title: The effect of Solvency II adoption by EU/EEA insurance firms on sell-side analysts’ research practices and information environment
Creators: name: Seretis, Evangelos
Publisher: name: University of Glasgow
Year: 2022

description: This thesis focuses on the effect of Solvency II adoption by EU/EEA insurance firms on sell-side analysts’ research practices and information environment. Solvency II framework was initiated, designed and finally implemented in 2016 to safeguard insurers’ financial soundness (Erdelyi, 2016), as a response to the deficiencies of the previous regulatory regimes (the latest being Solvency I). Prescribing mandatory public disclosures as part of its 3-Pillar structure, called Solvency and Financial Condition Report (SFCR), regulators aimed to enhance transparency and market discipline. Prior to Solvency II implementation, insurance undertakings disclosed risk-relevant and solvency related information to regulators. Thus, Pillar 3 disclosures aim to provide risk-relevant information to other stakeholders, addressing analysts and investors as the main recipients of this information (EIOPA, 2017). From a regulatory perspective, analysts are considered as the cornerstone of the market discipline since they can serve both as “direct” and “indirect” market discipline actors by influencing stakeholders’ investment decision (“indirect” monitoring) while, also, scrutinize management decision (“direct” monitoring) (Eling, 2012; EIOPA, 2017). Their interest on risk-related disclosures is established as insurers’ ability to conduct business and generate premiums is linked with the level of regulatory capital and solvency metrics (Nissim, 2013a). However, it is largely unexplored whether analysts incorporate such information (and of what type) in their equity research report in terms of Solvency II. From a broad perspective, the uniform adoption of a regulation might reduce information acquisition and processing costs (e.g. in the case of the mandatory implementation of International Financial Reporting Standards (IFRS) in the EU; Tan, Wang, and Welker 2011; Houqe, Easton, and van Zijl 2014). This could result in beneficial effects of Solvency II adoption. Evidence in relation to the period before the framework implementation indicates divergence in practices of insurance firms regarding the quantity, quality and perceived usefulness of risk disclosures (Malafronte, Porzio and Starita 2016, 2018). Contrary, the use of boilerplate language in the SFCR (Gatzert and Heidinger 2020; Insurance Europe 2021a, 2021b) and divergent audit practices on the report content (Accountancy Europe 2020) might impair the reliability and quality of disclosures. Deriving also from evidence in the banking sector, there is ambiguity whether additional disclosures can be properly used by analysts (Baumann and Nier 2004) and the potential of firms “compliance in form” rather than substance (Bischof et al. 2022). Against this backdrop, the three empirical chapters in this thesis are mostly focused on sell-side analysts. Sell-side analysts rely primarily on publicly available information, their valuation process is addressed to investors and has a pivotal role in financial markets’ operation (Ljungqvist et al., 2007; Chen, Cheng and Lo, 2010; Bowers et al., 2014). Evidence on the perceived usefulness of Solvency II information in the analyst context is rather limited. This mainly focuses on a short review of insurers’ disclosure practices and some very scarce evidence on analysts’ questions in earnings calls on Solvency II disclosures (Honour, 2016) as well as some preliminary evidence on analysts’ interest on organic capital generation (Mercer/Guy Carpenter, 2017), though before the publication of the first SFCR. UK regulators published some feedback from analysts’ and investors’ during roundtable discussions organised by them, in terms of FY2016 disclosures (see PRA, 2017), though it was mainly feedback to regulators on how to improve reporting rather than analysts’ use of information. Academic evidence on Solvency II disclosures is limited on equity markets as a whole (see Gatzert and Heidinger 2020; Mukhtarov, Schoute and Wielhouwer, 2021). However, it is not known whether, or to what extent, analysts regard SFCR and Solvency II information as important, how they mobilise this information in their decision-making and production of research, and what determines their usage of this information. The first empirical chapter is an exploratory study of analysts’ use of SFCR and Solvency II information. Using semi-structured interviews with five sell-side and four credit analysts, this chapter unveils how analysts acquire and process the relevant information and how they incorporate it into their research reports. This study contributes to knowledge on analysts’ information processing while it also provides some policy relevant insights on the perceived usefulness of Pillar 3 disclosures. Further, this chapter paves the way for the next two empirical chapters. The second empirical chapter focuses on sell-side analysts’ equity research reports. Specifically, it investigates the extent of presence and thus analysts’ use of Solvency II information in analysts’ published research reports, using computerised textual analysis on a sample of 11,743 analyst reports. The period covered is 2013 to 2018. Further, it explores firm and country-specific determinants of analysts’ levels of discussion of Solvency II information. This study provides insights over the types of Solvency II information that analysts tend to focus on. The third empirical chapter examines the effect of Solvency II implementation on the EU/EEA analysts’ information environment and analysts’ informational properties. Using a sample of 1-year ahead EPS forecasts and consensus metrics for the period from 2013 to 2018, this study explores the effect of Solvency II adoption on in earnings forecast errors, forecast dispersion and analyst following. Overall, this research, first, contributes specifically to the recent literature on the impact of Solvency II disclosures, as this strand of the existing literature has mainly focused on market wide effects. Second, this research extends the financial and risk-based reporting literature more broadly (e.g. Jorion 2002; Linsley and Shrives 2006; Kravet and Muslu 2013; Abraham and Shrives 2014; Elshandidy, Fraser, and Hussainey 2015) and with reference to the insurance industry in particular (e.g. Höring and Gründl 2011; Malafronte et al 2016; Malafronte et al 2018), by providing evidence on the perceived usefulness and beneficial effects of risk disclosures. Third, this study extends the analyst literature specifically with a focus on insurance (Nissim 2013a, 2013b) and banking (Fosu et al., 2017) by providing evidence on analysts’ use and perceptions of risk-based information. Fourth, since analysts are one of the cornerstone groups for market discipline, the study informs the relevant literature in terms of analysts’ influence on corporate disclosure practice as well as how the relevant information is used by them as part of insurers’ financial condition assessment (Flannery, 2001; Eling, 2012; Bryce et al., 2016; Flannery et al., 2004, 2019). Also, it adds to the wider literature on the usefulness of accounting information by analysts (e.g. Georgiou 2018, Georgiou et al 2021, Mazzi et al 2022). Finally, this study has policy implications in that it complements the findings from the recent 2020 Solvency II review conducted by European Insurance and Occupational Pensions Authority (EIOPA) (EIOPA 2020a, 2020b, 2020c) as well as the relevant amendments made in Solvency II regulation (EU 2021) and provides additional insights that can help improve regulators’ understanding of stakeholders’ needs.