Investment - Articles - Reinsurers risk being distracted by low investment yields


 Fitch Ratings believes that reinsurers may be distracted into seeking improved earnings fortunes through potentially higher-yielding - but unintentionally riskier - investment strategies, rather than continuing to focus on disciplined underwriting. The agency views the generally cautious approach taken so far to investment risk as being a key factor in the sector's rating resilience to the unprecedented scale of catastrophe losses seen in 2011.

 Earnings sustainability is set to become more challenging for reinsurers in 2013, so the desire to improve earnings through higher investment yields could expose companies to unforeseen investment risk.
 Reinsurers have generally been cautious in their approach to investment management in recent years. The sector has actively reduced exposure to troubled peripheral eurozone sovereigns, sought to lower solvency volatility by optimising the matching of assets and liabilities, as well as ensuring strong liquidity by holding substantial cash balances. The consequence of this prudence has been low-single-digit levels of investment return.

 Increased earnings pressure in 2013 - through a combination of continuing low investment yields, reduced technical profitability and diminishing prior year reserve surpluses - could tempt reinsurers to seek higher returns through shifts in investment strategies. Yet factors driving current macroeconomic uncertainty have little historical precedence, including the eurozone sovereign debt crisis and close-to-zero bond yields in most major economies. This could result in reinsurers increasing exposure to assets that ultimately prove to be more greatly exposed to a deterioration in the macroeconomic environment, serving to weaken reinsurers' balance sheets.

 The fact that the reinsurance sector was able to withstand the unprecedented level of catastrophe losses in 2011 was greatly helped by the asset side of the balance sheet, as reinsurers benefited from a positive change in unrealized investment gains as interest rates moved lower. Had companies been carrying more risk on the asset side, then it is likely that we would have seen a greater number of negative rating actions.
  

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