Ratings firm reports industry's diversified fixed-income holdings are vulnerable as credit losses spur downgrades
Despite holding diversified fixed-income assets, Canadian life insurers’ portfolios are in danger of degradation as slowed-down economic activity and extreme market volatility heighten credit risks, according to DBRS Morningstar.
In a new commentary, the ratings firm noted that insurance companies generally have highly diversified fixed-income portfolios, with exposures spread across asset classes, industry sectors, geographies, and credit ratings. Public and private investment-grade bonds, as well as commercial loans, frequently make up a large percentage of their portfolios, the firm added.
Citing data from MSA Research, the report said that within Canadian Life and Health Insurers’ investment portfolios totalling $832 billion, 68% are held in bonds. As of 2019, they had a reported $93 billion in private placements, $244 billion in publicly listed corporate bonds, and $228 billion in bond securities issued by government and related entities.
But the coronavirus pandemic’s chilling effect on global economic activity, as well as turbulence in financial markets, has increased risks in credit markets.
The considerably wide spreads in investment-grade and high-yield corporate bonds that erupted toward the end of Q1 have not fully recovered, with significant variation still present across industries and countries.
“Market dislocations and lack of information due to suppressed business activity has likely delayed the valuation of some asset classes,” DBRS Morningstar said, pointing to segments such as private placements, long-duration bonds, and commercial mortgage loans.
Downgrades are occurring across sectors, particularly those that have suffered disproportionately from government shutdowns or are facing bleaker perceived business prospects.
There are some shards of light. Unprecedented fiscal stimulus measures from governments are relieving some of the credit pressures, and life insurers benefit from downside-protection features such as covenants, collateral, and guarantees baked into some of the asset classes they hold.
“Life insurers can work directly with borrowers who are unable to meet their obligations to workout solutions, such as restructuring loans or extending maturity dates,” DBRS Morningstar said.
However, it forecast that companies will record future credit losses as they update estimates and change long-term macroeconomic assumptions over the next few quarters. The severity of credit losses will also remain uncertain as economies reopen, the firm said, adding that continued downgrades would lead to increases in non-investment-grade holdings and asset impairments over the next couple of quarters.
“Not all life insurers have the same capital buffers to absorb the increased credit risk in their fixed-income portfolios in the current economic environment,” the ratings firm said. “We consider that companies with higher-quality fixed-income investment portfolios and high capital buffers above regulatory minimums will be in a better position to absorb their credit losses.”
