Insurers in Europe have increased their exposure to risk in the bond markets, prompting concern at the European Insurance and Occupational Pensions Authority.
Twenty-seven percent of their bond holdings last year was rated BBB+ to BBB-, the lowest rung of investment-grade ratings, up from 11 percent in 2011, EIOPA said in a report Thursday. The portion of the safest bonds in their portfolios dropped over the same period and their exposure to higher-risk assets rose, the regulator found.
The EIOPA is closely monitoring their investment behavior to prevent excessive risk-taking as insurers search for yield in a low interest-rate environment, chairman Gabriel Bernardino said in a statement. The regulator found the portion of AAA-rated assets in their bond portfolios dropped to 18 percent last year, from 40 percent in 2011.
“When it was mainly AAA-rated investment grade portfolios, one of the risks was just that interest rates changed, and, if they rose, the value of the portfolio would fall and that would go on your balance sheet,” Daniel Banks, a director at U.K. investment consulting firm P-Solve, said in an interview. “Now, although you do still have interest rate risk, you have more downgrade risk.”
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Should the bonds they hold tumble into the high-yield, high-risk category, insurers will be forced to set aside more cash because of regulations governing risk, according to Banks.
“Unless you want to commit more capital to that bond, you have to sell it,” he said. “But you’ll be selling it when the yield has risen, so you’ll be making a loss on that bond.”
Insurers have sought to diversify their investment portfolios, with many targeting long-duration assets to provide a better match to their liabilities, according to Iain Forrester, head of insurance investment strategy at Aviva Investors.
But they’re also taking on more risk. The EIOPA study showed that the portion of assets in their bond portfolios with below-investment-grade ratings rose last year to 8 percent, from 5 percent in 2015.
A spokeswoman for the Association of British Insurers didn’t immediately provide comment.