Favourable refinancing conditions have driven an increase in financial leverage levels of large European insurers to an average 25% in a reversal of the eight year de-leveraging trend that began in 2009, Moody’s said in a recent market update.
Financial leverage has been in decline from its 2008 peak of 32.8%, however, 2016 and the first half of 2017 marked the shift towards leveraging levels increasing and Antonello Aquino, an Associate Managing Director at Moody’s, said he expects; “European insurers’ and reinsurer’s financial leverage to gradually increase over the next two years.”
He explained the primary drivers of the increase in leverage are; “persistently low-interest rates, which encourage (re)insurers to borrow and refinance existing debt cheaply, and growing focus on deployment of excess capital.”
Although interest rates rose during 2017 and 2018 YTD, they remain well below the average for the last 10 years, explained Moody’s, this allows insurers to take advantage of low refinancing costs.
In particular, senior debt has become very attractive with some insurers being able to issue debt at exceptionally low yields.
Any monetary tightening is expected to further accelerate new debt issuance as re/insurers seek to lock in current very low servicing costs.
A growing focus on deployment of excess capital is also likely to contribute to increased financial leverage.
As the largest re/insurers have solid overall capital positions, Moody’s anticipates they will start looking more closely at their surplus capital through share buybacks, dividend increases or acquisitions and “these measures will suppress growth in re/insurers’ shareholders’ equity, contributing to an increase in leverage.
“Although pressure to boost Solvency II ratios has eased compared with 2015 and 2016, when the regime was introduced, these ratios remain inherently volatile especially in the event of combined market movements.”
Moody’s added that it expects re/insurers to respond to any volatility in their ratios by issuing subordinated debt; potential uncertainty caused by the Italian elections in March and the ongoing Catalonian independence dispute could increase volatility in the ratios, although political risks in Europe have receded overall.
