Rating Agencies Turn Negative

David Worsfold

The darkening mood of ratings agencies is heaping more pressure on investment portfolios and managers in the insurance sector. No country, no market, no region seems immune from a growing sense of unease, as the red warning lights start to flash across the ratings dashboards.

When asked what makes them nervous about 2016, the major agencies point to investment performance and low interest rates, coupled with weak underwriting. The failure to increase premium rates in most classes of business weighs heavily on their minds. In the life and pensions markets, insurers continue to struggle in some European markets to wean customers off guaranteed returns on products. In the property and casualty markets, most agencies and forecasters expect 2015 to be a year of underwriting losses, something we are already seeing come true as the reporting season gets underway in the UK. The storms that gripped the north of England and Scotland at the end of 2015 tipped many fragile property portfolios into loss.

Even before this unexpectedly bad end to the year, the agencies were already predicting a zero return – no gain/no loss – on underwriting going forward in 2016.

All the pressure is then thrown once again onto investment portfolios to produce returns and rescue the bottom line profit. Some may say that this is nothing new, particularly since we pulled out of the 2008 crash. But – and it is a but that is causing concern at the ratings agencies – many insurers have turned to a widening mix of asset classes to find returns, moving away from their dependence on high quality top rated fixed income, and looking increasingly into opportunities in other asset classes and emerging markets.

This doesn’t always have a happy outcome, as the 2015 results from Brit last week vividly illustrated. Brit’s full year pre-tax operating profit fell from $232.9m to $91.7m. There was a decline in operating profits broadly in line with those elsewhere in the London insurance market, but the real damage was done by the slump in investment returns. These fell – collapsed perhaps is a more accurate description – from US$115.7m in 2014 to just US$10.3m in 2015. It is hardly surprising that CEO Mark Cloutier led the results announcement with an explanation of how the insurer was restricting its investment portfolio, especially by reducing credit exposures and increasing its commitment to government debt.

It was just this sort of scenario that Fitch had in mind when it presented its annual review of the European life and non-life insurance markets at its London roadshow at the end of January. Its Insurance Risk Radar (see figure below) makes for gloomy viewing.

Insurance risks that could change ratings Caption: Fitch Insurance Risk Radar, January 2016 (Source: Fitch).

The largest concern Fitch has about the insurance industry in 2016 is a black hole which simply says “Collapse in asset values”. Alongside this, it lists “Interest rates lower for longer” and “EU sovereign credit concerns”. These are the biggest risks with potentially the biggest impact on the agency’s ratings across the sector. They are also all asset management issues.

Other topics such as cyber risk and regulatory risk do get a mention but they do not carry quite the same weight. Depressingly, the only positive factor on their radar was “Faster economic recovery”.

In today’s environment and given recent markets, there will be few boards counting on that to lift the gloom. It might be easy to dismiss the mess Brit has made of its asset management as a maverick performance but looking across the global reinsurance sector, Standard & Poor’s recently highlighted that over the last four years, investment income has fallen by 30%. It also highlighted the investment performance risks in a report on European insurers’ capital adequacy in the post-Solvency 2 world at the end of last year: “So far in 2015, we have taken negative rating actions on insurers that appear particularly exposed to the risk of ‘lower for longer’ interest rates – a scenario that we increasingly expect to persist. We recognise the increased risk that low interest rates pose to insurers by elevating our assessment of industry risk in some of the most exposed markets”.

Top of its list of concerns is the familiar problem of the need to meet guarantees, a feature that disappeared from the UK market in the wake of the collapse of Equitable Life but which persists in many central European markets, especially Germany. It is starting to become a major issue for the ratings agencies, as a report issue by Fitch on 15 February stressed: “The pressures of low investment yields are the main driver of the negative outlook on the German life insurance sector. Fitch believes that for now the pressures are manageable and maintains a stable rating outlook. However, continued low interest rates, with further pressure on capital and earnings, could lead to a change in the rating outlook to negative”.

This sort of negativity can easily spread, and the prospect of a notch or two coming off a firm’s ratings will be a huge concern in boardrooms. If whole sectors move down, they will have to take it on the chin. But no one wants to be the firm that was picked out for harsher treatment by the ratings agencies because their investment performance let them down.

As volatility reasserts itself and macro risks climb, 2016 promises to be a bruising year for insurers.


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