A decade of low interest rates and tough underwriting conditions has led reinsurers to cautiously invest in riskier and more illiquid assets to generate additional return. The good news is that this strategy also has helped reinsurers tolerate the economic impact of the COVID-19 pandemic, according to a report from S&P Global Ratings.

“The economic impact of the pandemic has somewhat eroded reinsurers’ capital adequacy, but their caution has largely paid off,” despite unfavorable movements in the financial markets and in the economy, said S&P in its report titled “Investment Caution Has So Far Paid Off for Global Reinsurers.”

“The gradual shift in [investment] strategy has been successful – reinsurers’ capital adequacy has remained high, on average. Had their asset allocations remained unchanged, their investment returns would have shown an even more material decline.”

S&P was able to assess how reinsurers’ capital adequacy was affected by the economic impact of the COVID-19 pandemic by performing a stress test, which shows that most of the top 20 global reinsurers would retain a smaller but positive buffer.

Evolving Asset Allocation

The lower-for-longer interest rate environment has led large reinsurers to modify their investment guideline over the past decade, deliberately choosing to invest more in riskier assets, intended to offset the gradual dilution of their investment yield.

The report noted that risky assets rose from just over 5 percent of reinsurers’ investment portfolios in 2011 and represented 13 percent at the end of 2019, which S&P described as a manageable level.

The ratings agency view the capital adequacy of the top 20 global reinsurers as robust.

S&P defined risky assets as listed and private equities, real estate and alternative investments. The report said that listed and private equities are the most common risky assets in reinsurers’ portfolios, accounting for 9 percent of total investments.

Reinsurers also moved into illiquid assets, which are defined as real estate, hedge, private equity and loans. S&P said it considers the current level of just over 7 percent of total invested assets to be manageable. At year-end 2015, the figure for illiquid assets was less than 6 percent.

“The gradual shift toward these riskier and more illiquid assets has helped reinsurers to generate additional return and slowed the decline in their investment returns,” said S&P in the report.

The whole insurance industry experienced a dilution in yields as a result of years of lower interest rates, “but the reinsurance sector was hit faster because their business is shorter-tail in nature,” the report said. “Many primary players are very active in the long-term savings business; by contrast, reinsurers have limited exposure to this line of business.”

Since COVID-19 started to spread, S&P said it has conducted stress tests to measure the sensitivity of re/insurers’ capital to volatility in the financial market. “We consider the reinsurance sector to be more resilient than the global insurance sector….,” said the report.

(To measure the potential impact of the economic effect of the pandemic, S&P said it set up a range of stressed assumptions covering the main asset classes to which reinsurers are exposed: equities, bonds, real estate, and loans. “We compared the outcome of our stress tests with the year-end 2019 total adjusted capital available to determine how well the various players will weather the crisis. This gives us an indication of which ratings could be at risk.”)

“Our stress test suggests that, based on their investment portfolios, the Top 20 reinsurers are in a good position to navigate the crisis. Taken as a whole, we anticipate that capital adequacy will be reduced by a manageable amount that will still enable most reinsurers to meet their respective targets,” S&P continued.

Impact on Smaller, Less Diversified Reinsurers

Although the aggregate figures show a relatively healthy picture, S&P said, this conceals a “variation across the groups and at an individual level.”

Half of the top 20 reinsurers have excellent capital adequacy, in our view, and we forecast that nine of them would still have a positive buffer after our stress test,” said the report. “The players whose capital buffer could be exhausted under our stress test are typically smaller or less diversified regional reinsurers that have lower capital adequacy assessment.”

For some of these, the pressure on their credit quality could even trigger a rating action, said S&P. “That said, we take rating actions after considering a wide range of metrics. Investment-related risk is important, but far from the only factor we would consider.”

*This story ran previously in our sister publication Insurance Journal.