JV with Indian insurers due to recession: S&P

JV with Indian insurers due to recession: S&P
Our Banking Bureau
1 August 2002

Chennai: Global life insurers Sun Life Assurance of Canada, Prudential of the UK, Nationwide Life Insurance of the US, apart from their business, have two more things in common. That is, all of them have a business tie-up with Indian companies joint ventures and others and all have got their rating revised downwards by the global credit rating agency Standard and Poors (S&P).

The Sun Life group has a life insurance joint venture with the Birlas (Birla Sun Life Insurance) in India, and Life Insurance Corporation (LIC) will act as a corporate agent for Nationwide. Prudential has an Indian life insurance joint venture with ICICI.

In the recent times one finds S&P revising its outlook for life insurers across the globe. First it was the Japanese life insurance industry. It was soon followed by Swiss, German and UK life insurance sectors in Europe. And now it is the turn of US and Canadian life insurance industries to get the negative outlook rating from S&P.

The one common reason that permeates all these outlook downgrades is the volatility of stock markets and the insurers overexposure in equity assets.

Curiously, S&P now has either a negative CreditWatch or outlook on about one-third of the US life insurers that it rates. The rating agency has placed its ratings on four groups of life insurers on CreditWatch with negative implications and revised its outlook on six insurers to negative from stable.

A CreditWatch action with negative implications puts a company under increased surveillance for a possible downgrade in the short term. An outlook indicates the likely direction of a rating over a one-to-three-year time horizon.

These actions reflect strained capital adequacy at a number of companies, because of increased losses on credit instruments, lower values of equity holdings, increased reserving requirements for life-insurance minimum-death-benefit guarantees, and growth in fixed-annuity products, says states S&P. At the same time, insurers are contending with earnings pressures on products with fixed payouts, lower fees on variable products, and write-offs of the intangible asset known as deferred acquisition costs.

In its mid-year 2002 outlook on the US life insurance industry, S&P warned that stock-market shocks could lead to rating consequences for companies that are heavily dependent on equity market appreciation. Since then, the downtrend in equity markets has accelerated sharply, with both immediate and long-term adverse effects for a number of insurers included in todays rating actions.

Falling stock values affect life insurers both directly and indirectly. There is direct exposure through investment portfolios and for writers of variable annuity products, there is a decline in fee income. In addition, because of lower projected profitability in this product line, insurers are expected to accelerate the pace of acquisition costs.

As a matter of fact Britains Prudential groups rating went a notch down because of its US operations. S&P in its mid-year outlook on US in general noted that overall credit quality among corporate bonds was declining and cautioned that a continuation of this trend could become a problem for the industry.

Recent defaults by several prominent corporate-bond issuers on their debt have brought this factor into play, resulting in an overall decline in the credit quality of the life industrys fixed-income portfolio.

Though S&P says that its rating process is not tied to market sentiment, the latest rating actions signify the need for increased surveillance of insurers exposed to equity market volatility. S&P agreeing that the Canadian life and health insurance industry to be among the most financially strong in the world maintains a negative outlook on the sector.

Several challenges continue to face this highly rated industry, including: the continued pressure for insurers to increase their ROE, negative credit market trends, pressure on wealth management businesses due to continued softness in the global equity markets, market overcapacity, and risk associated with industry consolidation.

Although many companies in the industry remain strong, with substantial capital bases, improved operational efficiency, and strong sales trends in fixed products, there are several companies that are disproportionately exposed to risk, says Canadian life sector analyst Donald Chu.

In Europe S&P has revised its outlook on the life as well as non-life insurance groups to negative from stable. The rating actions mark the second tranche of outlook changes in as many weeks, with the outlook on up to 50 per cent of all rated life and non-life European insurers now negative, says Rowena Potter, a managing director at S&P Financial Group, London.

Again the reason is the sharp fall in equity values and continued volatility since the end of June 2002, resulting in persisting uncertainty in the capital markets and leading to the current rating actions. According to S&P the stock market falls and the continued uncertainty over asset values has reduced some European insurers financial flexibility to source new equity or debt capital relative to the capital requirement associated with their current rating levels.

Within Europe the German and Swiss life insurance sector downgrades are like to outpace upgrades over the next one to three years, says S&P. Allaying the fears expressed by other analysts about the solvency position of life insurers of these two countries, S&P is of the view that such concerns are exaggerated for securely rated life insurers.

Nevertheless, the depth and duration of the bear market will inevitably impact some insurers more adversely than others. This is especially true for those companies that substantially expanded their equity investments in recent years and whose asset-liability management techniques are not highly developed, says S&P.

The current state of the capital markets presents a particular challenge for life insurers, as their two main roles acting as capital gatherers and, at the same time, as investors are impacted.

Depressed capital markets are negatively affecting the insurers historically high asset value reserves, while at the same time reducing their capital strength and financial flexibility to raise capital and debt. In addition, the industry is finding it increasingly difficult to continue to smoothen high client bonus allocations and profit results.

In Germany though there has already been substantial pressure on life insurers in recent years because of low interest rates and strong competition, the situation was expected to ease from 2002 following the anticipated boom in private pension business as a result of the pension reform, which encourages individuals to purchase supplementary private insurance.

However, the business expansion has proven to be slower than expected and the only positive effect being that lower new business volumes also alleviate pressures on capital that would be accompanied by more rapid growth. Furthermore, the reduction in asset value reserves might result in sharper cuts in policyholder bonuses than would otherwise have been the case.

S&P expects a market consolidation of the weaker players, but at the same time the German life insurance industry as a whole remains solid, says Wolfgang Rief, a director at S&P Financial Services Group in Frankfurt.

On the other hand the Swiss group life insurance sector suffers from structural problems, putting additional pressure on the earnings prospects of companies active in this sector during periods of depressed investment returns, says S&P analyst Karin Clemens. Most Swiss life insurers have taken steps to protect their capital against stock market volatility. These include some reduction in equity exposure, as well as the use of derivative instruments.

Nevertheless, some ratings might be lowered, albeit by only one or two notches, if a prolonged period of stock market falls, coupled with reduced opportunities for capital and debt raising, result in a permanent reduction in companies financial strength.

In the group life market segment, Swiss life insurers have historically relied on appreciation in asset values to bridge the gap between the required minimum yield and (lower) Swiss bond yields. The decline in equity values from 2000-2002 has meant that, in recent years, Swiss life insurers have been obliged to subsidise this investment yield gap for this business class at the expense of other policyholder classes and shareholders.