Increases in interest rates globally affects the insurers balance sheets

Substantial increases in interest rates globally have significantly affected the balance sheets of some insurers this year, though the impact will depend on the accounting methods employed, suggests AM Best.

The insurers in countries using a market value approach saw material declines in available capital from unrealised losses, while insurers using an amortised cost approach showed no impact on available capital.

For some US insurers, the effect also depends on the credit quality of the bonds held, as statutory reporting uses amortised cost for investment-grade bonds, but market value for some non-investment-grade bonds.

Accounting differences may also distort the metrics and tools used by rating analysts, says AM Best, stating that it uses these metrics and tools on a globally consistent basis.

In this situation, however, the choices are at opposite ends of the spectrum, with one extreme showing the full impact of rising interest rates on the entire fixed-income asset portfolio, and the other extreme showing no impact at all.

The impact of rising interest rates on available capital should be viewed in conjunction with an insurer’s underwriting risk profile and liquidity profile, which includes the fixed-income portfolio and other sources of liquidity, including operating cash flow.

It notes that most insurers can hold fixed-income assets to maturity given their strong liquidity resources, so their available capital should not be charged for temporary unrealised losses, while others have exposures to shock losses that may force them to sell fixed-income assets at a loss, and their available capital should be charged for this potential loss.

AM Best observes the impact of interest rates as part of its ongoing surveillance and does not currently expect many ratings to be negatively affected, in light of most insurers’ strong starting capital, as well as other factors.