SpotLight: Insurance Bonds: Approaching Inflection Point
Higher rates support Solvency Positions
In January, we likened the sub insurance market to Schrödinger’s cat, neither dead nor alive. Now the cat has jumped out of its box but it is not the cat in the hat. We rather believe it is set to make a decent leap forward preying on yield as we get closer to a good entry point after bond valuations suffered from rising interest rates and the war in Ukraine. The FY21 results and Solvency II ratios of insurers already showed a tendency towards an overcapitalisation of the sector and several insurers maintained or initiated share buyback and debt reduction programs. We consider these together with dividends as the first line of defence against potential pressure on Solvency II ratios. As we wrote earlier in the year, rising interest rates usually support the Solvency II ratios of insurers. Not all insurers give quarterly updates on their Solvency II ratios and disclose the impact of interest rates on their Solvency II positions, but Q1 22 results support our view that the insurance sector is better capitalised than at the beginning of the year. The positive effect of rising interest rates was also stronger than other market movements such as losses on the investment side.
The most significant Solvency II ratio increase was reported by CNP. Its Solvency II ratio moved 26ppts upward of which 20ppts were driven by interest rates. The insurers which reported lower Solvency II ratios in Q122 explained the decline with idiosyncratic issues, a generally less interest rate sensitive business and active capital management, i.e. share buybacks. The strongest decline so far was at Allianz reporting a drop in the Solvency II position by 10ppts in Q122 following share buybacks but also the recognition of an additional reserve for the settlement with regards to Structured Alpha of EUR1.9bn or 7ppts in Q122. The issuer disclosed that the interest rate impact on the Solvency II ratio was positive which is in line with its published Solvency II sensitivities.
Manageable underwriting losses from the war
Disclosures of losses from the war in Ukraine gave so far no reason for concern. We note that these disclosures were not consistent across the sector and do not yet include all exposures. Local insurance operations by the issuers in our universe are generally small. Relative to the group size, UNIQA and Vienna Insurance Group are most exposed, but premium income from Russia and Ukraine has only been in the low single percentage region. Several insurers like e.g. Generali and Allianz have already divested or started to divest most of their Russian entities.
Underwriting losses from the Ukraine war are estimated to amount to USD10-20bn but likely to be closer to USD10bn according to several issuers. This amount is comparable to a mid-sized natural catastrophe event. Some uncertainty remains in the Aviation business and most insurers have so far not recognized any reserves for losses in Aviation business. Especially aircraft leasing companies could report major claims as aircrafts which are leased by Russian airlines are being held back in Russia. It is still unclear whether insurance claims have formally incurred. The situation is exceptionally complex and differs between individual insurers and policies. We expect settlements to take several years. Still we note that aviation business is a relatively small line of business for most insurers in our coverage. Any adverse development is unlikely to turn into a capital event.
Impairments partly shared with policyholders
Asset revaluations from the Ukraine war have also been manageable. While gross numbers look high in absolute terms (e.g. EUR 700m for Munich Re) impairments occurred mostly in the life insurance segment where some of the losses will be shared with policyholders.
Primary market coming back to life
Against this background the primary market came back to life in the second half of May after hibernating for several weeks and several large issuers came to the markets with benchmark size T2 issues. AXA issued a EUR1.25bn T2 bond to refinance the redemption of two bonds which were issued by XL before the group was taken over by AXA. The redemption will require a make-whole call, i.e. AXA redeems the bonds at a significant premium to market value. We consider this to be a sign of confidence. Allianz issued a EUR1.25bn T2 bond to refinance the upcoming call of a legacy perpetual. Munich Re came unexpectedly to the market and issued for the first time a USD denominated T2 of USD1.25bn. The deal slightly increases leverage which remains, however, below peers. Athora came to the market with a EUR500m T2 issue to fund the tender of a legacy perpetual. All new issues performed positively in the first days of trading and outperformed the market allowing investors – unlike in the previous months – to realize a good new issue premium. The picture changed slightly in June when Vienna Insurance Group came to the market with a T2 and Aviva with an rT1 new issue. Both did not perform in the first week in a weak trading environment. In our view, the recent new issues remove a backlog that piled up over the last weeks and that backlog had to be cleared before the market can return to business as usual. In addition, we note that many funds sit on elevated cash levels to be prepared for redemptions.
High spreads serve as additional protection
Spreads of Insurance Bonds have reached levels not seen since the dip in March 2020, when a sell-off occurred across markets due to the pandemic. The yield levels on a EUR-hedged basis are close to 4% in the Bloomberg Insurance Subordinate Total Return Index and are much higher in certain sub-segments of the market such as restricted Tier 1. We consider this level attractive bearing in mind that most issues on this index are rated investment grade. These elevated spread levels should give additional comfort to investors and will serve as protection against potential further spread widening. Investors are now able to benefit from higher spreads at higher Solvency II ratios compared to the beginning of the year.
Rötger Franz, Partner, Plenum Investments Ltd.
Kind regards
Your Plenum-Team
Your sincerlely
Plenum Investments Ltd.
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