By Ranamita Chakraborty
With corporate bonds constituting a majority of the insurance industry’s assets, the balance sheets of insurers are now at risk due to recent coronavirus-induced macroeconomic uncertainty. This finding was revealed in a new AM Best special report titled ‘Corporate bond holdings pose risk to insurers’ balance sheets’.
The report states that the corporate bond sector has been hit on two different fronts.
First, many companies have taken advantage of the low-interest-rate environment and as a result are more highly leveraged than they were a decade ago.
Secondly, a cut in corporate earnings due to closures of non-essential businesses and the significant rise in the unemployment rate during the COVID-19 will severely hamper earnings.
Corporate bonds account for nearly 70% of the bond portfolios of each of the three insurance segments and those bonds from industries such as services, manufacturing, retail, energy and public utilities will be affected more negatively than others.
Many of these sectors already had heightened below-investment-grade ratings as of year-end 2019.
In aggregate, the industry’s exposure to these sectors appears to be modest. However, individual insurers with larger allocations to these industries may face balance sheet risks.
Less than 20% of the bond portfolios of almost 90% of the P&C and health rating units are allocated to these sectors compared with just 47% of life and annuity (L&A) rating units.
The 20 rating units with the largest exposures to the high-impact sectors are predominantly L&A companies. While some insurers also have large amounts of below-investment-grade assets in these sectors, less than 2% of the rated companies have exposures that exceed 20% of capital and surplus.
If liquidity becomes a factor for many US bond holdings, the macroeconomic environment could prompt many insurers to re-evaluate portions of their asset holdings and lead to redistribution across market sectors and risk classes according to AM Best.
Asia Insurance Review