Analysts at Twelve Capital, an independent investment manager specialising in insurance investments, have commented on the potential fallout of the crisis currently affecting the banking sector, concluding that “liquidity risk is remote” for most re/insurers.
However, they warned that life-savings insurers, in addition to banks, could be more exposed to liquidity risk, although in most cases buffers are considered adequate.
Additionally, Twelve Capital suggests that re/insurers could look to re-assess regulatory risks around their investments, given the Swiss regulator’s move to impose losses on Credit Suisse’s AT1 bonds, following its rescue buyout by UBS.
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.
“This unorthodox move has inverted the typical pecking order of capital structure and pushed the market to reassess the risk of regulatory intervention,” noted Urs Ramseier, CIO & Founding Partner at Twelve Capital.
“Moreover, the authorities’ push for a swift merger between the two Swiss banks without going through the standard practice of submitting the transaction to shareholders’ vote has, as well, contributed to higher perceived regulatory risk,” he added.
However, Twelve Capital analysts also assure that the issues of SVB appear company-specific while Credit Suisse’s problems appear more linked to the long-term standalone viability of the group, shareholders’ treatment and losses incurred by bondholders.
Therefore, while banks and investment-heavy life insurers could face some liquidity risk, the situation should not be concerning for companies in the property and casualty, health and protection spaces, Twelve Capital says.
“We reiterate that insurers are better positioned than banks in the current environment. The average insurance average sector solvency levels are high, and in most cases well above the upper bounds of their prudent internally-set long-term target ranges,” Ramseier explained.
Twelve Capital notes that, as interest rates have increased, insurers and banks alike have more opportunities to deploy their liquid assets in higher-yielding investments, which may have incentivised them to reallocate bank deposits or surrender life savings products.
Another consequence of the rapid increase in interest rates is that the value of the fixed income investments falls and results in unrealised mark-to-market losses, although this situation would not be problematic if assets are carried to maturity and the notional repaid in full.
Moreover, movements in assets would typically be mirrored by similar movements in the value of liabilities for insurers, thus neutralising the effect on own funds.
But Twelve Capital acknowledged that there could be some risk if banks and insurers experience unforeseen increases in client money withdrawals requiring the disposal of assets to generate cash.
“Should a situation happen where clients massively close their accounts or lapse their policies, banks and insurers would be required to crystallise unrealised investment losses,” remarked Ramseier. “This would, in turn, reduce their liquidity buffers and potentially affect their capital position. To a certain extent this is what was seen at Silicon Valley Bank in the US.”
Looking at how the delicate banking situation will need to be managed going forward, Twelve Capital suggests that policymakers’ will need to strike a delicate balance between reducing inflation and avoiding exacerbating concerns on the financial sector in the next months.
Additionally, investors will need to adapt to higher perceived regulatory-intervention risk, something that could increase the long-term risk premium required to allocate to financials.
“Twelve Capital’s focus during this period of market uncertainty is to position the portfolios it manages in a defensive way,” Ramseier concluded. “We currently prefer insurers to banks, while we believe that in both sub-sectors there are defensive names and bond structures that are well positioned to show resilience in the current market volatility. Moreover, albeit cautious, buying opportunities could arise.”
