Reinsurers could find themselves exposed to increased investment risk that damages their balance sheets to as they bid to increase their earnings, Fitch Ratings warned today.
The generally cautious approach taken to investment risk was a key factor in the reinsurance sector maintaining its credit ratings in the face of unprecedented catastrophe losses last year, the agency said in a note.
In particular, the sector has actively reduced its investment exposure to troubled countries on the periphery of the eurozone. It has also sought to lower its solvency volatility by ensuring assets and liabilities are matched as much as possible, as well ensuring strong liquidity by holding substantial cash balances.
This, however, has resulted in low-single-digit levels of investment return and Fitch said it expects the earnings pressure reinsurers will face next year to 'distract' them into trying to earn more through 'potentially higher-yielding - but unintentionally riskier - investment strategies'.
The note stated: 'Increased earnings pressure in 2013 - through a combination of continuing low investment yields, reduced technical profitability and diminishing prior year reserve surpluses - could tempt reinsurers to seek higher returns through shifts in investment strategies.'
It noted though the current macroeconomic uncertainty had little historical precedence, in particular in relation to the eurozone sovereign debt crisis and close-to-zero bond yields in most major economies.
'This could result in reinsurers increasing exposure to assets that ultimately prove to be more greatly exposed to a deterioration in the macroeconomic environment, serving to weaken reinsurers' balance sheets,' it explained.
Fitch added that, if reinsurers had carried more risk in their investments when they faced last year's catastrophe losses, the sector might have seen a greater number of negative credit rating actions that had actually been the case.