Today’s low investment yields are leading to a false sense of security as regards the underlying capital strength of the global reinsurance industry.
Ultra-low interest rates have driven up the value of fixed interest investments, which has allowed many reinsurers to derive their recent investment returns more from capital gains than interest payments. So long as interest rates remain at their current level the capital appreciation will remain—though one has to wonder if any further capital appreciation is possible with the current rock-bottom interest rates.
What is much more concerning is that when interest rates start to rise, the capital appreciation on the fixed interest investments will collapse, leading to a rapid reduction in the asset base of reinsurers. To make matters worse, there is the strong possibility that an increase in interest rates may coincide with an increase in inflation, impacting the reserving levels of reinsurers with longer-tail liabilities. What is of real concern is that this scenario is well known and clearly seen by many market participants, but no real action is being taken to address this impending cliff edge.
|This post was part of the special feature about Our Scariest Risks, published October 29, 2012. The feature also included these other risks:|