Moody’s Investors Service has released a report which shows how COVID-19 has impacted the global economic slowdown, creating significant challenges for EMEA insurers, whilst amplifying many existing key areas of concern.
Analysts at Moody’s noted that along with low interest rates and asset quality risks, which are tilted to the downside, COVID-19 has accelerated disruptive trends including those related to new technologies and rising environmental, social and governance (ESG) risks.
COVID-19 is likely to continue severely affecting economic activity globally, and significant downside risks that could threaten the economic recovery will therefore remain.
The pandemic triggered extreme financial market volatility in Q1 2020, as reflected in a significant drop in interest rates, a deterioration in equity markets and a widening of credit spreads.
Whilst Moody’s sees the reinsurance industry as resilient overall to the coronavirus, there is still additional pressure on insurers’ profitability and capitalisation.
Insurers with large equity holdings and those with fixed income investments in the lower investment grade and speculative grade rating categories experienced the largest deterioration in their capital positions.
The decline was partly offset by some counterbalancing uplift from the suspension of dividends and share buybacks, additional issuance of hybrid instruments, balance sheet de-risking, and countercyclical measures built into the Solvency II regime.
However, central banks and governments have taken substantial monetary and fiscal measures to support the economy which has been sufficient to tame financial market volatility.
As a result, equity markets and credit spreads largely returned in Q2 to pre-coronavirus levels, supporting insurers’ capitalisation. For most groups Solvency ratios remained at strong levels and within their target range. In the absence of further major financial market dislocations, we expect insurers’ capital to remain broadly intact.
The rating agency also believes that the sector will be able to absorb the impact of the pandemic and replenish its capital over the coming years. For this reason, Moody’s has only taken a limited number of negative rating actions on European insurers.
While monetary easing has helped stabilise financial markets, it has also reduced yields further from already low levels.
This increases the risk of interest rates remaining low for longer than previously expected. Ultra-low interest rates are credit negative for the sector, as they pressure investment returns, eroding profitability and economic solvency.
The economic shock from the coronavirus eroded the sectors’ earnings in the first half of 2020, largely through weaker investment returns.
Moody’s expect a rise in asset quality risk, as falling interest rates force EMEA insurers to invest in lower-rated securities and illiquid assets in the search for higher yields. The credit quality of insurers’ fixed income portfolios will also likely deteriorate as a consequence of rating downgrades and corporate bond defaults during the coronavirus- induced recession.
It believes that these factors will intensify price competition in the P&C retail market in 2021, ultimately putting pressure on insurers’ profitability, which is already squeezed by rising claims inflation.
The importance of adopting to new digital technologies has been highlighted throughout the pandemic, with Moody’s now expecting an acceleration in the transformation of insurers traditional businesses through adopting more digital solutions.
Distribution and underwriting are likely to move online, helping EMEA insurers reduce costs and remain relevant to policyholders.
The shift towards greater digitalisation will also expose them to new data and security risks, therefor it will require significant investment.
Insurers seeking to catch up with the accelerated pace of digital transformation will likely increasingly invest in IT in the months ahead, potentially seeking additional collaborations with InsurTechs.