European insurers are having trouble adjusting to life in the land of Zirp.
While 2008 insurance results were all about impairments, the latest round of Euro insurer figures show a growing preoccupation with yield.
Munich Re, RSA Swiss Re and Zurich, for example, have all reported third-quarter earnings impacted by lower levels of interest. Various strategies for “mitigating falling yields” have cropped up in recent insurance presentations.
This, BNP Paribas credit strategist Rafael Villarreal argues, is a signal: the quest for yield has begun a-new.
Life insurers and pension funds need long term assets to match their long term liabilities, meaning investments in long-dated government bonds are key. Non-life and reinsurers meanwhile have short to mid-term liabilities, meaning liquidity is their key consideration. This in turn, leads them to invest in short to medium term government bonds where yields have fallen even further.
At a time of near-zero interest rates it is easy to forget that falling government bond yields are part of a longer-term trend (as the chart below shows).
The returns on these investments are not enough. Now that the pyrotechnics of exploding structured products are starting to fade, insurers are again having to face up to the yield problem.
This must involve moving down the ratings ladder, switching away from AAA-rated bonds into riskier territory to achieve the yield needed to operate profitably. Villarreal notes that recent years have seen insurers move:
. . . from a policy maintained for most of their histories . . . of investing in only AAA and AA rated securities, to step down to A and then on to BBB-rated securities. Some added what they thought were solidly rated structured products only to find out otherwise later on but the proportions in structured assets is small.
In moderation this is no bad thing. Lower-rated companies will gain extra access to capital, while insurers diversify their assets and make higher returns.
But, chasing the yield curve can be like chasing the horizon, with every further step down the ratings chain reducing risk premiums as a whole.
That, as we all know, can sometimes get a little messy.
Related links:
Delusions, corporate credit edition – FT Alphaville
Globally zirped – FT Alphaville