In response to rising interest rates, persistent inflation, and subdued economic growth, European insurers are poised to recalibrate their investment portfolios, gradually shifting towards higher quality bonds, according to a Moody’s report.
This move follows a previous trend where insurers increased exposure to lower quality instruments during the low-interest-rate era to enhance yields. European insurers are expected to gradually de-risk their bond portfolios, specifically moving towards more highly-rated corporate debt.
At the end of 2022, nearly half of insurers’ corporate bonds were rated Baa or lower, exposing them to potential risks from rating migration and defaults. The shift towards higher-grade bonds will be a measured process to avoid crystallising unrealised losses triggered by recent sharp increases in interest rates.
While insurers had increased exposure to illiquid assets to 18% of total investments in 2022, there is now a trend towards moderation, particularly among continental European players.
However, the demand for illiquid assets remains strong among UK life insurers, driven by the growing bulk purchase annuity market. Real estate, though, is expected to see reduced demand due to current sector risks.
Insurers’ liquid resources are reported to be ample and well-diversified, enabling them to maintain a high ratio of liquid assets to liquid liabilities.
This liquidity strength positions insurers to manage potential policy surrenders as interest rates rise, preventing forced sales of fixed-income assets and minimising unrealised losses.
Fixed income securities, constituting around 65% of Moody’s rated European insurers’ investment portfolios at the end of 2022, are expected to see a gradual shift towards higher quality assets. This comes as insurers react to the recent substantial rise in bond yields and heightened economic uncertainty.
Sovereign bond valuations have experienced a significant decline, especially for long-dated government bonds held by European insurers. Continental European insurers, with a higher allocation to government debt, have been more affected than multinational and UK players.
Moody’s rated European insurers are considered well-positioned to manage rising credit risk, boasting strong diversification across sectors and a robust average Solvency II ratio above 200%. The positive impact of rising interest rates has further strengthened their regulatory solvency positions.
Given the recent surge in bond yields and ongoing economic uncertainty, insurers are expected to reduce their appetite for lower-rated corporate debt, equities, and illiquid assets. Purchases of sovereign and highly-rated corporate bonds are anticipated to increase gradually, with a complete transition expected over time.
