South African life assurance – Potential capital release boost
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South African (SA) life assurers have targeted conservative solvency capital requirements (SCR), which have held up well despite recent investment market stress and increased claims from the COVID-19 crisis. This suggests there may be room for a reduction in solvency capital targets when the crisis abates, which may result in visible capital releases and enhanced returns on group equity value (RoGEV). In this report we consider the winners and losers from a possible release in capital.
COVID-19 shock absorbed by SA life assurers
SA life assurers have targeted high solvency coverage ratios of 1.5–2.1x SCR under the Solvency Assessment Management (SAM) solvency regime. The COVID-19 crisis has caused substantial volatility in the financial markets and the need for insurers to shore up claims provisions, which is a real-life test on the appropriate levels of solvency capital under SAM. Despite the stressed experience, the SA life assurers’ solvency ratios have remained strong at over 1.8x.
A case to hold less solvency capital post COVID-19
Given the robust SCR ratios, we believe there is a case for the SA insurers to hold solvency capital at a lower target range while still demonstrating considerable financial strength. This is only likely to materialise once the uncertainty surrounding the COVID-19 pandemic dissipates.
Capital releases of 5–23% GEV and boost to RoGEV
A hypothetical scenario of an SCR coverage ratio of 1.6x for the SA life assurers would potentially result in capital releases of 5–23% of GEV. We estimate ZAR14bn and ZAR15.8bn for Sanlam and Old Mutual respectively, based on their 1.87x (SLM Group) and 2.08x SCR at 30 June 2020. In the case of Liberty Holdings, Momentum-Metropolitan Holdings (MMH) and Discovery Holdings, we estimate ZAR3.6bn, ZAR5.5bn and ZAR3.3bn respective capital releases based on 1.81x, 1.95x and 1.8x SCR at 31 December 2020. A boost to RoGEV of between 0.2% and 2.4% is estimated, which compares to internal return targets of around 12.5%.
- Old Mutual stands out in delivering a 19.3% relative boost to its average RoGEV from releasing solvency capital from its SA life assurer from 2.08x (30 June 2020) to 1.6x SCR.
- MMH, Liberty and Sanlam would show enhancements to their average RoGEVs of 7.3%, 6.0% and 4.8% respectively by releasing excess capital from 1.95x, 1.81x (December 2020) and 1.87x (June 2020) to 1.6x SCR.
- Discovery would generate the lowest increase to RoGEV (2.3%) by releasing capital from 1.8x (December 2020) to the 1.6x SCR at Discovery Life.
SA life assurers have targeted conservative solvency ratios since the introduction of the SAM regime in 2018. Despite the investment market stress and the increase in claims reserves due to the COVID-19 crisis during 2020, the solvency capital requirement ratios have remained strong. This suggests there may be room for a reduction in solvency capital targets when the COVID-19 crisis abates, which may result in visible capital releases to shareholders and enhanced returns on group equity values.
SAM: A conservative solvency regime
South Africa introduced SAM, a new statutory solvency regime for insurers effective from 30 June 2018. This regulatory solvency requirement for insurers was largely based on the Solvency II (SII) principles adopted by the European regulators for European insurance players. Both SAM and SII regulatory capital requirements are structured such that an insurer will hold available solvency capital known as eligible own funds (EOF) to cover the SCR where the SCR is based on the ability of the insurer to absorb losses and demands on capital with a 99.5% level of confidence measured over a calendar year; in other words, capital to support a one in 200-year event.
Many of the standard model requirements used to determine the SCR are the same or similar under SAM and SII. For example, both regimes require an insurer to allow for an immediate fall of 30% in the market value of listed equities held by the insurer, as well as the financial effect of an immediate 40% loss of individual life policyholders (a mass lapse event) for life assurers.
However, there are some different requirements under SAM that are more conservative than SII. For example, the stress scenario that allows for catastrophic mortality and morbidity cover is more severe under SAM. Further, most of the base levels of risk items are much higher in South Africa compared to Europe, such as mortality risk (partly affected by the experience with HIV/AIDS) and policyholder lapse risk (the average annual lapse rates in South Africa are around four times higher than for most European territories). Proportional shocks or stresses required by the regulations on such higher levels (lapse rates) result in much higher capital requirements compared to European counterparts. Therefore, the SAM SCR requirements are expected to be more conservative for SA life assurers.
Strong solvency ratios targeted
Despite a generally stronger risk capital requirement under SAM for SA life assurers compared to insurers operating under the SII regime, most major SA life assurers have targeted a solvency coverage ratio measured as EOF:SCR at similar levels to many of the European players of around 1.5–2.1x. Exhibit 1 highlights the targeted SCR ratios for four of the main SA life assurers. The ratios for Sanlam and Old Mutual are target ratios for the group of companies (includes non-life insurers, insurers in other territories and other financial services companies) within each stable. Typically, the SCR target for the life assurer within the group would be higher. A life assurer that posts a SCR coverage ratio of two times implies it holds available solvency capital to cover the requirements of two one-in-200-year shock events in succession.
Exhibit 1: Targeted SCR coverage ratio
|Company||SCR coverage ratio|
Source: Company financial statements. Note: *Applies to the group.
The volatility in financial markets and need for insurers to make provisions for a potential spike in claims experience due to the global COVID-19 pandemic is arguably an example of the shock events that the SAM solvency test is designed to cover, namely, a stress scenario that occurs once every 200 years. At the end of March 2020, the SA government declared a national state of disaster and implemented a hard lockdown, restricting personal mobility and economic activity except for the provision of essential services such as healthcare and the continued supply and sale of food and other essential consumables. The South African All Share Index suffered a sharp fall of over 30% between the beginning of January 2020 and 8 April 2020.
In anticipation of an expected increase in mortality, morbidity and loss of income claims as well as the expected increase in policyholders lapsing their policies, most of the main SA life assurers strengthened their claims reserves (provisions) at 30 June 2020, which resulted in a reduction in group equity values. Exhibit 2 illustrates this June 2020 increase in reserves (provisions) and strengthening of valuation assumptions to allow for the effect of COVID-19 for the main SA life assurers (excluding non-life insurers and insurers outside South Africa). Sanlam had historically set up a pandemic reserve before the onset of COVID-19.
The table also shows the updated COVID-19 reserves at 31 December 2020 for Liberty, Momentum-Metropolitan and Discovery, allowing for the utilisation of reserves to settle all known claims up to the end of December 2020 as well as additional provisions to allow for the adverse experience in January 2021 (wave two) and expectations around wave three. Sanlam and Old Mutual have not yet reported their full-year 2020 financial results.
Exhibit 2: COVID-19 reserves
Source: Company financial reporting. Note: *ZAR760m held before COVID-19. N/A: not available at time of publication.
Despite such a shock event unfolding during 2020, the main SA life assurers have managed to maintain strong SCR coverage ratios. Exhibit 3 illustrates the progression of SCR coverage ratios from December 2018 to December 2020 for each of the five large life assurers in South Africa that form part of the listed life assurance groups. As advised by the company, we have used Sanlam Group coverage ratios as the reported information for Sanlam Life may have been distorted by various accounting issues. The movement between December 2019 and June 2020 covers the main COVID-19 shock period (fall in asset values and substantial increases to claims provisions for the insurers). Over this period, the coverage ratios remained strong for all the SA life assurers, namely in excess of 180%. A recovery in the financial markets during the second half of 2020 partly offset by an increase in claims reserves largely supported a stable, or improvement, in the solvency ratio cover at the end of 2020.
Exhibit 3: SCR coverage ratio
Source: Company financial statements. Note: *Estimate based on June 2020; **Sanlam Group. N/A = not available at time of publication.
Discovery’s strong SCR coverage at December 2020 was after increased conservatism in COVID-19 reserving. Liberty Life has also increased the prudence of its SCR calculation and maintained a strong ratio over and above the increased COVID-19 reserves and reduction in its value of in-force. Momentum Metropolitan Life (shown as MMH) posted a ratio over 1.8x over the first half of 2020, which improved to 1.95x at the end of 2020 largely due to a stronger investment market and despite reserve strengthening. The increased reported coverage ratio for MMH at December 2019 was artificially inflated as new debt was issued before prior debt was repaid. The subsequent decline to June 2020 was therefore impacted by the subsequent debt elimination and the acquisition of Alexander Forbes Insurance.
Old Mutual Life Assurance Company of South Africa maintained strong SCR coverage of over 200% at June 2020 and Sanlam showed a modest improvement from June to September 2020.
It appears that most of the major SA life assurers have robust capital structures. Solvency capital is strong even after absorbing a shock event that typically places stress on the financial strength. For example, Momentum Metropolitan Life reported at June 2020 that a further 30% fall in the market value of its equity investments would still leave its SCR coverage ratio at 1.48x, which would be even higher following the cover increase to December 2020.
The reported financial strength for the SA life assurance groups could be enhanced further by implementing excess of loss reinsurance arrangements such as mass lapse protection. Such management structures reduce the SCR for the insurer. Liberty, Momentum and Discovery already have such structures in place for certain lines of insurance business.
Given the general robust and relatively high levels of capital held by the main SA life assurers, we believe there is a case for insurers to hold solvency capital that supports a lower general target range to cover its solvency capital requirements, while still demonstrating considerable financial strength. In other words, we believe there is sound motivation for the SA life assurers to release some available solvency capital. However, given the uncertainties around the impacts of the COVID-19 crisis on life assurance groups’ profitability and financial strength, we also believe insurers will err on the conservative side of holding strong capital buffers in the short to medium term. So far Discovery Life, Liberty and Momentum Metropolitan Life have strengthened their COVID-19 claims reserves at the end of 2020 to allow for the expected increase in claims arising from the second wave of infections at the turn of the year, but have all indicated that their solvency levels are strong.
We assess the impact of the SA life assurers introducing a modest release of capital while maintaining a strong target level of SCR cover of 1.6x, which is within the target range for Old Mutual and Liberty. We calculate the impact for each of the main SA life assurance group’s expected enhancement to its return on GEV (or group embedded value) assuming a hypothetical scenario whereby the SA life assurance operations lower their SCR coverage ratios to 160%. In the case of Momentum Metropolitan Holdings, we only lower the SCR coverage ratio for Momentum Metropolitan Life and not Guardrisk Life, which is a cell-captive insurer within the MMH group that structurally supports a lower level of SCR cover.
Exhibit 4 illustrates the enhancement to the return on GEV by allowing for the release of excess available solvency capital for each of the SA life assurers in excess of 1.6x SCR cover. The calculations are based on the GEV and SCR coverage levels at 31 December 2020 for Liberty, MMH and Discovery. Sanlam and Old Mutual have not reported their respective financial results for the year ending December 2020, hence the June 2020 metrics are used. In the case of Sanlam, we base the calculation on the Sanlam Group solvency capital and coverage ratios. The calculation allows for the enhancement to the return on group equity by reducing the GEV by the capital release. The average annual return on group equity over December 2018 to December 2019 is used as the base level of return. The average excludes the returns in 2020 due to the extreme volatility due to the COVID-19 crisis. We adjust the return to allow for an assumed offset of lost yield of 4.5% per year investment return on the capital released. With current low interest rates, this may be overly penal, creating more impetus to put low-yielding capital in the hands of shareholders.
Exhibit 4: Enhancement to RoGEV from capital release
|SA Life EOF||30,275||97,000||68,311||30,789||29,434|
|SA Life SCR||16,703||51,872||32,794||15,797||16,352|
|SA Life SCR cover||1.81||1.87||2.08||1.95||1.80|
|SA Life EOF adjusted (1.6 x SCR)||26,725||82,995||52,470||25,275||26,163|
|Solvency capital release||3,550||14,005||15,841||5,514||3,270|
|Enhancement to return on GEV (%)||0.6%||0.4%||2.4%||0.6%||0.2%|
|Average return on GEV: Dec 2018 to Dec 2019 (%)||9.8%||7.4%||12.3%||8.5%||8.6%|
|Boost to average return on GEV (%)||6.0%||4.8%||19.3%||7.3%||2.3%|
Source: Company financial statements, analyst calculations. Note: *Sanlam Group numbers used (not Sanlam Life).
On this basis, each SA life assurer could release substantial amounts of capital: Liberty ZAR3.6bn, Momentum Metropolitan ZAR5.5bn, Discovery Life ZAR3.3bn, Sanlam and Old Mutual Life Assurance Company of South Africa a substantial ZAR14bn and ZAR15.8bn, respectively. This represents a release of between 5–23% of the GEVs. There are various methods on how this capital could be released or deployed, such as a normal or special dividend to shareholders, the groups re-purchasing their own shares or investing the funds in high growth opportunities (possibly outside South Africa given the depressed SA economy and low-growth life assurance market).
Ignoring any potential windfall payment to shareholders such as a dividend, Exhibit 4 illustrates the enhanced return to the GEV of the capital release. The enhanced returns from the capital release compared to the average annualised return on GEV is 0.6% versus 9.8% for Liberty Holdings, 0.4% versus 7.4% for Sanlam, 2.4% versus 12.3% for Old Mutual Limited, 0.6% versus 8.5% for MMH and 0.2% versus 8.6% for Discovery Holdings. In the case of Old Mutual, the reported group embedded value is diluted compared to the other groups. Old Mutual adjusts its net assets to exclude ‘committed’ or ‘tied up’ capital in various insurance entities within the group. This has the effect of boosting the illustrated enhancement and average return on GEV. We therefore show the relative boost to the average return on GEV (RoGEV) from the capital release.
The relative enhancement to the average RoGEV is substantial for Old Mutual at 19.3%. There would also be a modest boost to the average RoGEV for Liberty, MMH and Sanlam of 6.0%, 7.3% and 4.8% respectively, while Discovery Holdings would only be 2.3%.
It is unlikely the SA life assurance groups will release excess solvency capital in the near term given the current COVID-19 crisis. They are likely to remain conservative until the market volatility abates and there is more certainty on the impact of COVID-19 on insurance claims and policyholder lapses. This is despite the current solvency capital levels being strong and demonstrating robustness to recent shock events. However, we believe discussions around capital levels will start coming to the fore and pressure from shareholders will increase in due course.
Winners: Based on the hypothetical scenario discussed above, Old Mutual stands out in delivering a 19.3% relative boost to its average RoGEV from potentially releasing solvency capital in its SA life assurance business in excess of 1.6x SCR. Sanlam, Liberty and MMH would enhance their respective average RoGEV by around 5–7% by releasing capital above the 1.6x target.
Losers: Discovery Holdings would generate the lowest enhancement to its average RoGEV from targeting a capital release above the 1.6x SCR level at Discovery Life.
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