The recent downgrade by S&P of the U.S.’s long-term sovereign debt rating will likely not have a serious direct impact on the financial profile of U.S. life, property & casualty and/or health insurers. This is largely due to:
1) The rationale for S&P’s downgrade of the remaining AAA rated insurers; i.e., S&P was essentially forced into this downgrade by its convention of not allowing insurer ratings to exceed those of its sovereign government. Moody’s and Fitch have not reacted in like manner;
2) The current non-impact to insurer risk-based capital charges of government securities, as these remain comfortably within the Class 1 (AAA to A-) range.
However, the indirect impact of this downgrade – as an expression and reflection of both present and perhaps future worldwide economic uncertainty – could have a significant impact on insurers’ financial performance.
For instance, capital market reaction to this downgrade, in conjunction with negative news in other areas (European fiscal issues, unrest in the Middle East, the impact of the substantial earthquake/tsunami losses in Japan, worldwide economic retrenchment in both developed and developing countries, etc.), has contributed today to further substantial sell-offs in U.S. equity markets. As discussed, lower equity markets have a direct earnings impact on writers of variable annuities, while low interest rates (attendant upon global economic weakness) impact the investment yields/credit spreads of insurers, compressing margins. Weak capital markets also often result in net capital losses and/or credit impairments, which can lead to decreased capitalization. Lastly, weaker economic conditions impact the sales of all insurance products and could be especially damaging to the P&C market which appears to be struggling to raise pricing after seven years of soft market conditions.
In short, more than three years after the onset of the financial crisis, the macroeconomic conditions that directly impact insurers both on a revenue generation and earnings basis appear to be once again in great flux. The downgrade of the leading economic power’s sovereign debt only exacerbates current global financial anxiety.
We conclude on a positive note, however, by reiterating the U.S. insurance industry’s inflated but higher capital levels since the onset of the global financial crisis, macro hedges for statutory capital, continued hedging for variable annuity guarantees and other products, derisked investment portfolios and product suites, higher cash and liquidity levels at holding companies, as well as lower reliance on short term debt at holding companies. These all serve as some protection against the impact of a potential second round of serious economic and capital market deterioration.
1) The rationale for S&P’s downgrade of the remaining AAA rated insurers; i.e., S&P was essentially forced into this downgrade by its convention of not allowing insurer ratings to exceed those of its sovereign government. Moody’s and Fitch have not reacted in like manner;
2) The current non-impact to insurer risk-based capital charges of government securities, as these remain comfortably within the Class 1 (AAA to A-) range.
However, the indirect impact of this downgrade – as an expression and reflection of both present and perhaps future worldwide economic uncertainty – could have a significant impact on insurers’ financial performance.
For instance, capital market reaction to this downgrade, in conjunction with negative news in other areas (European fiscal issues, unrest in the Middle East, the impact of the substantial earthquake/tsunami losses in Japan, worldwide economic retrenchment in both developed and developing countries, etc.), has contributed today to further substantial sell-offs in U.S. equity markets. As discussed, lower equity markets have a direct earnings impact on writers of variable annuities, while low interest rates (attendant upon global economic weakness) impact the investment yields/credit spreads of insurers, compressing margins. Weak capital markets also often result in net capital losses and/or credit impairments, which can lead to decreased capitalization. Lastly, weaker economic conditions impact the sales of all insurance products and could be especially damaging to the P&C market which appears to be struggling to raise pricing after seven years of soft market conditions.
In short, more than three years after the onset of the financial crisis, the macroeconomic conditions that directly impact insurers both on a revenue generation and earnings basis appear to be once again in great flux. The downgrade of the leading economic power’s sovereign debt only exacerbates current global financial anxiety.
We conclude on a positive note, however, by reiterating the U.S. insurance industry’s inflated but higher capital levels since the onset of the global financial crisis, macro hedges for statutory capital, continued hedging for variable annuity guarantees and other products, derisked investment portfolios and product suites, higher cash and liquidity levels at holding companies, as well as lower reliance on short term debt at holding companies. These all serve as some protection against the impact of a potential second round of serious economic and capital market deterioration.
