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The Actuary The magazine of the Institute & Faculty of Actuaries
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Sovereign debt exposure could prompt insurer downgrades

AM Best recently undertook a stress test of a representative sample of major European insurers' exposure to sovereign debt and other investment vehicles within Europe.

Slower growth within Europe's major economies has increased the possibility of a double-dip recession and exacerbated the sovereign debt crisis in a number of Eurozone countries - namely Portugal, Italy, Ireland, Greece and Spain.

The stress test-performed using AM Best's proprietary capital model, Best's Capital Adequacy Ratio - was undertaken due to the severe market turbulence in July and August 2011, and the outcomes are reported in its publication European Investment Stress Test Flags Sovereign Debt Risk.

Although AM Best does not employ a sovereign ceiling, sovereign debt downgrades are considered when assessing the financial strength of an insurer. The recent market volatility has highlighted to European insurers and reinsurers the increasingly challenging investment and economic environment in which they maintain critical operations.

The report says:"Many major European (re)insurers have progressively reduced their exposures to Portugal, ireland and Greece inthe past year so that sovereign debt of these countries only represents approximately 1% of total investments and less than 10% of shareholders' funds of the insurers tested.

In isolation, these now reduced exposures did not have a significant impact once stressed, but larger exposures to Italy and Spain resulted on greater falls in risk-adjusted capitalision. italian and Spanish sovereign debt represents appoximatley 7% of total investments and more than 50% of shareholders' funds of these companie, with Italy in particular representing a competitive market amoung the large European (re)insurers."