Solvency II is a Catalyst for Change for Insurers, Finds Oliver Wyman/Morgan Stanley Report

London —

- Solvency II will expose the industry’s economic risk

- Increase in M&A, focus on asset liability management and restructuring of traditional products are features of change

LONDON 23 September 2010 – Today Oliver Wyman and Morgan Stanley published a report, Insurance: Solvency II, Quantitative & Strategic Impact: The Tide is Going Out, which concludes that the impact of Solvency II will be greater than reduction in Solvency ratios and will act as a catalyst for change for insurers. The report finds that Solvency II, the EU insurers’ regulation which aims to improve the link between capital and economic risk, will have a profound strategic impact on the insurance industry and will cause a reappraisal of traditional business models. It states that M&A opportunities will arise from the transparency of insurers’ balance sheets and the resulting identification of risky businesses from those with sustainable profit streams. Therefore, insurers’ need to shift their product mix and achieve business diversification and balance sheet scale will drive M&A deals.

Oliver Wyman and Morgan Stanley state that insurers’ management teams will focus on restructuring the life insurance portfolio from traditional towards unit-linked and variable annuity-type products. Additionally, there will be a stronger focus on asset liability management, e.g. hedging, risk management and reinsurance.

The report applies its own Solvency II model to assess the impact of the regulation on four fictitious Europe-based insurers: a global composite, a global life company, a reinsurer and a pure primary non-life business. Overall, the results show that strongly capitalised reinsurers will benefit the most from Solvency II owing to demand from mutuals that lack alternative sources of capital and an increase in the use of reinsurance as a risk mitigation tool. The model suggests that small, geographically narrow insurers – including many mutuals – will be most challenged by Solvency II since most of the buffer capital comes from the benefit of business and product diversification.

"Solvency 2 will reveal the true economic volatility of many European insurers' balance sheets - and while we are supportive of the framework - in the short-run we believe this could lead to a higher observed cost of capital,” said Jon Hocking, Head of the Insurance Research Team at Morgan Stanley in London. “We expect insurers to adopt far more sophisticated asset-liability management techniques in order to optimise returns on economic capital”.

“It’s clear from our analysis that certain business structures are inefficient from a capital perspective,” said Lukas Ziewer, Partner, Insurance Practice, Oliver Wyman. “Some groups still have several insurance carriers in single markets which support different brands, for example. Whilst consolidation of insurers across European markets is complicated, Solvency II means that it is very likely to happen. Overall, we expect a limited impact on group structures of mainstream companies in the short term, but a significant increase in intra-group capital optimization through reinsurance and leveraged capital structures.”

The report includes a summary on how insurers can adapt their corporate structures to benefit from Solvency Capital Requirements (SCR). There are three major levers to achieve this: the consolidation of subsidiaries into one legal entity; internal reinsurance; and, introduction of leverage into the Group’s capital structure.

NOTES TO EDITORS

About Morgan Stanley

Morgan Stanley (NYSE: MS) is a leading global financial services firm providing a wide range of investment banking, securities, investment management and wealth management services. The Firm's employees serve clients worldwide including corporations, governments, institutions and individuals from more than 1,200 offices in 42 countries. For further information about Morgan Stanley, please visit www.morganstanley.com.

About Oliver Wyman

With more than 2,900 professionals in over 40 cities around the globe, Oliver Wyman is an international management consulting firm that combines deep industry knowledge with specialised expertise in strategy, operations, risk management, organisational transformation, and leadership development. The firm helps clients optimise their businesses, improve their operations and risk profile, and accelerate their organisational performance to seize the most attractive opportunities. Oliver Wyman is part of Marsh & McLennan Companies [NYSE: MMC]. For more information, visit www.oliverwyman.com.