Sovereign Debt Pressure Spreads to Insurers’ Balance Sheets: A.M. Best

Continuing economic weakness in Europe and the debt crisis in the United States have elevated the risk profile of U.S. insurers, stirring insurance rating agency A.M. Best to stress test insurers for how they might be affected by the ongoing economic uncertainty.

According to its Best’s Capital Adequacy Ratio stress tests, the current economic conditions are more likely to affect the balance sheets of life insurers than those of property/casualty insurers.

It is not yet clear what effect downgrades to U.S. sovereign debt might have on corporate debt held by insurers, A.M. Best said in its July 18 briefing, Sovereign Debt Pressure Spreads to Insurers’ Balance Sheets.

Sovereign debt downgrades like the one Standard & Poor’s issued on the U.S. government last Friday are one of the factors the rating agency takes into consideration when assessing the financial strength of an insurer. A.M. Best said that debt ceiling deal recently signed by President Obama “falls short of erasing all uncertainty as to the credit quality of U.S. sovereign debt.” Its stress test considered the possibility of a sovereign rating downgrade more severe than what has occurred to date.

A.M. Best said its stress test showed that less than two percent of all P/C rating units potentially could have their ratings affected.

The biggest threat to balance sheet strength would occur if the market value of fixed-income assets declined because of an increase in interest rates. The impact on capitalization was less for P/C companies compared with life/health companies due to the lower asset leverage, as well as the need to hold shorter term, more liquid investments, the firm said.

Those P/C insurers most likely to be affected by the economic stress scenario told A.M. Best that they are not altering their investment strategies, but they would find additional capital to offset any deterioration in their balance sheets by possibly obtaining funds from parent companies and affiliates, raising equity, and retaining earnings.

“These strategies illustrate that in addition to a strong balance sheet, explicit support from parents and affiliates, strong financial flexibility and strong operating performance are needed to survive an economic downturn,” said A.M. Best in its report.

Stress testing had a more significant impact on life/annuity BCAR ratios. On July 19, 2011, A.M. Best indicated that it was considering a revision in the rating outlook for the U.S. life/annuity sector to negative from stable.

A.M. Best said it will continue to review each company on a case-by-case basis and take rating actions accordingly.

A.M. Best has a video briefing on its Web site discussing the issues addressed in the most recent briefing.