Western Europe’s insurers are tinkering with their asset allocations, but remain largely stable from a capital and credit ratings perspective, a report from Standard & Poor’s Global Ratings (S&P) has said.
The decline in interest rates, reaching ultra-low to negative levels in 2016, means insurers’ use of the asset side to “pump up profitability” is under extreme pressure, said the rating agency’s paper.
“S&P Global Ratings has identified low interest rates as the main risk facing Europe's insurance companies, and for that reason we've been closely following how insurers have been adjusting their strategic asset allocations and liability profiles,” said S&P.
“The answer is not as easy as chasing after higher-yielding investments. While insurers do look at returns, they also weigh the risks, as they aim at matching the profile—the duration, guarantees, and liquidity—of their liabilities, the insurance policies and products that they sell,” said the report.
“What's more, all insurers have to abide by regulation, and in Europe, Solvency II, which requires that insurers back up investments into riskier asset classes with more capital,” added S&P.
Despite declining average bond ratings that have increased credit risk over the past few years, S&P expects its rated insurers to keep “strong credit quality” in their bond portfolios over the next three years.
The rater assumes that capital adequacy will keep pace with growth in asset risks by “adequate earnings retention”, and that insurers will most likely favour "capital-light product strategies rather than take on excessive asset risk”.
However, in a hypothetical stress scenario where credit quality in an insurer's bond portfolio markedly deteriorates, S&P saw “greater pressure on capital adequacy and potentially on the ratings”.
The report’s scope encompassed property and casualty (P&C) insurers, life and composite insurance firms as well as reinsurers, in the UK, France, the Netherlands, Germany, Scandinavia, Belgium, Spain and Italy.
“What's in flux are product features such as the duration of liabilities, guarantees, liquidity, and extent of risk transfer to policyholders. For years to come, we believe that most insurers in Europe will continue to act on product structures and pricing, and take management actions on in-force liabilities, such as closing books of business or externalizing more risk to enhance balance sheet resilience,” said S&P.
“In P&C lines, insurers will place greater emphasis on underwriting quality and prudent reserving, and try to raise prices to soften the impact of lower investment returns. Insurers will also look at reducing management and acquisition costs through tighter network specialization and digitalization,” said the report.
“Yet, we believe that it would be an exaggeration to talk about a sudden transformation of business models. Constraints such as the highly competitive environment across Europe, increasing consumer protection mechanisms, evolving regulation, and higher scrutiny from local regulators are likely to result in rather gradual changes in business models,” S&P added.
Reactions recently held an event in New York for North American re/insurers' chief investment officers; check out the investment discussion here (also published in the July/August issue of the magazine).