A new report from S&P Global Ratings says that the current unrealised losses on most fixed-income securities for the world’s twenty leading reinsurers do not represent a material risk.
The paper, Top 20 Global Reinsurers Can Ride Out Unrealized Losses, says that higher interest rates in the last year-and-a-half have led to a ‘material decline’ in the fair valuation of fixed-income investments held by reinsurers.
“For the top 20 global reinsurers, shareholders’ equity dropped by 20% at year-end 2022 compared with a year earlier, reflecting in part the imbalanced accounting treatment between the valuation of assets and liabilities,” said the report.
The authors added: “But while these valuation changes look like they could be a cause for concern, we do not view them as posing a material risk for the top 20 reinsurers because of the reinsurers’ approach to cash flow management.
”Along with robust liquidity, this limits the risk that the losses will have to be realized. We will continue to monitor changes in interest rates and any unexpected liquidity stress, because these could bring unexpected challenges to reinsurers’ balance sheets.”
The likely outcome is that the losses on fixed-income securities are likely to unwind, according to S&P Global Ratings.
The rating agency estimated that these unrealised losses have so far negatively affected shareholders’ equity by 7% for ever 100 basis point increase for the top 20 reinsurers.
“We don’t expect that material unrealized losses on the fixed income side will form, instead thinking that most will likely end up unwinding, reflecting the top reinsurers’ robust financial and liquidity positions, the relatively short duration of the fixed income portfolio they hold, and generally reasonable matching between cash inflow and outflow,” said the report.
“This will generally allow these companies to hold these investments to maturity. We estimate that 25% of the total unrealised losses will unwind by year-end 2023, assuming rates remain similar to those of year-end 2022.”
The authors went on: “We think the sharp rise in interest rates heighten risks in illiquid investments such as real estate, private debt, and private equity. During the ultra-low interest rate era, reinsurers moderately increased their exposure to these assets seeking higher yields. However, we believe that the exposure is relatively small and that higher reinvestment yields partially offset potential impairment pressure in view of lower economic growth and higher interest rates.”