Hybrid capital is an important element in many European insurers' financial strength, both under Solvency II and in S&P Global Ratings' credit rating analysis. It can provide insurers with additional loss-absorbing capacity, enhance their solvency or liquidity positions, reduce their cost of capital, and diversify their funding structures.

We believe that most of the 40 largest European insurers rated by S&P Global Ratings and operating under Solvency II have the flexibility to issue further hybrid capital if they need to. However, the degree of flexibility differs across insurers, particularly in stressed situations, when their capacity to issue capital might be limited or tested.

Indeed, there are restrictions on the extent to which insurers may use hybrid capital as part of available capital, both within the Solvency II framework and our credit ratings analysis.

Quality of capital remains high in aggregate for European insurers in our sample. Roughly 18% of the Solvency II-eligible capital at year-end 2023 comprised hybrid capital in the form of restricted Tier 1 (RT1), Tier 2, and Tier 3 capital. In comparison, in S&P Global Ratings' framework, capital is slightly less reliant on hybrids, and on average, hybrid capital represents 13% of our calculation of total adjusted capital.

In our rating analysis, among other factors, we consider how the various elements of capitalization, including hybrids, the quality of capital, and financial leverage, interact and influence an insurer's financial strength.

Chart 1

Despite Growth In RT1, Tier 2 Remains Insurers' Hybrid Of Choice

We don't expect the Solvency II regulatory capital limits to overly constrain the medium-term funding options of most insurers in our sample.  On average, 60% of Solvency II hybrid capacity is unused, with more capacity for RT1 (40%) than for both Tier 2 and Tier 3 (20%). However, the average unused capacity masks wide differences between the 40 insurers in our sample (see chart 2). In general, non-mutual insurers more focused on optimizing their cost of capital and returns on equity have used a greater proportion of their Solvency II hybrid capacity (50%) than mutual insurers (20%).

Chart 2

In our view, most insurers using hybrids are likely to continue using more of their Tier 2 than their RT1 capacity.  This is because Tier 2 is cheaper for issuers and a more traditional choice for investors. Nevertheless, from a capital management perspective, we trust that insurers will look to maintain substantial Tier 2 headroom in times of stress. Consequently, we believe that some insurers may want to refinance maturing subordinated debt (Tier 2 and grandfathered Tier 1) not only with Tier 2, but also with RT1 hybrid debt.

In our opinion, the need to replace older instruments is likely to drive further RT1 issuance in the near future.  Since the introduction of Solvency II in January 2016, issuance of RT1 has been growing steadily. RT1 issuances accelerated in 2020 and 2021, when European insurers issued about €4 billion and €5 billion, respectively.

Currently, we estimate that the total outstanding amount of RT1 instruments far exceeds €20 billion. We believe that this figure may increase as insurers have legacy Tier 1 instruments that they will likely refinance into RT1 or Tier 2 instruments by January 2026.

RT1 issuances from La Mondiale, AXA S.A., ASR Nederland N.V., NN Group N.V., Gjensidige, and SCOR SE in 2024 and Achmea B.V. and Storebrand ASA in early 2025 underline the trend of refinancing grandfathered debt with RT1s or refinancing RT1s on a like-for-like basis.

Insurers with less Tier 2 capacity would likely have to take specific management actions or issue RT1 hybrid debt if they needed to strengthen their equity bases.  Beyond mutual insurers--which do not pay dividends and often focus less on achieving high return-on-equity ratios--Tier 2 capital is widely used, representing 72% of non-Tier 1 capital (see chart 3). In our sample, nine insurers have used most of their Tier 2 issuance capacity and have less than 10% capacity remaining. Those insurers may have already explored the RT1 market to maintain capital market access.

Chart 3

We expect insurers to continue to shy away from the Tier 3 market.  Due to the relatively short maturity of Tier 3 instruments--typically about five years--and the low deferral risk, the coupon is more attractive to insurers than on Tier 2 instruments. On the other hand, because of their features, Tier 3 instruments are highly unlikely to receive S&P Global Ratings intermediate equity content. Example of Tier 3 issuers include CNP Assurances and Mapfre S.A.

In addition, the Tier 3 capital bucket--which can only account for up to 15% of the Solvency capital requirement--includes an allowance for net deferred tax assets (DTAs). At year-end 2023, this allowance represented more than 80% of Tier 3 usage. Consequently, in the event of a loss, some insurers might preserve their ability to build up further DTA capital credit by not using all of their Tier 3 capacity. As European Insurance and Occupational Pensions Authority stress tests show, leaving room for more DTAs makes the Solvency II ratio more resilient to stress.

S&P Global Ratings' Allowance For Hybrids Is Another Factor In Insurers' Financial Flexibility

For most insurers we rate, the eligibility limit for further hybrid issuance within our capital model is more of a constraint than the Solvency II limit.  For insurers in the European Economic Area or the U.K., we consider treating a hybrid instrument as part of total adjusted capital only when it is eligible for Solvency II own funds. For this reason, the remaining capacity for additional hybrid issuance in our credit rating analysis is limited to the remaining eligible capacity under Solvency II. In addition, inclusion in S&P Global Ratings total adjusted capital is subject to the tolerance limits set out in our criteria, "Insurer Risk-Based Capital Adequacy--Methodology And Assumptions," published Nov. 15, 2023 (see chart 4).

Chart 4

Most rated European insurers maintain capital flexibility even under S&P Global Ratings' constraints.  The average remaining hybrid issuance capacity is 40% of potential eligible Solvency II issuances under S&P Global Ratings' capital model versus 60% under Solvency II. The Solvency II limits cap the S&P Global Ratings limits for only 25% of the insurers in our sample (see chart 2).

In Europe, we have rarely assigned high equity content to hybrids issued by insurers.  As per our hybrid capital criteria, we assess hybrid securities as having high, intermediate, or no equity content. To assign equity content, we consider the notes' subordination, deferral, principal loss absorption, and duration features. Eligible Solvency II Tier 2 and RT1 notes issued by insurers in Europe tend to fall into the intermediate equity content category. We typically assign high equity content to mandatory convertible securities that have the distinct features outlined in our methodology.

We may observe greater flexibility at some European insurers to support the loss-absorption capacity of their S&P Global Ratings-calculated capital base.  Under our capital model criteria, "Insurer Risk-Based Capital Adequacy--Methodology And Assumptions, published Nov. 15, 2023, we expanded the scope of eligible debt-funded capital to include certain types of nonoperating holding company debt that has loss-absorbing features. Under Solvency II, this increases the range of regulatory instruments that we may include as eligible capital subject to our 20% tolerance limit.

In our sample, there are two insurance groups where we have recognized debt-funded capital as a form of capital--Credit Agricole Assurances' 10-year bullet Tier 2 instruments and Mapfre's Tier 3 instrument.

Available Hybrid Capacity Could Provide Capital Resilience In Times Of Stress

The flexibility to issue additional hybrid instruments could give an insurer about 60 percentage points of additional Solvency II coverage on average.  Solvency II coverage is healthy, averaging 221% in our sample of 40 European insurers at year-end 2023 (see chart 5). In general, this is well within management targets. Therefore, we do not envisage many insurers in this sample further leveraging their balance sheets through incremental hybrid issuances without having a specific reason, like the need to finance a merger or acquisition.

In times of stress, the drop in the value of eligible own funds will reduce the eligibility of additional RT1 issuance, which is based on 25% of unrestricted Tier 1 (UT1) capital.

Chart 5

Some insurers may rethink their capital structures and reduce their reliance on hybrids thanks to their healthy solvency positions.  Some insurers with capital buffers under Solvency II and our capital model framework may seek to improve their funding flexibility by reducing their reliance on debt. Other parameters, such as the cost of capital, may also influence these decisions. We also think that the Solvency II reforms--which we expect to provide insurers with capital relief--could prompt insurers to adjust their debt structures.

We estimate capital relief of up to €80 billion in Europe as a whole. A little over half of this will be an increase in UT1 capital deriving from a reduction in the risk margin. The UT1 benefit may, in some cases, reduce insurers' incentive to issue RT1 hybrids (see "Solvency II Update Offers EU Insurers €80 Billion In Capital Relief," published June 10, 2024).

Weaker Funding Structures May Offset The Benefits Of Increased Hybrid Issuance

While having hybrid capacity could provide financial flexibility, accessing the debt market increases financial leverage and weakens fixed-charge coverage.  This would worsen our view of an insurer's creditworthiness if the size and cost of debt became difficult to absorb using profits alone. In our credit rating analysis of an insurer, we typically take a negative view if the financial leverage ratio exceeds our 40% threshold, or if EBITDA covers interest costs by less than 4x (see "Insurers Rating Methodology," published July 1, 2019).

Alongside the quality of capital, we think that funding structure is likely to be more of a constraint on hybrid debt utilization than the actual tolerance limits.  This is the case under both the Solvency II and S&P Global Ratings' framework. Financial leverage would increase materially if insurers used their full Solvency II hybrid capacity. At full capacity, we calculate a 20 percentage-point increase in the average financial leverage ratio of our sample to 45% from 25% (see chart 6).

In addition, the resulting increase in interest costs could push many insurers' fixed-charge coverage ratios below 4x. We think that for many insurers, such a weakening in funding structure may not align with their internal targets. For context, regulatory headroom is about €150 billion above the roughly €100 billion of outstanding hybrid debt in the sample.

Chart 6

Our view of rated insurers' funding structures takes into account their underlying equity capital.  We don't have a negative view of the funding structures of any insurers reporting under International Financial Standard (IFRS) 17 in our sample. Our financial leverage calculation has increased under IFRS 17 in Europe due to the drop in reported shareholders' equity. For those insurers where the ratio already exceeds our 40% threshold, we consider reported capital to be materially understated, and we believe that this mitigates the risk arising from leverage. For the other insurers, we may consider their IFRS 17 contractual service margin in our assessment of funding structure if they were to exceed the 40% threshold in future (see "How We Treat Insurers' Leverage Amid Accounting Changes And Bond Market Fluctuations," published July 14, 2023).

Hybrid Capacity Is Only One Part Of The Rating Equation

Hybrid capacity by itself does not provide a large amount of information for our rating analysis. We consider several factors to understand how an insurer can employ any unused capacity effectively in different scenarios without increasing its indebtedness or putting undue strain on its quality of capital.

When assessing an insurer's capital flexibility, we also consider alternative capital management options that might be available, such as investment hedging, reinsurance, balance sheet de-risking, and equity raising. Accessing capital markets by issuing hybrid debt is only one of insurers' many options.

Appendix

Table 1

Related Criteria

• General Criteria: Hybrid Capital: Methodology And Assumptions, Feb. 10, 2025
• Criteria | Insurance | General: Insurer Risk-Based Capital Adequacy--Methodology And Assumptions, Nov. 15, 2023
• Criteria | Insurance | General: Insurers Rating Methodology, July 1, 2019

Related Research

• European Insurance Outlook 2025: Holding Up Well, Nov. 11, 2024
• Solvency II Update Offers EU Insurers €80 Billion In Capital Relief, June 10, 2024
• How We Treat Insurers' Leverage Amid Accounting Changes And Bond Market Fluctuations, July 14, 2023