A prominent effect of the global slowdown has been pressure on countries’ tax revenues and difficulty in financing national budgets. The southern European periphery and Ireland have been particularly susceptible to heightened risk premia. While Greece obtained a funding package from the European Union and the International Monetary Fund (IMF) in March, it has been speculated that the likes of Spain and Italy are simply “too big to save” given current central bank and IMF resources in a similar event (1).
The result of this uncertainty has been (re)insurers moving towards higher-grade investments such as Swiss, U.S., German, Japanese and British government bonds. These low yielding assets, which now dominate sector portfolios, are perceived as less risky but offer lower investment returns. In this environment of declining investment income, together with lower growth expectations in certain lines, underwriting results will be even more central to carriers’ earnings profiles. Figure 1 shows the striking contrast in existing yields between higher-grade sovereign debt and those in or exposed to the European periphery.
Even as yields remain low, companies’ “flight to quality” into higher-grade fixed income securities continues unabated. Reinsurers are more conservatively invested now than at any time in recent memory with low exposure to European peripheral sovereign debt and low equity gearing as shown in Figure 2. This has resulted in reinsurers’ portfolio yields dropping to new lows during 2012 (see Figure 3).
1 Greece’s economy recorded a GDP of EUR218 billion in 2011 with outstanding sovereign debt of EUR350 billion. For Spain, the 2011 GDP and sovereign debt balance was EUR1,073 billion and EUR735 billion, respectively. For Italy, 2011 GDP was EUR1,580 billion, while the sovereign debt balance was EUR1,898 billion. (Source: International Monetary Fund).