The financial leverage of Europe’s leading insurers rose to a record high of 28.2% on average in the first half of the year.
Moody’s said that there had been a rise of 483 basis points over that time, with the increase reflecting a sharp decline in reported equity driven by unrealised investment losses. These losses were themselves driven by falling bond prices and rising interest rates. However, Moody’s wrote that it did not expect to see most of these losses materialise.
The sector’s debt maturity profile is currently favourable, with just 9% of instruments due to mature in 2023, and its access to funding remains good. Nevertheless, higher borrowing costs may prompt some insurers to de-lever in the months ahead.
Moody’s picked out three trends that it was either seeing or predicted in the near future. These were that leverage had jumped on the back of rising rates, that debt issuance would be moderated in the coming months, and that access to funding remained good.
With insurers’ average financial debt remaining broadly unchanged in H1 2022, the hike in leverage principally reflects the adverse impact of rising rates on the industry’s bond portfolio valuations.
This generated net unrealised investment losses which eroded their shareholders’ equity, although the impact on debt servicing ability was limited. When unrealised investment gains and losses are excluded, average H1 financial leverage remained flat.
The sector’s funding needs are also relatively low as some insurers preemptively refinanced upcoming maturities before the recent hike in interest rates.
Some insurers may also seek to de-lever over the coming years by using surplus capital to redeem or repurchase securities. Given the current composition of insurers’ Solvency II own funds and rising borrowing costs, the sector is most likely to refinance or issue new Tier 2 subordinated debt notes.
Weaker equity is unlikely to hinder dividends, which are typically correlated with economic capital and earnings. Debt servicing costs will rise as debt is refinanced, but better investment returns will provide an offset.
This will support earnings coverage of interest, which improved to a healthy 9.5x in 2021. IFRS 17 accounting rules could weigh on some insurers’ leverage metrics, although they will also become less interest rate-sensitive.
The measurement of leverage on regulatory balance sheets will be unchanged, providing some continuity.