New capital rules set to benefit big EU insurers

By Simon Challis, European Insurance and Funds Correspondent

LONDON, July 6 (Reuters) - Europe's insurance giants are set to benefit from the most radical accounting shake-up to hit the industry in decades, with rule changes due to be unveiled next week by the European Commission.

The new rules -- known as Solvency II -- will calculate the amount of capital insurers should hold based on the risks in their businesses rather than on their volume of premium, as is still the case in many European countries today.

The changes, aimed at creating a more competitive and efficient market while boosting policyholder protection, have been embraced by Europe's largest insurers, such as AXA (AXAF.PA), Allianz (ALVG.DE) and Generali (GASI.MI), which dominate the continent's 7 trillion euro ($9.5 trillion) sector.

The new rulebook will bring regulation up to date with the methods insurers use to manage their own risks.

For instance, for the first time firms will get credit from watchdogs for their practice of mixing different risks to hedge themselves against a single major event -- whether a disaster or epidemic -- putting them out of business.

Solvency II will offer insurers so-called "diversification benefit", meaning that better managed and better spread firms should have to hold less capital than rivals.

This could have knock-on benefits for customers, who may enjoy cheaper cover for low-risk motor, property or life policies, because insurers have to commit less capital to back this business under the new rules.

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The changes won't necessarily be the death knell for smaller companies. Those that are well managed or have carved out an established and lucrative niche in a particular market should continue to prosper under the new rules, analysts say.

"It isn't in any way a downer for small companies," said Peter Vipond, director of financial regulation and taxation at the Association of British Insurers (ABI).

But companies without the diversity of larger rivals or the expertise of niche players are likely to be vulnerable.

"Mid-sized generalist companies are the ones that will suffer," said Vipond.

The new rules may spark a wave of M&A, as companies merge to diversify their businesses or ease the burden of compliance costs or where firms sell off units in sectors in which they can no longer compete, analysts say.

Investors should also benefit from the changes. Some insurers may need less regulatory capital to run their businesses and may exploit asset liberalisation measures to replace equity capital with relatively cheaper debt, which could push up the industry's mediocre returns to shareholders. SHAREHOLDER WINDFALL UNLIKELY