When insurance regulators take it easy on firms, they may be adding to their long-term credit risks, warns Moody’s Investors Service in a new report.
The rating agency published a new special comment today warning that “a global increase in cases of regulatory forbearance in the insurance industry exacerbates long-term risks for creditors.” It notes that the temporary relaxation of conservative regulatory requirements is generally aimed at limiting market disruption, but that this “is a high-risk strategy that can be credit negative”.
“Regulatory forbearance offers relief from short-term pressures and creates time for insurance companies to adapt their strategies to a challenging environment,” explains Simon Harris, managing director in Moody’s Financial Institutions Group. “In some cases, a temporary relaxation of regulatory requirements that, with hindsight, were conservative, can allow firms to continue trading and re-build capital buffers. But forbearance can also increase risk exposures and elevate risk appetite. Insurers might take more risks than regulators would typically allow and/or delay corrective action to shore up their financial positions in the face of adverse market conditions.”
For example, Moody’s says that the relaxation of regulatory standards can encourage insurers to retain deteriorating assets or businesses. It notes that in Europe, insurance regulatory forbearance in Italy, Switzerland, and the Netherlands, has focused on reducing pressure arising from falling asset values or persistently low interest rates.
“These practices may encourage insurers to retain, or even increase their exposure to assets that ultimately incur losses, or delay de-risking initiatives to reduce product guarantees or reliance on spread income,” it says. “If the affected companies fail to recover, creditors could experience even greater losses than if the forbearance had not been extended.”
Additionally, Moody’s says that frequent regulatory forbearance may reflect a weakening of regulatory control. “As regulators soften or by-pass their own controls over capitalisation, forbearance may undermine investors’ confidence, as solvency ratios become difficult to understand and predict, causing customers and investors to feel less protected,” adds Nadine Abaza, a Moody’s associate analyst for European insurance.
Moody’s says that regulatory forbearance does not affect its assessment of capital, but typically signals credit weakness. And, Moody’s notes that its evaluation of insurers’ credit profiles is driven by the credit challenges that lead to regulatory forbearance, such as falling asset values and weakened capitalisation. The ultimate credit impact of any forbearance measures “will vary depending on the economic environment, the strength of existing regulatory frameworks, market conditions and issuer specifics prevalent at that time”, it says.