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Fitch Ratings : risk avoidance drives reinsurers’ investment; some favour shorter asset duration

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Fitch Ratings expects reinsurers to continue to abide by their core investment principles in the face of a possibly protracted low-yielding investment environment. Nevertheless, some smaller reinsurers are preferring to keep asset duration to a minimum (of about one year) as they seek to reduce the balance-sheet (solvency) shock which could occur when interest rates rise, while also providing the opportunity to reinvest earlier at higher interest rates, according to a new report.

Fitch expects reinsurers to remain focused on maintaining sufficient liquidity to meet and settle liabilities in a timely manner, and avoiding excessive balance sheet volatility. Inability to accomplish this due to a lack of adequate liquidity could have negative outcomes including regulatory intervention, rating downgrades and loss of confidence by policyholders and investors.

“In general, Eurozone concerns and potential shocks to investment assets are trumping reinsurers’ desire for higher yields,” says Martyn Street, Director in Fitch’s Insurance rating group. “While conventional wisdom advocates closely matching the duration of assets and liabilities, some smaller companies appear less inclined to follow this approach rigidly.”

Major sovereign bonds now yield around 0.5%, compared with 4-5% in mid-2007. As yields remain persistently low, reinsurers’ attention has turned to the asset side of the balance sheet. Uncertainty created by the macroeconomic environment, and the implications for yields on certain key asset classes of policymakers’ handling of the crisis have made decisions more challenging. Attention has been focused by the reality of reinvesting maturing bonds at significantly lower yields.

Fitch regards direct exposure to the Eurozone debt crisis as manageable overall for reinsurers, although contagion would be a concern. The broadening of the Eurozone sovereign crisis is intertwined with the investment challenges created for reinsurers by the current and future level of interest rates.