At present, Moody’s Investor Service sees little immediate threat to European insurers from the recent banking turmoil.
According to new analyst note, a prompt regulatory response has reduced the risk of severe systemic financial strain. The bank bond holdings of Moody’s rated European insurers are also of moderate size, and their exposure to riskier Additional Tier 1 (AT1) instruments is negligible.
AT1 bonds are bank bonds and are sometimes referred to as contingent convertibles or “CoCos.” The name comes from the ability to convert them into either equity or write them off under certain scenarios. They are considered a relatively risky form of junior debt, therefore coming with a higher yield and are often bought by institutional investors.
In its note Moody’s says: “We estimate that the average AT1 exposure of Moody’s rated insurers is less than 1% of their total bank debt holdings, with some variation between companies. AT1 bonds are riskier than other bank debt because they are the most junior instrument in banks’ capital structure.”
It adds, however, that the insurance sector nonetheless faces an increased risk of asset quality deterioration amid worsening economic conditions and rising interest rates, which could erode its earnings and solvency:
“In light of recent trends, we expect the corporate default rate for speculative-grade financial and nonfinancial companies to rise to 4.6% at year-end 2023 under our baseline scenario, up from 2.9% at the end of March, and to peak at 4.9% in early 2024.”
Severe economic downturn is sector’s main risk, Moody’s says, noting that European insurers face increased asset quality erosion in the year ahead as economic growth decelerates and interest rates remain high:
“An adverse scenario in which economic conditions deteriorated more quickly than we currently expect could severely reduce the quality of insurers’ corporate bond portfolios. This would prompt them to set aside more capital against risky assets, reducing their Solvency II ratios.”