Rising interest rates, inflation and geopolitical instability are among the high winds currently buffeting the financial industry and presenting underwriting with new challenges. In a recent IB Talk podcast, Chris Unwin, director at Travelers Europe and Sam Meehan, development underwriter at Travelers Europe, revealed how these conditions are impacting financial institutions: including asset managers and insurance companies.
Looking first at insurance companies, Meehan highlighted that factoring in specific investment approaches, it’s a fair presumption that high-interest rates should lead to a better return on investment while, on the flip side, also leading to claims inflation. This will impact all lines of insurance, he said, but some will more quickly and easily identify that than others.
“Property claims, as an example, have almost immediately been materially impacted,” he said. “In the UK, we experienced an unprecedented increase in construction materials inflation, which peaked at 26% in June last year. Now long-tail lines might not move as quickly as this but certainly things like solicitors’ fees, impact and defence costs and settlements will impact claims inflation.”
Inflation and interest rate increases will materially impact every strategy that asset managers review and write, he said. And this will be a compounded issue when leverage has been adopted. Touching on some of the areas that Travelers Europe deals with, he highlighted that private equity hasn’t seen the same level of activity that it did last year, which saw it hit record highs.
Q1 of this year saw the value of M&A deals drop by 45% year on year. 2023 started slow, Meehan said, but the banking crisis did compound conditions. Of the PE risk that he’s seeing, he has noticed an increase in trade buyers as opposed to financial buyers, which may be due to increased interest rates among other macro issues.
“And at a portfolio company level, the knock-on of these could also lead to an increase in insolvencies, which is of concern,” he said. “Credit funds with respect to new transactions, similar to the impact on banks - higher returns with potentially higher defaults.
“Alternatively, there may be funds dominated by old transactions at low interest rates that now face underperformance issues. This could lead to increased redemptions and issues from that. And real estate funds being another obvious strategy affected. We’re always conscious of LTV ratios and refinancing run rate in these. And that’s now materially hardened.”