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Greater Ratings Stability Is Ahead For The French Insurance Market, Despite Lingering Downside Risks
Primary Credit Analysts: Gwenaelle Gibert, Paris (33) 1-4420-6693; gwenaelle.gibert@standardandpoors.com Merryleas J Rousseau, Paris +33144206729; merryleas.rousseau@standardandpoors.com Secondary Contact: Lotfi Elbarhdadi, Paris (33) 1-4420-6730; lotfi.elbarhdadi@standardandpoors.com Research Contributors: Rene Fuenfle, Paris (33) 144-207-323; rene.fuenfle@standardandpoors.com Alice Peruzzotti, Paris (33) 1-4420-7321; alice.peruzzotti@standardandpoors.com Media Contact: Michelle James, London +44 (0)20 7176 3274; michelle.james@standardandpoors.com
Table Of Contents
Life Insurers Are Set To Emphasize Margin Preservation Amid Low Interest Rates P/C Insurers' Earnings Are Back On Track, But Could Suffer From Competitiveness And Evolving Regulations Related Criteria And Research
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT
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Standard & Poor's Rating Services believes that its ratings on the French insurance sector show prospects for greater stability in the next two years than in 2011 and 2012. Low industry and country risk for both life and property/casualty (P/C) in the French markets, which compares favorably with those in most other European markets, supports our view about the sector's stability. It also shows good potential for stability in P/C underwriting earnings, underpinned by good reserving, as well as in life insurance, due to the absence of high guaranteed rates and good earnings potential from the non-savings business. In addition, the market boasts strong balance sheet liquidity, in our opinion. Furthermore, capital adequacy has been improving with the pickup in earnings and in the investment markets over the past year, which helped rebuild cushions relative to the ratings level. The ratings on French insurers remain exposed to some downside risks, such as the sensitivity of capital adequacy to investment market conditions, and a potential narrowing in earnings capacity due to stiff competition. Despite an improvement during 2012, capital adequacy generally remains a ratings weakness and is subject to growing asset risks. Furthermore, the market remains highly competitive, which is likely to constrain the potential for strong underwriting margins, since interest rates remain low. Finally, a number of regulatory initiatives are likely to gradually reshape investment practices, product offerings, and the competitive landscape for the life and P/C businesses, which could weigh on earnings potential. Overview The sector's ratings remain in the 'A' category (strong) on average, with the bulk of them carrying stable outlooks. French insurers operate amid low industry and country risk, in our view, which provides good conditions for the growth and stability of both the life and P/C markets. A flurry of regulatory changes is likely to alter the competitive landscape and change the way insurers invest and the kinds of product they offer. Low interest rates are continuing to weigh on earnings and are testing the ability of insurers' to adapt crediting policies and tailor new high-margin, low-risk products. In the mature P/C market, stable earnings amid low interest rates will depend on insurers' ability to strike a balance between raising prices and safeguarding market share. The sector's capital adequacy is good and improving, but remains highly sensitive to investment markets.
We rate 15 French insurance groups, and a total of 36 rated entities (as of Nov. 12, 2013). Our scope of analysis covers approximately 56% of the market's gross premiums written (GPW). Despite a general downward trend over the past year, our ratings on French insurers remain in the 'A' category on average, denoting what we deem as strong financial strength characteristics (see chart 1). Many ratings on the sector
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benefit from notches of uplift due to the support they receive from their large international parents.
Chart 1
As of the date of publication of this report, 73% of our ratings on French insurance entities carried stable outlooks (the remainder carries negative outlooks) (see chart 2). In contrast, at the end of June 2012, when we last published our report on the sector, stable outlooks represented only 32% of the total and 68% of the ratings had negative outlooks and CreditWatch placements. The current distribution reflects our expectation of greater ratings stability over the next two years.
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Chart 2
Since June 2012, we have raised the rating on one entity and lowered the rating on seven. In addition, we assigned five new ratings and withdrew the ratings on two groups at their request (see tables 1 and 2).
Table 1
French Market Rating Actions, July 2012-November 2013

Group Caisse Centrale de Reassurance CGPA Assurances Mutuelles de France MMA IARD S.A. Covea Risks Covea Fleet Generali France La Mondiale MMA Assurances Mutuelles La Societe Hospitaliere d'Assurances Mutuelles To AA/Stable A-/Stable A/Stable A/Stable A/Stable A/Stable A-/Negative BBB+/Stable A/Stable NR From AA+/Negative NR NR NR NR NR A/Negative BBB+/Negative A-/CreditWatch Developing BBB/Negative Date Nov. 12, 2013 Nov. 8, 2013 Nov. 7, 2013 Nov. 7, 2013 Nov. 7, 2013 Nov. 7, 2013 July 12, 2013 June 6, 2013 April 26, 2013 April 4, 2013 (Rated entities No.) 1 1 1 1 1 1 2 1 1 1
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Table 1
French Market Rating Actions, July 2012-November 2013 (cont.)

Allianz France Euler Hermes Generali France AXA France La Societe Hospitaliere d'Assurances Mutuelles Groupama Chartis Europe AG2R MMA Assurances Mutuelles BNP Paribas Cardif April Aviva France La Mondiale AA/Stable AA-/Stable A/Negative A+/Stable BBB/Negative NR NR BBB+/Stable A-/CreditWatch Developing A+/Negative A-/Negative A+/Stable BBB+/Negative AA/Negative AA-/Negative A/CreditWatch Negative AA-/Negative BBB/Stable BB-/Negative A/Stable A-/Negative A-/Stable AA-/Negative A-/Stable AA-/CreditWatch Negative A-/Negative March 20, 2013 March 20, 2013 Jan. 23, 2013 Dec. 18, 2012 Dec. 12, 2012 Dec. 7, 2012 Dec. 6, 2012 Dec. 4, 2012 Nov. 21, 2012 Oct. 25, 2012 Sep. 24, 2012 Aug. 15,2012 Aug. 2, 2012 4 1 2 4 1 4 1 2 1 3 1 2 1
This list excludes public information or 'pi' ratings. NR--Not rated. Source: Standard & Poor's.
Table 2
Standard & Poor's Ratings On French Insurance Companies And Subsidiaries

Group AG2R Allianz France Insurer financial strength rating BBB+ AA Outlook Stable Stable Entities rated (No.) France-based rated entities 2 4 AG2R Prvoyance, PRIMA* Allianz Vie, Allianz IARD, Allianz Global Corporate & Specialty* (France), Allianz France (holding company; counterparty credit rating A+/Stable/A-1) Aviva Vie S.A.*, Aviva Assurances S.A.* AXA France Vie*, AXA France IARD*, AXA Corporate Solutions Assurances*, AXA (holding company; counterparty credit rating A-/Stable/A-2) Axria Prvoyance Cardif Assurance Vie*, Cardif-Assurances Risques Divers*, BNP Paribas Cardif (holding company; counterparty credit rating: A/Negative/--) Caisse Centrale de Reassurance CGPA CNP Assurances , CNP Caution Euler Hermes SFAC Generali Vie*, Generali IARD* La Mondiale Assurances Mutuelles de France*, MMA Assurances Mutuelles*, MMA IARD S.A.*, Covea Fleet*, Covea Risks* Prvoir Vie, Prvoir Risques Divers, Socit Centrale Prvoir (holding company; counterparty credit rating BBB/Stable) SCOR Global Life SE, SCOR Global P&C SE, SCOR SE, Prvoyance Re
Aviva France AXA France
A+ A+
Stable Stable
2 4
April BNP Paribas Cardif
AA+
Negative Negative
1 3
Caisse Centrale de Reassurance CGPA CNP Assurances Euler Hermes Generali France La Mondiale Covea Prvoir SCOR
AA AA+ AAABBB+ A AA+
Stable Stable Negative Stable Negative Stable Stable Stable Stable
1 1 2 1 2 1 5 3 4
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Table 2
Standard & Poor's Ratings On French Insurance Companies And Subsidiaries (cont.)
Note: This list excludes public information or 'pi' ratings. *Core group operating entity. Guarantee provided by the parent. Source: Standard & Poor's.
Life Insurers Are Set To Emphasize Margin Preservation Amid Low Interest Rates
Industry and country risks are low for French life players, based on our insurance industry and country risk assessment (IICRA) methodology. Our assessment means that the sector's overall dynamics are unlikely to negatively affect the business profile of a well-established insurer, if it has diversified product lines. Factors weighing negatively on our views about the sector are mostly related to the insurers' financial risk profiles and in particular to capital and earnings. Among the factors putting a drag on earnings are low interest rates and intense competition that is squeezing investment margins on savings products. These factors will continue, in our opinion, to test management's ability to maintain good levels of earnings over the next few years.
Profit-sharing policies and product mix changes will likely drive our opinion about the business and financial profiles of life insurers
We believe that French insurers will continue to face a difficult trade-off between capturing volume and earnings preservation. Since financial markets conditions worsened in 2008, credited rates have been steadily declining. Rates credited to policyholders declined by 10-20 basis points (bps) in 2012 to about 3% on average, after a 20-30 bps decrease in 2011 and a 30 bps decrease in 2010 (see table 3). We expect this downward trend to continue through 2015, mirroring investment declines in yields. The recent pickup in equity markets might encourage some insurers to refrain from lowering their credited rates further. An aggressive crediting policy is likely to safeguard volumes in the short term, but hamper margins in the long run, in our opinion, which could further weaken earnings potential.
Table 3
French Life Insurers' Competitive Position, Selected Indicators

For the 20 largest French life insurers, excluding reinsurers (Bil. ) Gross premium written (GPW) Total life provisions Unit-linked reserves (% of life and savings reserves) Outflows on average reserves (%, including lapses, death, and contractual maturities) Credited amounts on average reserves (%, guaranteed contracts) Net inflows (% reserves) 2008 109,315 772,827 16.2 8.0 3.9 2.5 2009 128,762* 870,428* 16.9 8.5 3.7 4.3 2010 127,627 881,091 17.4 8.0 3.4 4.2 2011 112,557 944,022 14.7 9.0 3.1 2.2 2012 108,245 959,110 16.2 9.2 3.0 -0.2
*2009 data reflects the restatement of accounts of one large player. Source: Standard & Poor's.
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Chart 3
Life insurance has a leading role as a savings vehicle, and long-term growth prospects remain strong in light of growing pension needs
We view the long-term growth prospects of the market as strong, particularly because life insurance in France is largely a savings vehicle that has many roles, from medium-term savings product, to pension instrument, and to a wealth management tool. In addition, tax advantages, though gradually declining, continue to give insurance an edge over other forms of savings. As a result, saving contracts in France comprise 76% of life reserves compared with only 8% in the U.K. and 20% in Switzerland. The large savings feature of French products often exposes life insurance to competition from other forms of savings, such as bank savings accounts and "Livret A." Nevertheless, the low interest rate on short-term savings accounts (currently 1.25%) currently lessens their competitive power. Life players could face sizable lapse risk, particularly in a stress scenario of sharply rising interest rates, which could exacerbate competition with short-term savings vehicles. However, our base case assumptions call for only a marginal increase in lapse rates over the next two years. Lapses (including surrenders, maturities and death benefits) in 2012 remained in line with 2011 levels at 8.5% (versus 6.9% in 2010). They are most likely to increase as a result of greater numbers of policyholders retiring and cashing out their contracts, a possibility we see in the high share of old policies in insurers' portfolios. We expect an increase in lapse rates in 2013-2015 to remain limited to up to 1 percentage point per year from last year's levels.
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Protection and health products are likely to gain in importance

Insurers are taking on a growing role as a provider of health and protection covers, in light of the declining state share in such coverage (see chart 4). If adequately priced, the protection business generally can offer an alternative profit sources amid low interest rates. However, French group term life, creditor term, and disability are facing stiff competition by traditional players, bancassurers, protection institutions ("Institutions de Prvoyance"), and mutuals. Furthermore, a change in French profit-sharing regulation has reduced the prospects for high margins on such product lines, while the extension of the legal age of retirement further calls into question the profitability of group protection. New French regulation (the "Accord National Interprofessionnel"), is not only likely to create growth opportunities, but also increase competition and potentially lead to market consolidation.
Chart 4
The sector is facing many regulatory and tax changes

The taxation of life contracts has been steadily increasing over the past few years, but these products still have tax advantages over other savings products. We expect in our base case assumptions that further reductions in tax incentives relating to life policies will remain gradual over time. Other noticeable regulatory changes have resulted from the government's aim for insurers to orient life insurance inflows more toward investment in private-sector enterprises through equity stakes and lending, given that banks are
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reducing their lending, and the high cost of funding for small and midsize enterprises (SMEs). "Euro-Croissance" is an example of future products that life insurers are developing in response to these regulatory changes, in order to favor further investment in risky assets. In addition, since August 2013, insurers have been allowed by the regulator to invest up to 5% of their investments in loan funds, in another measure to encourage SME funding. We expect the impact of these measures to pose opportunities--and risks--to the sector. Investing in loans could help insurers turn around their investment yields but would, if the amount of loans becomes material, weigh on liquidity and potentially risk-based capital. On the other hand, Euro-Croissance would present higher risks for policyholders than traditional savings products. Nevertheless, it would still expose the insurers to credit and volatility risks after eight years of contract. All in all, we currently do not foresee any widespread ratings impact from these tax and regulatory measures. We nevertheless view them among the main areas we will be monitoring in the sector, as insurers adapt their investment and product offering to these changes.
P/C Insurers' Earnings Are Back On Track, But Could Suffer From Competitiveness And Evolving Regulations
We consider that French P/C players face low industry and country risks (as our IICRA indicates). This means that the dynamics of the French P/C sector are unlikely to negatively affect the business profile of a well-established and diversified P/C insurer. We observe that restored earnings followed more disciplined underwriting over the past three years, continuously adequate reserving practices, and cost control efforts (see table 4). However, we believe that P/C insurers will face a number of challenges over the next two years, including changes in regulation, continued low yields, and unrelenting competition in several business lines, stoked by the increasingly visible presence of bancassurers, and a defensive stance by mutuals and traditional players.
Table 4
French P/C Insurers' Competitive Position, Selected Indicators

For the 20 largest P/C French insurers, excluding reinsurers (Bil. ) Return on equity (%) GPW Change in GPW (%) Net combed ratio (%) Net loss ratio (%) Net expense ratio (%) Gross loss reserves/GPW (%) 2008 8.7 44.8 2.5 99.6 76.1 23.5 145 2009 7.6 45 0.4 104.5 80 24.5 149 2010 8.1 46 2.2 103.4 79.6 23.8 148 2011 5 47.9 4.1 99.3 75.8 23.5 148 2012 7.8 49.4 3.1 99.2 75.8 23.4 154
GPW--Gross premiums written. Source: Standard & Poor's.
We expect the sector's overall net combined ratio to remain lower than 100% in 2013 (see chart 5). We view a potential for increase, however, in 2014 and 2015, to up to the 100%-102% range. We believe that the sector has benefitted from price increases over the past three years. However, underwriting results in recent years also benefitted from what we believe are shorter-term factors, such as lower claims frequency in motor, and the absence of catastrophe claims. The market recorded two consecutive years of positive underwriting results in 2011 and 2012, with
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combined ratios averaging 99%, following two years of underwriting losses when the combined ratio was between 103% and 104%.
Chart 5
The sector's broad diversification by business line is a positive for underwriting earnings. In particular, lower claims frequencies in motor mitigated growing frequencies in personal property. Furthermore, the overall growth of commercial lines in 2012 overshadowed sharp declines in specific lines such as transport and construction, which suffered more from the economic downturn. Consequently, we believe that insurers will continue differentiating price increases by business line. Accordingly, lines such as personal property, where the combined ratio remains in excess of 100%, should continue seeing higher-than-average price increases. The sector features sound P/C reserving, which underpins our view regarding operating performance. The ratio of gross claims reserves to GPW stood at 154% in 2012. Nevertheless, reserving ratios vary widely among players. Traditional players and mutual companies show the highest reserving ratios, while bancassurers appear to have lower ratios. That's partly because bancassurers have less of a track record in writing long-tail lines, in our view. Finally, we expect low interest rates to continue encouraging price discipline in the next two years. We expect investment yields for P/C insurers to remain subdued over the same period following the declines witnessed over the
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past five years (2.2% in 2012 versus 4% in 2008).
P/C players are also facing important regulatory and tax changes
The French P/C sector is also bracing for a number of regulatory changes, which are likely to test its profitability and could result in even stiffer competition: For bodily injury annuity claims starting in January 2013, insurers will directly pay for the costs arising from annuity indexation, instead of a state fund. The possibility for policyholders to terminate, without any penalty or cost, their motor and property contracts at any time (previously only at anniversary) after the first renewal date ("loi Hamon"). An increase in the value-added tax to 10% from 7% on property renovation and construction, from Jan. 1, 2014. We do not foresee immediate implications for the ratings from these changes, but we believe their potential effect on profitability could vary in significance, depending on the degree of diversification of each player. Annuity indexation could have a relatively large impact on the small players where motor represents the bulk of the portfolio. For the sector as a whole, we estimate the overall hit to the combined ratio at 0.3 to 0.5 of a percentage point, which we believe most players can absorb through price increases. However, small motor insurance players could incur relatively higher costs. In such a highly competitive market, players applying higher-than-average price increases run the risk of weakening market shares, which could ultimately foster the consolidation of small players. The ability of policyholders to terminate contracts at any time instead of at anniversary could increase competitiveness among players. We expect bancassurers and direct players to take advantage of this change to attract new clients. As a result, players such as mutual and traditional players will likely develop defensive strategies to ward off a loss of contracts. Insurers are also likely to further emphasize expense management, and enhance specialization of distribution networks, to retain their competitiveness in personal lines.
Mutuals and tied agents remain the main distribution vehicles, but market dynamics are evolving
Although tied-agent networks and mutual insurers collect the bulk of P/C premiums, bancassurers continue to gain market share. To counter such growth, the traditional players have developed direct insurance subsidiaries--such as Avanssur (whose parent is AXA), Amaguiz (Groupama), and Eurofil (Aviva)--and are targeting different and new client segments through them. Nevertheless, bancassurers should continue to benefit from the strong distribution power of their parents. Consequently, the next two years are likely to witness continuing competition, which in turn could further test underwriting discipline.
Capital adequacy is good overall, but remains vulnerable to investment market movements
Capital adequacy for the players we rate improved in the past year and we view it overall as adequate (that is, on average, consistent with the 'BBB' assessment category, based on our risk-based capital adequacy criteria). For rated insurers over the past year, we saw approximately 20% growth in our measure of capital, total adjusted capital or TAC. However, at the same time, risk-based capital charges grew because of increased market and credit risks, which contained the gain in capital adequacy. Credit risk and market risk combined accounted for 64% of total risk-based capital charges at year-end 2012 (versus 63% in 2011). Furthermore, TAC sensitivity remains high in our view owing to its general reliance on unrealized gains and the present value of future profits (see chart 6).

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Chart 6
A higher, but still sensitive, capital base

We believe that exposure to credit risk, whose share in risk-based capital increased by 2.4 percentage points in 2012, is likely to increase further for French insurers. This is a reflection of rating downgrades in 2012, particularly on sovereigns. Insurers seeking yield amid low interest rates, at the expense of higher-rated instruments, has also likely played a role in rising credit risk. If the number of downgrades increases, which is not among our base case scenario assumptions, the resulting rise in the cost of credit risk in capital could lead us to revise our opinions about capital adequacy, and possibly lower the ratings for players showing low excess capital. More particularly, lower sovereign ratings on the periphery of the eurozone could hurt the sector's capital and earnings. We estimate the exposure to such assets at almost 6% of French insurers' technical provisions, although down from 2011. Our assessment is that asset-liability management (ALM) risks are manageable overall. We estimate an average duration gap across the sector of 1-2 years at the end of 2012. Furthermore, we do not expect ALM risks to weigh further on capital, because insurers are seeking to further narrow their duration gaps ahead of Solvency II. Exposure to equities represents 10% of investments on average (see chart 7). With the stock markets picking up, this exposure has recently led to an increase in unrealized gains and better capital adequacy positions. However, this exposure remains one of the most significant drains on capital owing to the capital consumption it incurs.

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Chart 7
Insurers are also exploring new asset classes, such as unsecured loans. We saw a number of insurers increasing or intending to increase their asset allocations to corporate and infrastructure debt in 2012 and the first half of 2013. We expect this asset class to become significant only for large players, but remain lower than 2%-3% of investments through 2014. Small insurers will likely continue to prefer liquid, easily tradable investments. At these levels of exposure, we do not expect this class to weigh materially on insurers' capital adequacy. Earnings retention is likely to help insurers maintain capital adequacy in the adequate category. According to our base case assumptions, however, we believe that it is unlikely that retained earnings alone would boost capital adequacy to levels we consider as strong (consistent with the 'A' assessment category). In our view, a long-term improvement would likely arise from the combination of improving investment markets, stronger underwriting profitability, and management actions favoring bigger capital cushions, such as higher earnings retention, and contained credit and market risks (see chart 8).

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Chart 8
Regulatory uncertainties are weighing on capital management

Uncertainty regarding future rules for capital adequacy is not helping French insurers develop effective capital management strategies, in our view. EIOPA's recent publication of recommendations for long-term guarantees brings implementation of Solvency II one step closer, but there are still many hurdles to overcome. Furthermore, insurers might not have much time to adjust before the rules take effect, which is now set for Jan. 1, 2016. The new designation of Global Systematically Important Insurer (G-SII)--as determined by the global Financial Stability Board--brings a further level of regulation to a number of players in the French market, including AXA, Allianz, Aviva, and Generali. On the bank side, BNP Paribas, Groupe Crdit Agricole, HSBC, and Socit Gnrale have received the designation of Global Systematically Important Bank (G-SIB). Such designations mean that this new level of regulation is likely to have an impact directly or indirectly on approximately 48% of the French life market and 35% of the P/C market. Finally, Basel III regulation is likely to result in changes to the capital structures of French bancassurers, as banks' capital management needs are likely to shape those of their bancassurance subsidiaries. This could lead to a lower equity component in bancassurers' capital, with a higher share of hybrids and other forms of capital. One of the

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possible consequences of such capital policies could lead to greater room for competition from bancassurers in the market.
Related Criteria And Research

Insurance Industry And Country Risk Assessment: Property/Casualty Insurers Face Low Risk In France, Nov. 7, 2013 Insurance Industry And Country Risk Assessment: Low Risk For France's Life Insurance Sector, Nov. 7, 2013 Insurers: Rating Methodology, May 7, 2013 Group Rating Methodology, May 7, 2013 Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers, May 7, 2013 Principles Of Credit Ratings, Feb. 16, 2011
Additional Contact: Insurance Ratings Europe; InsuranceInteractive_Europe@standardandpoors.com

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Greater Ratings Stability Is Ahead For The French Insurance Market, Despite Lingering Downside Risks

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French Market Rating Actions, July 2012-November 2013

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French Market Rating Actions, July 2012-November 2013 (cont.)

Standard & Poor's Ratings On French Insurance Companies And Subsidiaries

Aviva France AXA France

April BNP Paribas Cardif

AA AA+ AAABBB+ A AA+

Stable Stable Negative Stable Negative Stable Stable Stable Stable

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French Life Insurers' Competitive Position, Selected Indicators

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Protection and health products are likely to gain in importance

The sector is facing many regulatory and tax changes

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French P/C Insurers' Competitive Position, Selected Indicators

GPW--Gross premiums written. Source: Standard & Poor's.

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past five years (2.2% in 2012 versus 4% in 2008).

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A higher, but still sensitive, capital base

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Regulatory uncertainties are weighing on capital management

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Related Criteria And Research

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