As European insurers report their 2022 mid-year results, it is becoming apparent that large unrealised losses have been incurred on their investment portfolios due to the deteriorating economic environment, according to a new report by rating agency AM Best.
The report titled, “Adverse Economic Environment Driving Significant Unrealised Losses in Insurers’ Investment Portfolios”, highlights that losses are being attributed to the combined effects of rising interest rates, widening credit spreads, and volatile market performance, which ultimately has led to a decrease in the market values of investments.
However, while asset values may revert following a speedy recovery of economic conditions, the ongoing inflationary environment suggests that the impact on investment portfolios may be prolonged.
The latest forecasts by the International Monetary Fund (IMF) in July 2022, includes a decrease of 0.4% for global economic growth as well as an increase of 0.9% in inflation expectations for advanced economies, which support a more pessimistic outlook. If economic conditions continue to deteriorate, insurers’ investment portfolios may see further losses.
Additionally, AM Best states that a clear, economic view on the magnitude of the impact the unrealised losses have had on capital bases is obscured by how unrealised losses are presented within the different accounting regimes used throughout the European market.
The report notes that among the largest insurers, the impact on regulatory capital ratios – namely Solvency II SCR ratio – is modest. In many cases, solvency ratios even increased over the first half of the year.
AM Best also highlights the disconnect between the sharp decline in capital, and the limited impact on regulatory ratios in part by the valuation of insurance liabilities under Solvency II, which incorporate the current economic environment when discounting liability cash flows.
Therefore, this means that in many cases, losses in investment portfolios were offset by a decrease in liabilities, leading to stable ratios.
Lastly, the report notes that AM Best views positively the relative stability of SCR ratios in the context of the large unrealised losses. The stability indicates effective asset and liability management (ALM) and enterprise risk management (ERM) programmes, which have successfully managed insurers’ profiles at an enterprise level through this current shock.
AM Best does warn however, that if the inflationary environment continues, ALM and ERM programmes will continue to be tested.
