When Standard Life and Legal & General, two UK life and savings groups, reported first half results this month, both were closely watched for hints that they could soon return a large amount of cash to shareholders.

Some analysts believe they got those hints. Andy Hughes, at BNP Paribas, believes Standard Life would have a very large cushion of surplus capital above its requirements under Solvency II, the new European capital rules for insurers that are being finalised and due to be implemented in 2013.

“We welcomed the comments from management that they would look again at the right equity base for the business after Solvency II,” he says.

As markets go through another crisis, it may seem odd that anyone should talk about insurers handing back capital. European insurers’ own share prices have suffered wild swings as investors have worried about their exposure to weaker sovereign debt. In 2008 investors had real concerns about insurance company solvency alongside the banks.

The insurers have made plenty of noise about the excessive prudence of the new European capital rules. At one point they raised fears that the industry could be forced to raise up to €300bn ($432bn) of extra capital.

But in response to the 2008 crisis and the progress of the new rules, the biggest companies have been steadily building up their capital and are reporting billions of pounds and euros in surpluses over their current statutory requirements. For most companies these surpluses are significantly larger than they were in 2007.

In the UK, L&G, Standard Life and Prudential have all increased the amount of surplus capital they hold, according to data from Deutsche Bank. Although solvency calculations in different European countries are not directly comparable, a similar trend is evident at Allianz of Germany and Axa of France.

A number of companies have also published figures for their so-called economic capital. How these numbers are worked out is not made public and so they cannot be strictly comparable. But they are being seen as a guide to where those companies see their capital requirements coming out under Solvency II and they are showing similar levels of surplus.

So does this mean investors can expect to see a wave of special dividends or share buybacks once the new rules are finally settled? The official answer from insurers is that it is too early to say, while the answer in most analysts’ eyes is almost certainly no. That’s because once the new rules are in place, insurers’ capital needs are going to become significantly more volatile as both assets and liabilities will have to be marked to market.

Duncan Russell, analyst at JPMorgan, thinks that companies will voluntarily insert an extra buffer in their capital over and above their requirements – the debate is about how much.

“What’s driving this debate behind the scenes is that solvency capital is volatile because it uses a markets-based approach,” he says.

The new rules have two levels of requirement. The minimum capital requirement (MCR) is the level that was used as a base in the recent European stress tests and the one that, if breached, will lead regulators to in effect take over a company. The higher solvency capital requirement (SCR) is what insurers are meant to target and is roughly equivalent to a triple-B financial strength rating. If that is breached, regulators will start paying more visits to an insurer to talk about ways to improve its strength.

The SCR can be seen in some ways as a bit like a central bank’s inflation target. There should be no real shame in occasionally breaching this softer capital requirement, but Matt Gosden of Oliver Wyman says that the fact that regulators require action at that level means insurers are seeing it as an effective minimum.

“Regulatory action can have a dramatic negative impact on new business prospects,” he says. “Breaching the SCR would be seen as a failure by the vast majority of insurance management and boards.”

Farooq Hanif, analyst at Morgan Stanley, says insurers will make a judgement about how much their capital base could move within a year and whether they could breach the SCR.

“Those companies who already have economic capital models, the caution they are showing is with an eye to the back testing they have done and what can happen in markets – it is not about waiting on the regulators to settle the rules.”

Holding more capital than today will have an effect on the kind of returns insurers generate for shareholders, the price of insurance and the kinds of products they are willing to offer.

But how much more capital will they hold? Mr Gosden says the rule of thumb being discussed around life insurers is for a surplus of between 25 and 50 per cent above the SCR. Mr Russell reckons that among continental insurers that surplus could end up being 70 per cent or more.

“Behind the scenes, regulators are putting on the pressure,” he says. “Logically, you’re going through a major market crisis and that is making regulators more nervous.”

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