Life & general insurers to face higher asset risk charges on a sovereign downgrade

Life & general insurers to face higher asset risk charges on a sovereign downgrade | Insurance Business

Life & general insurers to face higher asset risk charges on a sovereign downgrade
Life and general insurers are at risk of getting higher asset charges in the event of a sovereign downgrade, Financial Standard reported.

Standard and Poor’s (S&P) Global Ratings has revised the Australian sovereign rating outlook in July from ‘stable’ to ‘negative,’ implying a one in three chance of a ratings downgrade. As a result, the ratings agency has also revised the outlook of Australian major banks’ AA- ratings and New South Wales, Victoria, and Australian Capital Territory state governments’ AAA-ratings from ‘stable’ to ‘negative,’ the report said.

Darren Langer, senior portfolio manager – fixed income at Nikko Asset Management, noted the downgrade would potentially impact insurance companies that are required to comply with the Life and General Insurance Capital (LAGIC) Standards introduced by the Australian Prudential Regulation Authority in (APRA) 2013.

"The credit stress portion of LAGIC's overall asset risk charge (ARC) is rating-based so any downgrade of the Australian major banks and state governments would have consequences for Life and General Insurers under the existing legislation," Langer said.

"It is possible that APRA might adjust the current LAGIC rules to account for a downgrade. However, in the absence of any adjustment, we have conducted analysis on a model portfolio to assess the potential outcomes for Life and General Insurers should a downgrade occur."

The analysis found that under the current ratings, “the LAGIC credit stress charge would be approximately 2.15 per cent” but “would increase markedly” under increased stress strategies.

Langer said there is not much insurers can do to avoid an increased LAGIC credit charge without APRA amending the rating tiers, particularly if they wished to retain their current asset allocation.

"There are potential courses of action that could help minimise a credit charge increase, such as to maintain interest rate duration through the use of derivatives, while reducing credit duration by owning shorter maturity securities. However, this is likely to reduce portfolio income, which at a time of already low yields might be unpalatable,” Langer said.

"Given the potential for a significant increase in the LAGIC capital charge, we believe it would be in most insurers' interests to enter into discussion with APRA about the consequences of a downgrade before it happens.”

"It may be the case that APRA will consider amending the rating tiers should this occur. At the same time, we think it prudent for insurers to be exploring the potential outcomes for their portfolios with their asset manager, as well as possible strategies for managing any changes.”

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