Recent macroeconomic uncertainty due to the COVID-19 pandemic is a concern for insurers’ balance sheets, as corporate bonds constitute a majority of the insurance industry’s assets, according to a new AM Best report.
The corporate bond sector has supposedly taken advantage of the low interest rate environment and as a result are more highly leveraged than they were a decade ago.
Furthermore, a cut in corporate earnings due to closures of nonessential businesses and the significant rise in the unemployment rate will severely hamper earnings.
AM Best notes how corporate bonds account for nearly 70% of the bond portfolios of each of the three insurance segments, and those bonds from industries such as services, manufacturing, retail, energy and public utilities will be affected more negatively than others.
Many of these sectors already had heightened below-investment-grade ratings as of year-end 2019.
According to the report, the leverage bubble may have led to a downward migration in credit quality, but the pullback in consumer demand is likely to exacerbate the credit crisis for borrowers.
State shutdowns have sparked a rise in new bond sales, driven by companies trying to borrow their way through the economic downturn.
The shutdowns also have driven a surge in the number of bonds trading at distressed levels, with a greater potential for defaults.
AM Best states companies with heightened exposures to the aforementioned vulnerable industries will be at a higher risk of experiencing downgrades and defaults.
In the rating agency’s view, the industry’s exposure to these sectors appears to be modest; however, individual insurers with larger allocations to these industries may face balance sheet risks.
Less than 20% of the bond portfolios of almost 90% of the property/casualty and health rating units are allocated to these sectors, versus just 47% of life/annuity (L/A) rating units.
The 20 rating units with the largest exposures to the high-impact sectors are predominantly L/A companies.
Some insurers also have large amounts of below-investment-grade assets in these sectors, although less than 2% of the rated companies have exposures that exceed 20% of capital and surplus.
If liquidity becomes a factor for many U.S. bond holdings, the macroeconomic environment could prompt many insurers to re-evaluate portions of their asset holdings and lead to redistribution across market sectors and risk classes.
