A new report from AM Best states that the balance sheets of UK life insurers have proved resilient through a period of market turbulence in financial markets due to the sharp and rapid rise in yields on UK gilts towards the end of September 2022.
Sharp moves in yields have placed particular pressure on defined benefit (DB) pension schemes using liability-driven investment (LDI) strategies to help manage their exposure to interest rate risk and inflation risk.
Best notes that for UK life insurers that are employing LDI strategies on behalf of their pension-fund clients, collateral calls, as well as any financial risk associated with having to liquidate assets, fall on the plan sponsors, rather than on the balance sheet of the life insurer.
However, the rating agency warns that both the reputational and regulatory risk associated with employing these investment strategies may now have increased for life insurers’ asset management divisions.
Life insurers’ balance sheets are exposed to the financial risks associated with LDI hedging in their own PRT portfolios, but these risks appear to be manageable. At the same time, where hedging is used, insurers are often able to post assets other than cash as collateral, therefore reducing the liquidity risk associated with margin calls.
Best also noted that the regulatory solvency ratios of life insurers have not been adversely affected and may have even increased in the face of rising yields, as the impact on asset prices is offset by a decrease in liabilities on economic balance sheets.
Furthermore, the report states that Best has a stable outlook on the UK life market reflecting the strong opportunities for pension-related products, sufficient capital in the sector to fund projected medium-term expansion and the expectation of further releases from longevity reserves in the near term.
As a result of the drop in demand for with-profits products and investment bonds in the UK, the active product profile of UK life insurers has become concentrated in pension-related products, particularly large bulk annuity transactions.
AM Best expects pension business to continue to account for more than 90% of the total premium of the UK life segment in 2022.
Throughout recent years, UK life insurers have increased their exposure to illiquid assets to match liabilities and protect investment yields in a low interest rate environment. Even though interest rates are now rising and liquid assets are starting to become more attractive, illiquid assets are expected to remain a material proportion of life insurers’ investments.
At a segment level, AM Best views this as an appropriate way to create value from the role of insurers as gatherers of illiquid liabilities.
Best concludes that since it has revised its outlook on the UK life insurance market to stable in April 2022, economic conditions have deteriorated and investment markets have been volatile. The rating agency noted that it is closely monitoring the impact of these trends on UK life insurers.