Wider contagion and low yields still a risk

Stock market figures

European (re)insurers are well-positioned to withstand current stock market volatility, according to AM Best.

In a statement the rating agency said that the changes to (re)insurers’ investment portfolios put them in this good position, namely a trend away from shares to high-quality fixed income assets.

The rating agency put out its report after the declines in the Shanghai Composite Index, most notably the slump on August 24 when the index fell 8.5%.

The report said: ‘The majority of the large European (re)insurers are currently extremely well capitalised and are well aware of the speed at which liquidity can freeze up and how contagion effects can spread to both real estate and equities’.

The rating agency said that most of the highest-rated large European insurance groups had a buffer of at least 20% to 30% in their investment portfolios to withstand market value fluctuations without any downgrade risk.

AM Best said that none of the European (re)insurance firms on its books had large direct investments in China, but added that the ‘contagion effect’ of China’s slowing economic growth was a worry.

The rating agency added: ‘The significant declines seen in global equity markets in the past few months, and the drop in commodity prices, come at a time when European (re)insurers have started to move assets back into stocks and real estate.

‘Investment portfolios are still largely concentrated on fixed income instruments. Companies are conservative in their approaches and maintain a strict policy of cash and extremely liquid assets to enable credit facilities to be available.

‘However, given the low interest rate environment, many companies have recently begun to search for yield and have shifted into real assets including infrastructure projects, equities and real estate’.

AM Best added that European life insurers in particular faced mounting concerns about the duration gap between assets and liabilities and the associated reinvestment risk.

These companies have sought greater returns by diversifying into non-traditional commercial loans, infrastructure projects and mortgage books, according to the rating agency.

‘If there are worries about a slowdown in global economies, options for insurers to try to increase their investment returns will become more limited as they focus largely on high-quality fixed-income securities that generate lower yields’, AM Best concluded.