Analysts at Moody’s Investors Service view the Bank of England’s (BoE) decision to cut its base rate to 0.25% as a credit negative for UK insurers.
The cut, which is designed to offset the economic shock of the coronavirus (COVID-19) outbreak, is expected to increase pressure on the UK insurance sector’s investment income, which is already under strain from a prolonged period of very low interest rates.
Moody’s also warned that the cut will weigh on UK life insurers’ capital ratios under the Solvency II regime, which are especially sensitive to falling interest rates.
However, it added that a separate BoE measure allowing life insurers greater transitional relief from their Solvency II capital requirements will provide some counterbalancing uplift.
Insurers will also benefit to the extent that the BoE’s measures cushion the negative economic impact of coronavirus.
UK life and non-life insurers predominantly invest in fixed-income securities, but falling bond yields force them to invest new money or reinvest maturing assets at rates below their current investment yield.
Analysts note that the BoE’s rate cut will therefore further pressure insurers’ investment income at a time when bond yields are already at a record low.
UK life insurers’ Solvency II ratios are also vulnerable to falling interest rates because their technical provisions include a risk margin requirement that increases when risk-free rates fall.
That said, UK insurers are allowed to recalculate their Solvency II transitional measures – which provide temporary capital relief in order to help them adjust to the Solvency II regime – if there is a material change in their risk profile.
And on a more positive note, UK life insurers’ profitability is much less vulnerable to a prolonged period of low interest rates than that of their peers in countries such as Germany and Norway, Moody’s observed.
This is because UK insurers have focused on unit-linked products, which leave investment risk with the customer.
Additionally, since the duration of UK insurers’ assets and liabilities is very closely matched, their reinvestment risk is low.
