According to analysts at Peel Hunt the UK Non-life insurance sector “pulled back” last week as rising interest rates, high catastrophe & man made losses, and the ongoing soft motor cycle weighed negatively on share prices across the board.
While rising interest rates in U.S and UK continue to dominate the headlines, analysts say rates in the past week have remained fairly stable.
Nevertheless, the sector pulled back as it reacted to the decline in sovereign bond values.
On an economic basis, the impact of declining bonds is modest and, long-term, the insurance sector benefits from higher reinvestment yields, adding 10% to adjusted Profit Before Tax (PBT) over time.
Once interest rate expectations have bedded down, the insurance sector will start to positively react to a higher interest rate environment, says the report.
Investment income accounts for ~25% of Peel Hunt’s coverage universe’s earnings before tax and contributes ~4% to Return on Equity.
The largest contributor to investment returns is the fixed income portfolio and the equity gearing to the fixed income portfolio is 2.1x.
A rising interest rate environment is positive for Non-Life insurers with maturing bonds reinvested at higher interest rates, boosting pre-tax profits.
While fair value losses on the bond portfolio have an initial negative impact on PBT and equity, holding these bonds to maturity erases these losses over time.
Analysts say this mark-to-market volatility is non-economic and does not reflect the underlying positive impact of rising interest rates.
