Analysts at JP Morgan have assured that European insurers’ exposure to bank corporate credit and AT1 bonds are low, after a rescue deal for the beleaguered Credit Suisse shocked some investors by leaving their bonds worthless.
JP Morgan notes that the average exposure to bank credit is around 6% of European insurers’ investment portfolios, with minimal exposure to sub-investment grade.
And in addition to low exposure, analysts also cite several other “pressure valves” that should help to reduce the risk for the insurance sector as volatility in the banking system persists.
Most insurers, for instance, also hold a large proportion of their bank credit portfolio in participating life products where the risk is shared with policyholders.
Pointing to specific insurers, JP Morgan says this is the case with AXA, Generali and Allianz, where it believes policyholder sharing could mitigate losses on AT1 by 60% to 90%.
Similarly, UK life insurers using the ‘matching adjustment’ can offset higher bond yields with a higher discount rate for liabilities, JP Morgan says. Specifically, these insurers can take into account a large proportion of the credit spread in the discount rate for liabilities, where credit is held to ‘match’ a long-term illiquid annuity portfolio, which mitigates the Solvency II risk of widening bank corporate credit spreads.
AT1 bonds and other banking investments have come under the spotlight in recent days after the share prices of Swiss bank Credit Suisse plummeted, following the discovery of “material weakness” in its financial situation.
Markets had already been jittery since the collapse of Silicon Valley Bank in the preceding week and fears of a repeat of the 2008 financial crash led to government intervention and the buyout of Credit Suisse by UBS in a US $3.2 billion deal.
But holders of Credit Suisse AT1 bonds discovered after the buyout that their holdings were now worthless, having previously been valued at a collective $17 billion.
AT1 bonds are converted into equity if a bank falls below a certain strength or capital limit and are designed to limit taxpayer exposure in the event of a banking collapse and subsequent bailout.
But while Credit Suisse has been saved for now by the UBS buyout, Swiss regulators have decided to leave creditors out of the rescue deal, effectively wiping out the value of any AT1 bonds.
The surprise move will potentially add further volatility to the banking environment in the days to come as the price of other AT1 bonds is likely to drop, but for insurers at least the danger appears to be minimal, according to JP Morgan.
Looking at the exposure disclosed by specific re/insurers, analysts note that for Munich Re only 2% of its bank credit portfolio is loss-bearing, while L&G only has £1 million invested in bank tier 1. Similarly, Zurich has informed JP Morgan that it “does not have an appetite for AT1”.
