Things are far from rosy in the European life insurance sector. Buffeted by profit warnings, huge investment losses and falling solvency ratios, and with shares being picked on by the hedge funds, the sector has embodied all the wild volatility of global stock markets in recent weeks.
But the slump in July, sparked by profit warnings at Aegon and Fortis, took even the bears by surprise. Few names in the sector went unscathed: Axa, Zurich, Skandia and Prudential also took a pounding. And although the subsequent bounce in global stock markets prompted a rally, analysts believe there is plenty more downside.
Rising capital adequacy problems as a result of increasingly heavy investment losses from the stock and credit market deteriorations are the key worry. “Capital adequacy is at an all-time low,” says Andrew Ritchie, European insurance analyst at specialist investment bank Fox-Pitt, Kelton.
Lurking problems
Also rising fast is the concern that credit risk – whether through corporate bond investments or through the assumption of banking risk through credit derivatives, collateralized debt obligations and other forms of risk transfer – has stored up other, so far unseen, problems.
Aegon’s profit warning was partly caused by losses on corporate bonds. It took a $200 million hit on WorldCom. With its higher than average investment in fixed income, and its substantial US operation, Aegon is particularly vulnerable to the credit downturn.
But big equity holders are in an even worse state. Fortis said last month that its investment portfolio had fallen below cost value for the first time ever. And Axa’s investment portfolio, which was showing a e10 billion unrealized gain at the start of the year, is now reckoned to be some e1 billion negative.
Falling solvency ratios are raising two concerns: first, that the life companies will become forced sellers of equities, exacerbating the downward pressure on stock markets; second, that a number of companies will be forced to raise new capital, either in deeply subordinated debt or in equity.
Analysts say the most vulnerable companies from a capital adequacy standpoint include Zurich, Axa, Swiss Life, Royal&Sun Alliance, Aviva (the former CGNU) and Aegon. Both the Swiss and German life insurance sectors have been put on negative outlook by Standard&Poor’s and analysts fear there is worse to come.
“We’re not out of the woods yet,” says Ritchie. Although operating earnings are generally holding up well in the sector, investment losses are causing some very nasty surprises. Added to which, the activity of the hedge funds is not making life any easier.
Brokers say the sector has been heavily targeted by hedge funds in recent weeks. The funds have been shorting life company stocks, because of their heavy gearing to equity markets, and buying indices as a hedge.
“This is a sector where no-one really understands the accounting, and which is particularly sensitive to market movements,” says one analyst. “As a result it has been one of the most active sectors for hedge funds.”
Perhaps in retaliation, a growing number of insurers have stopped lending stock to hedge funds. Market sources say Axa and Allianz have both stopped in recent weeks. “It’s going to get increasingly hard for people to borrow stock,” says one broker.
