Brexit turmoil only beginning to play out for insurers: Gadfly

[LONDON] A crisis in financial markets normally equals a crisis in the insurance industry.

Insurers have done plenty to defend themselves against the Brexit storm, but they are entering an environment where having enough capital will come a distant second to having a lot more than enough.

The companies' problem is that they are big investors in financial assets, and the markets are moving in all the wrong directions. Stocks are falling while spreads on corporate bonds are widening. This diminishes the value of insurers' assets. In the UK, gilt yields are falling, too. That inflates the value of their long-term liabilities by reducing discount rates.

Short-term market volatility shouldn't affect the underlying economics of insurers' operations. The snag is that the industry has to record assets and liabilities at market value in its accounts. June 30 is fast approaching - the next date insurers must produce balance sheet for half-year results. The big worry is that market volatility will have badly damaged their capital position when that snap-shot is taken.

Such fears look overdone. Analysts at Citigroup have run a stress test on the sector which includes an assumed 30 per cent drop in the stock market. It found that no major European insurer would have less than 120 per cent of the capital they are required to hold by regulators in a nightmare scenario. This impression of resilience was buttressed on June 27 after Aviva, the UK insurer most exposed to Europe, said its solvency calculated as of June 24 was at the top of its "working range" of 150 per cent to 180 per cent.

This makes some intuitive sense. Insurers cut their exposure to equities after the stock-market collapse of 2002. The financial crisis on 2008 and eurozone crisis of 2011-12 forced further moves to bolster capital - helped, ironically, by new European Union regulations. The Markit iTraxx Europe index, a measure of fear in credit markets, jumped to 95 in the wake of the Brexit vote from 75 before - but it is still below the high of 125.7 touched in February when fears of corporate bond defaults in the oil and gas sector plagued the insurers.

UK life insurers were among the biggest fallers on Friday, with Aviva, Standard Life and Legal & General all down between 16 and 20 per cent. The FTSE-350 life sector slid another 7 per cent on Monday, compared with a 2 per cent decline for the broader FTSE 350. Many large European insurers are yielding more than 7 per cent.

A wave of emergency rights offerings may look unlikely, at least in the short term. What's more, Brexit shouldn't necessitate a radical rethink of business models or legal structures as insurance is largely written and capitalized on a local basis.

The difficulty is that the industry isn't cheap historically. FTSE-350 life companies trade on a forward price- earnings ratio of 9.5. That measure fell to 7.5 in the sovereign debt crisis and 4.8 in the financial crisis of 2008. Demand for their products is likely to suffer in an economic slowdown. A sustained period of slow growth may ultimately force insurers to rethink seemingly generous dividend policies to defend their capital positions.

Even if insurers are a whole are well capitalized, investors will probably pick winners according to one metric: relative capital strength.

BLOOMBERG

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