incorporate a capital and earnings (C&E) adjustment, modifying the assessment down by one or two categories (see chart 3).

Chart 3

For example, hybrid instruments require refinancing from time to time. A difficult market environment might increase the cost of this refinancing. We analyze any potential concerns in our assessment of funding structure. VIF can be very volatile, and fluctuate with small changes to underlying interest rates and spreads. Off-balance-sheet unrealized capital gains in Europe often relate to real-estate assets. So far, these have been spared the volatility of stock markets, but prices could be affected by prolonged lockdowns and the recession.

Although it forms an integral part of our analysis, in most cases the funding structure of EMEA insurers does not affect our rating on it. The vast majority of EMEA insurers display a well-balanced funding structure. We assess the funding structure as neutral where financial obligations are below 40% of reported shareholders' equity, moderately negative where they exceed 40%, or negative where they exceed 50% (see chart 4). Ratings are only affected where financial leverage is particularly high and where EBITDA does not cover interest by at least 4x.

Chart 4

Our risk-based capital model captures assets and liabilities, with very detailed charges for each exposure. Asset exposures are charged by asset class, duration, and rating. Thus, insurers' investment exposures are captured in our analysis of capitalization, which covers four years: the latest reported business year, the current year, and the two subsequent ones. However, we also observe risk factors, including concentrations in specific assets that could heighten investment risks, or higher-risk lines of business, that are not fully covered in our assessment of capitalization. To capture these factors, we use our risk exposure score. Heightened risk and insurance exposures, including pandemics, are incorporated here, where they have a direct impact on the anchor (see chart 5).

Chart 5

Exposure to speculative-grade or unrated bonds is one of the investment risks captured in the risk exposure score. In many regions, unrated bonds indicate a greater credit risk than investment-grade bonds. In EMEA, it is rare to find regions where large corporates do not commonly have a credit rating, although this does occur in some Nordic countries. Given that interest rates in EMEA are extremely low, even negative in some countries, EMEA insurers have gradually increased their exposure to speculative-grade bonds. Given the current environment, we view such bonds as more vulnerable to further downgrades and/or defaults (see "Credit Trends: Fallen Angels Rose Sharply In First-Quarter 2020 Amid COVID-19 And Oil Price Shocks," published on April 16, 2020, and "Credit Trends: 'BBB' Pulse: U.S. And EMEA Fallen Angels Are Set To Rise As The Economy Grinds To A Halt," published on April 9, 2020).

The Recovery Forecast For 2021 Is Not Certain Enough To Support Rating Actions

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Although we assume some rebound in GDP for most EMEA regions in 2021, we take a cautious approach to any potential financial market recovery; this does not form the basis of our rating decisions. Should capital market volatility worsen, for example, after an unexpectedly long lockdown, we will revisit our assumptions.

Related Research

• COVID-19: Coronavirus- And Oil Price-Related Public Rating Actions On Corporations, Sovereigns, And Project Finance To Date, kept updated
• Credit Conditions Europe: The Lowdown On Lockdowns, April 27, 2020
• Credit FAQ: How COVID-19 Risks Factor Into U.S. Property/Casualty Ratings, April 27, 2020
• Credit Trends: Fallen Angels Rose Sharply In First-Quarter 2020 Amid COVID-19 And Oil Price Shocks, April 16, 2020
• Insurers' Dividend Pause Amid COVID-19 Concerns Likely Indicates Caution, Not Credit Risks, April 15, 2020
• Credit Trends: 'BBB' Pulse: U.S. And EMEA Fallen Angels Are Set To Rise As The Economy Grinds To A Halt, April 9, 2020
• Default, Transition, and Recovery: Recession Likely Will Spur The European Speculative-Grade Default Rate To Rise Toward 8%, March 31, 2020
• COVID-19 Will Test Insurers' Resilience, March 25, 2020