Special Report: Gibraltar Insurance Market Enjoys …...Based on 34 Gibraltar-domiciled...

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BEST’S MARKET SEGMENT REPORT21 November, 2018

Gibraltar’s insurance market is concentrated on motor business

Gibraltar Insurance Market Enjoys Solid Performance but Brexit Creates UncertaintyGibraltar’s insurance market has experienced significant development over the past decade, with new entrants contributing to growth in the territory’s premium base. There are now approximately 60 insurers registered in Gibraltar, who together generate premium revenue of around GBP 4 billion. They operate primarily in the United Kingdom’s competitive motor market and account for approximately 6% of the overall UK non-life market, based on gross written premiums (GWP).

Insurers have been attracted to the British overseas territory by the ability to write cross-border business into the UK and other EU countries, as well as a favourable taxation system. The corporate tax rate and income tax rate are lower than the UK, in addition no VAT is due on goods or services based in Gibraltar. Whilst Insurance Premium Tax (IPT) is not payable on risks situated in Gibraltar, A.M. Best notes that coverage provided to policyholders based in the EU customs union would incur IPT, assuming the service is consumed within that jurisdiction.

Based on the 34 companies for which A.M. Best has collated Solvency II returns for the year ending Dec 31, 2017, non-life business accounted for 97% of the territory’s GWP, with the market overwhelmingly concentrated on motor business (see Exhibit 1).

BrexitThe UK’s decision to leave the EU creates some uncertainty for Gibraltar-domiciled insurers. Gibraltar is a member of the EU by virtue of UK membership, and when this is relinquished by the UK, it will also lose any benefits of EU membership, such as passporting rights. However, with almost 90% of business coming from the UK, A.M. Best expects companies to be largely unaffected by the loss of EU passporting rights. That said, those companies that do write business in the other 27 EU countries will have to make contingency plans or cease to underwrite this business.

Market PerformanceA.M. Best observes that overall earnings for Gibraltarian insurers are good and the market has consistently generated a return on equity (ROE) in the high single digits, helped by a relatively

Analytical Contacts: Timothy Prince, LondonTel: +44 207 397 [email protected]

Catherine Thomas, LondonTel: +44 207 397 [email protected]

Editorial Managers:Yvette Essen, LondonTel: +44 20 7397 [email protected]

Richard Hayes, LondonTel: +44 20 7397 [email protected]

2018-159

66%

20%

5%3%

3% 3%Motor Vehicle Liability

Other Motor

Financial Loss

Life

Remaining Non-Life

Fire

Exhibit 1Gibraltar Market - Split by Line of Business (2017)(%)

Notes:Based on 34 Gibraltar-domiciled insurers' Solvency II returns.Source: A.M. Best data and research

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Market Segment Report Gibraltar Non-Life and Life

high level of underwriting leverage. Earnings have been supplemented by other income and modest investment returns. The ROE metrics suggest that companies are efficiently deploying resources to the benefit of their shareholders, especially during an extended period of low interest rates and challenging market conditions.

With the UK motor market subject to fierce competition, Gibraltar-domiciled insurers have found themselves exposed to significant pricing pressure in recent years. They have also had to contend with the consequences of the significant cut in the discount rate used to calculate lump-sum personal injury compensation from 2.5% to minus 0.75%, announced by the UK government in February 2017. The rate change had a material impact on the market in Gibraltar due its bias towards motor business, with many companies taking the associated one-off reserve hit in their 2016 results. However, the extensive use of reinsurance by the market, typically in the form of excess of loss cover, partly mitigated the impact on earnings and balance sheets.

The industry’s non-life combined ratio has hovered around 100% in most years, which would normally suggest that companies are struggling to generate an underwriting profit. However, results have historically been supported by “other underwriting” income. Strategies across the market vary, but overall insurers appear to be pricing policies at around breakeven, with ancillary income or other underwriting income (which relates to additional administration or service fees) contributing to overall earnings. This reliance by some market participants on other underwriting income to generate positive earnings may present them with a longer-term issue, as the Gibraltar Financial Services Commission (GFSC) and the UK’s Financial Conduct Authority (FCA) raise the bar for consumer welfare.

A.M. Best also notes that investment income generated by Gibraltar-domiciled insurers is generally modest, as a result of conservative asset allocations that are focused on cash and fixed-income securities. Returns on both asset classes have been subject to an extended period of low interest rates, with investment yield (excluding gains and losses) for the market ranging at between 1% and 2%.

UK Legislative ChangesThe Civil Liability Bill, which includes proposed changes to the way the UK’s personal injury discount rate is set, entered the House of Commons in June 2018. To better reflect claimant investment behaviour, it is recommended that the discount rate is set by reference to expected rates of return on a “low risk” diversified portfolio of investments rather than “very low risk” investments as is assumed in the current minus 0.75% rate. Also, it is proposed that the rate is reviewed shortly after the legislation comes into force and, thereafter, at least every five years. In A.M. Best’s opinion, this would mean that future changes will be less dramatic than that announced in February 2017.

In addition to changes to the way that the government sets the personal injury discount rate, the bill seeks to crack down on fraudulent whiplash claims, which A.M. Best believes is likely to have a positive impact on claims experience. The bill will ban offers to settle claims without the support of medical evidence and increase the small claims track limit for road traffic accident-related personal injury claims to GBP 5,000 and for all other claims to GBP 2,000.

Once implemented, measures in the Civil Liability Bill should improve claims experience in the UK. However, in such a competitive market, A.M. Best expects any savings to be quickly passed to insureds in the form of premium reductions. In addition, the claims environment

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is likely to remain challenging, due to persistent issues with fraud, higher repair costs and a growing compensation culture.

Market CapitalisationBased on the Solvency II returns captured by A.M. Best, the combined Solvency II ratio (calculated as the market’s solvency capital requirement (SCR) over the sum of available funds) for the insurance market in Gibraltar was approximately 154% at year-end 2017. Although this is comfortably in excess of the minimum SCR ratio of 100%, A.M. Best notes that more than half of companies in the EU reporting under the standard formula have scores in excess of 200%.

The level of capitalisation among Gibraltar-domiciled insurers varies materially (see Exhibit 2). A.M. Best notes that despite capital injections, two companies (which had suffered significant underwriting losses in 2015 and 2016) were below the minimum requirement as at year-end 2016. This reduced to one as at year-end 2017. Half of the observed companies had solvency ratios less than 150% at year-end 2017, which suggests to A.M. Best that insurers are often willing to operate with a relatively thin regulatory capital buffer. Motor business in the UK is typically distributed from insurers via aggregators and managing general agents (MGAs) to policyholders and, as such, competition is heavily price-driven and consumers have very little awareness of the financial strength of their insurers.

On average, the combined SCR for insurers is driven by non-life underwriting risk, with market risk being the second largest contributor (see Exhibit 3). This is to be expected given the focus on non-life business and when viewed alongside the investment strategies of insurers operating in this market, where the allocation to conservative assets such as cash, deposits and bonds has been increasing.

Motor insurers typically have high liquidity requirements and, with the exception of bodily injury claims, relatively short liability durations. Consequently, a high proportion of liquid assets is necessary.

Premium retention can vary significantly between companies in Gibraltar but on average is relatively low (approximately 40% of GWP in 2017). This is commensurate with local companies’ small capital bases, which limit their capacity to absorb risk. Consequently, exposure to the ability and willingness of reinsurers to pay claims is high. Mitigating this credit risk, for example through the use of diverse panels of financially strong reinsurers, is a particularly important component of insurers’ risk management.

The introduction of Solvency II has raised the importance and awareness of risk and capital management practices. In line with these more stringent controls A.M. Best has witnessed an increasing allocation to cash and bonds over the past decade for Gibraltarian insurers. A large proportion of Gibraltar-domiciled insurers operate with relatively low regulatory solvency

1

8 8

11

6

Below100%

100% - 125% 125% - 150% 150% - 200% Above200%

Exhibit 2Gibraltar Market - Split by Solvency Ratio (2017)


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ratios (between 100% and 150%) and are therefore less able to absorb market risk than those companies that have large solvency buffers.

Regulatory and Political Developments Pressure Current ModelsGibraltar-domiciled insurers have enjoyed good technical performance, supported by ancillary income. Analysis of Solvency II filings shows that there is generally an adequate capital buffer over the regulatory minimum, and that capital requirements are driven primarily by underwriting risk. The implementation of Solvency II, and the associated increase in capital requirements, was a challenge for market participants that had weak capital positions. As a consequence, a number of companies have raised additional funds in recent years, while some others have ceased writing business.

Exhibit 3Gibraltar Market - Solvency Capital Requirement by Risk Type (2017)(GBP)


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In 2016, the GFSC worked with Elite Insurance Company after identifying risks arising from its governance, delegated underwriting and reserving processes, and issued directions to inject capital and to cease writing new business. By July 2017, Elite had ceased writing new business and entered into run-off. In addition, in July 2016, Enterprise Insurance Company went into provisional liquidation and a few months later in October, the GFSC launched a major investigation into the company and its board of directors.

A.M. Best expects both political and legislative changes to continue to have an impact on the earnings of insurers in Gibraltar. Uncertainties surrounding Brexit overhang the market, and whilst the trading relationship with the UK (Gibraltar’s key market) is expected to remain relatively unchanged, those companies operating in other EU countries may need to look for alternative solutions. These may include establishing new subsidiaries or potentially exiting a market if it is considered no longer economically viable to continue operating there.

UK legislative changes, particularly in respect of bodily injury, also create potential volatility for the market. In A.M. Best’s view, it will be those companies that have prudent underwriting and reserving approaches, as well as healthy capital buffers, that will manage the prevailing uncertainty most effectively. For those insurers that are below or close to regulatory minimum solvency levels, additional capital may be required, and it will be up to shareholders to determine if they continue to see value in this highly competitive market.

Although market conditions are challenging, A.M. Best notes that there are some potential positives for earnings. Insurers writing UK motor business should benefit from proposed changes to the UK personal injury compensation system as outlined in the Civil Liability Bill. In particular, an increase in the discount rate would likely lead to reserve releases for Gibraltarian companies retaining bodily injury risks. Furthermore, with UK interest rates beginning to rise, insurers will begin to realise additional investment income on invested funds, which represents a key component of earnings for cash-flow underwriters.


Market Segment Report

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Best’s Financial Strength Rating (FSR): an independent opinion of an insurer’s financial strength and ability to meet its ongoing insurance policy and contract obligations. An FSR is not assigned to specific insurance policies or contracts.

Best’s Issuer Credit Rating (ICR): an independent opinion of an entity’s ability to meet its ongoing financial obligations and can be issued on either a long- or short-term basis.

Best’s Issue Credit Rating (IR): an independent opinion of credit quality assigned to issues that gauges the ability to meet the terms of the obligation and can be issued on a long- or short-term basis (obligations with original maturities generally less than one year).

Rating Disclosure: Use and LimitationsA Best’s Credit Rating (BCR) is a forward-looking independent and objective opinion regarding an insurer’s, issuer’s or financial obligation’s relative creditworthiness. The opinion represents a comprehensive analysis consisting of a quantitative and qualitative evaluation of balance sheet strength, operating performance, business profile, and enterprise risk management or, where appropriate, the specific nature and details of a security. Because a BCR is a forward-looking opinion as of the date it is released, it cannot be considered as a fact or guarantee of future credit quality and therefore cannot be described as accurate or inaccurate. A BCR is a relative measure of risk that implies credit quality and is assigned using a scale with a defined population of categories and notches. Entities or obligations assigned the same BCR symbol developed using the same scale, should not be viewed as completely identical in terms of credit quality. Alternatively, they are alike in category (or notches within a category), but given there is a prescribed progression of categories (and notches) used in assigning the ratings of a much larger population of entities or obligations, the categories (notches) cannot mirror the precise subtleties of risk that are inherent within similarly rated entities or obligations. While a BCR reflects the opinion of A.M. Best Rating Services, Inc. (A.M. Best) of relative creditworthiness, it is not an indicator or predictor of defined impairment or default probability with respect to any specific insurer, issuer or financial obligation. A BCR is not investment advice, nor should it be construed as a consulting or advisory service, as such; it is not intended to be utilized as a recommendation to purchase, hold or terminate any insurance policy, contract, security or any other financial obligation, nor does it address the suitability of any particular policy or contract for a specific purpose or purchaser. Users of a BCR should not rely on it in making any investment decision; however, if used, the BCR must be considered as only one factor. Users must make their own evaluation of each investment decision. A BCR opinion is provided on an “as is” basis without any expressed or implied warranty. In addition, a BCR may be changed, suspended or withdrawn at any time for any reason at the sole discretion of A.M. Best. Version 021518

Special Report: Gibraltar Insurance Market Enjoys …...Based on 34 Gibraltar-domiciled...

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