Low interest rates together with highly liquid and stable financial markets have prompted European insurers to tap the capital markets in their efforts to lower the cost of capital and optimize levels of risk-adjusted capitalization, according to a new report from A.M. Best.
The A.M. Best report, titled “A.M. Best Examines Debt Trends in the Capital Structure of European Insurers,” states that some European insurers have been rebalancing their capital positions ahead of the introduction of Solvency II.
New hybrid debt instruments have been structured in line with the requirements for capital credit under the new regulations, the report said. However, as the Jan. 1, 2016, deadline for implementation of the insurance directive approaches, Solvency II is likely to become less of a driver for insurer debt issuance.
The report’s findings were based on in-depth analysis of over EUR 90 billion ($99.1 billion) of debt issued by European insurers between 2005 and 2014.
The conclusions drawn in the study, which focuses primarily on rated debt issued by A.M. Best clients, is considered representative of the overall European insurance debt market, according to the ratings agency.
The research also notes that debt issuances are commonly several times oversubscribed.
“The current interest rate environment is causing investors to search for yield, with limited opportunities to obtain even reasonable returns,” said Stefan Holzberger, managing director, analytics.
“Insurance debt is attractive as it offers relative security and insurers have tended to avoid many of the issues that have plagued the banks,” he added. “In general, insurers have strong free cash flow ratios, enabling good service of interest and steady payment of dividends. This is despite the general understanding that insurance market conditions are soft, growth levels will be modest at best, and returns are under pressure.”
However, the insurance debt market is likely to remain active as European insurers’ capital management efforts lead to continued opportunistic redemption and refinancing activity.
“In recent years, European Union insurers have improved their ability to manage down both operating and financing costs – a necessity in today’s highly competitive, low growth environment,” said Yvette Essen, director, research & communications.
Factors likely to influence issuance activity in the remainder of 2015 and into 2016 include changes in interest rate policies by the U.S. Federal Reserve, the Bank of England and the European Central Bank (ECB), the report said.
Quantitative easing-related purchases by the ECB, together with reduced corporate and sovereign debt issuances, have engineered an acute shortage of highly rated assets in Europe. A.M. Best expects these conditions will fuel continued demand for insurer debt and keep issuance costs low, but also remove much hope of a badly needed rise in investment income.
Source: A.M. Best
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