As European insurers release their 2022 half-year results, it is becoming clear that significant unrealized losses have been incurred on their investment portfolios due to the deteriorating economic environment, according to a new report from the rating agency. AM Best.
The report entitled “Adverse economic environment resulting in large unrealized losses in insurers’ investment portfoliospoints out that the losses are attributed to the combined effects of rising interest rates, widening credit spreads and market volatility, which ultimately led to a decline in the market value of the investments.
However, while asset values may return following a rapid recovery in economic conditions, the current inflationary environment suggests that the impact on investment portfolios may be prolonged.
The latest forecast from the International Monetary Fund (IMF) in July 2022, includes a 0.4% decline in global economic growth as well as a 0.9% increase in inflation expectations for advanced economies, which supports more pessimistic outlook. If economic conditions continue to deteriorate, insurers’ investment portfolios could suffer further losses.
Furthermore, AM Best states that a clear economic view of the magnitude of the impact of unrealized losses on equity is obscured by the way unrealized losses are presented in the different accounting regimes used in the European market. .
The report notes that among the largest insurers, the impact on regulatory capital ratios – namely the Solvency II SCR ratio – is modest. In many cases, solvency ratios even increased during the first half.
AM Best also highlights the disconnect between the sharp drop in equity and the limited impact on regulatory ratios partly by the valuation of insurance liabilities under Solvency II, which takes into account the current economic environment when discounting flows cash from liabilities.
Therefore, this means that in many cases losses in investment portfolios have been compensated by a decrease in liabilities, leading to stable ratios.
Finally, the report notes that AM Best views the relative stability of SCR ratios positively in the context of large unrealized losses. Stability indicates effective Asset Liability Management (ALM) and Enterprise Risk Management (ERM) programs, which have been successful in managing insurer profiles at the enterprise level during the current shock.
AM Best warns, however, that if the inflationary environment continues, the ALM and ERM programs will continue to be tested.