With interest rates having already risen across the UK and Europe and further hikes expected in the coming months, analysts at Goldman Sachs have predicted that higher interest rates will prove beneficial to reinsurance companies in the long term.
Although interest rate growth could lead to lower investment income due to negative impacts on realised gains in the short term, Goldman Sachs says higher reinvestment yield will ultimately lead to higher future investment income.
For the life segment, higher interest rates economically benefit them, as the insurers can release some capital as the capital requirement reduces, analysts note.
But reinsurance companies assets have a longer duration and hence the positive impact from a higher reinvestment yield would be slower to flow through the portfolio than for other sectors.
Therefore, Goldman Sachs argues that the decline in realised gains would be more prominent in the short term, given a less positive offset from higher ordinary investment income.
“We expect FY22 to see lower investment income, apart from Hannover Re that benefits from inflation-linked bonds, but will see higher investment income from 2023E onward,” analysts explained. “However, higher rates are still a positive economically for the reinsurers, even if the benefit takes longer to work through.”
Reinsurers have seen reinvestment yield increase significantly at the half year, with Munich Re’s rate increasing to 2.8% at the half year from 2.1% at Q1 2022, while SCOR’s reinvestment rate reached 4.1%, almost double that of FY 2021, and Swiss Re’s reinvestment yield is now 3.1% vs 0.9% at Q1.
Hannover Re did not provide an explicit number for the reinvestment rate but indicated that the reinvestment yields vary across different geographies, with the US at 3.1% and Europe at 1.5%.
Aside from higher future investment income, Goldman Sachs believes solvency ratios would also benefit from the higher interest rate, while underwriting discipline is also unlikely to suffer as the higher rates help to offset inflation.
“We see this as an industry-wide positive,” analysts concluded. “We believe insurers should be rewarded for the underwriting risk and not investment risks … In our view, the higher investment returns are not necessarily competed away as they will help insurers get to their higher ROE targets.”
