The handling of the current crisis situation has many facets, and as time goes by there is an increasing awareness, and hence also risk of hindsight bias in the assessment of the situation. The following lines focus more on looking forward than back, and aim to underline the fact that temporary crisis measures must not result in permanent regulatory tightening.
Until then, pandemics had been an extremely rare event with a 1 per cent probability of occurrence in an insurance companies’ risks management statistics. A year ago, however, the statistic suddenly became reality, and probability theory was confronted with the coronavirus pandemic.
The handling of this crisis situation has many facets, and as time goes by there is an increasing awareness, and hence also risk of hindsight bias in the assessment of the situation. The following lines focus more on looking forward than back, and aim to underline the fact that temporary crisis measures must not result in permanent regulatory tightening.
The following considerations are made from a shareholder perspective. Not as a first priority, but downstream, which is why chronology plays an important part: the shareholder perspective is adopted once insured persons have received their benefits, suppliers and partners have been remunerated, taxes and social security contributions have been paid and regulatory costs have been borne, employees have received their wages and natural resources have been handled responsibly. Shareholders ultimately bear the entrepreneurial risk – they have provided risk capital, and expect to receive appropriate compensation. And this brings us to our starting point: the character of the Baloise share.
As a listed company with all of its shares publicly held, the Baloise Group belongs to its shareholders. The nature of the business model means that insurance stocks are strong dividend and distribution securities that are held by private and institutional investors based on their strength and reliability in terms of distribution.
At the beginning of April 2020, the European Insurance and Occupational Pensions Authority (EIOPA), an independent European advisory body urgently recommended – as a result of the coronavirus pandemic – the temporary suspension of all discretionary dividend distributions and share buybacks, pointing towards the importance of maintaining insurance companies’ risk transfer function. From that point on, the discussion that emerged as the result of an exceptional circumstance became superimposed on existing regulatory and equity-related requirements. Added to this was the fact that insurance companies, as financial service providers, were tarred with the same brush as the banks. The argument was based more or less directly on the concept of victim symmetry: it cannot be that everyone is suffering while shareholders keep on receiving their dividends. This includes not least pension funds that accumulate assets via funded schemes and pay pensions.
«This demand failed to take into account the existence of shareholders whose business model depends on a regular return, i.e. dividends, on their shares.»
While the discussion above receded into the background following the dividend season in the first half of 2020, the silence was deceptive. In December 2020, EIOPA again advised insurers to exercise “extreme caution” in the distribution of dividends. Next year’s dividends should again be contained “within reasonable bounds” and not threaten insurers’ capitalisation. The supervisory authorities of the individual countries should make sure that companies took measures in their solvency planning to factor in the uncertainty as to how significantly and for how long the coronavirus pandemic could impact the financial markets, and what this meant for their business models and financial planning.
In contrast to national interventions, those undertaken by the EIOPA are difficult to counter, with the recommendations being issued autonomously and with no prior political discussion. They have the result, however, of further legitimising any subsequent national interventions.
The NBB guidelines published at the end of January 2021 suggest that the issue of distribution will gain momentum as we approach the 2021 dividend season, accelerated further by the generally lower solvency levels.
The Belgian net is tightly woven: (1) if the planned dividend is not higher than the maximum level of dividends in 2018 and 2019 and (2) solvency is at least 150 per cent and (3) the planned dividend is less than 10 per cent of the solvency capital, then, and only then, can it be paid.
The regulatory basis for normal circumstances has been increased (hopefully really only temporarily). A solvency ratio of 100 per cent means that a company would be in a position to meet all of its obligations in a single stroke. The solvency calculation and its mechanism are called into question when the calculation or the meaning of solvency (suddenly 150 per cent is being demanded instead of 100 per cent) are changed.
It also makes it more difficult to ensure meaningful operational and financial consolidation when national regulation prevents economies of scope and improvements in capital efficiency.
Such regulations, which increase the distribution threshold of the solvency mechanism, can result in dividends suddenly becoming uncertain in a way that cannot be directly influenced by the company. The result is a loss of investor confidence, which can have a devastating effect on capital costs and the raising of capital, as well as the assessment of a company’s strength.
All of these developments have now become reality, despite having been only a highly unlikely scenario before the pandemic. And – for the Belgian example at least – with a time limit (in the case of Belgium until the end of September 2021 at the moment).
With all their good intentions, the regulators would do well to consider the principle of proportionality and the law of action and reaction. It would not be conducive to value creation to shift the locus of the game: in future, instead of paying dividends, companies could be tempted to use cash for interest payments or transfer prices from subsidiaries to parent companies. The same would apply to the increased use of internal risk transfer in its function as capital replacement. All of this would offer further legitimation for regulation and control, as the new arena would, by its very nature, be shaped by increased information asymmetries. This would result in increased complexity and additional regulatory costs.
It remains to be seen whether, after the coronavirus pandemic (if there is such a clear “after”), the special regulatory measures will be withdrawn completely. The less clearly defined the transition to “after”, the more likely it will become that the special measures will rapidly become established and will be revised only slowly and partly.
All’s well that ends well? This will only become apparent in hindsight. The withdrawal of the restrictive coronavirus regulations in the coming months will be necessary to enable responsible private sector management to hold on to its space for the future.