Dramatic increases in interest rates worldwide have significantly affected the balance sheets of some insurers at midyear 2022; in particular, according to a recently published Best’s Commentary from ICMIF Supporting Member AM Best. Insurers using a market-value approach on their balance sheets saw significant declines in available capital.

The Best’s Commentary, Impact of rising interest rates on insurers’ balance sheets will depend on accounting methods, notes that unrealised losses in the first half of 2022 totalled more than USD 200 billion. At the same time, the impact of rising interest rates on insurers’ fixed-income assets has depended on the accounting method employed. For some US insurers, the effect also depended on the type of bonds held, as statutory reporting uses amortised cost for investment-grade bonds, but market value for some non-investment-grade bonds. The analysis showed that insurers using an amortised cost approach showed no impact on available capital.

“AM Best’s approach is to make these metrics and tools consistent. In this situation, however, the choices are at opposite ends of the spectrum, with one extreme showing the full impact of rising interest rates on the entire fixed-income asset portfolio, and the other extreme showing no impact at all,” said Thomas Mount, Senior Director, AM Best.

The commentary notes that AM Best’s rating analysts can manually adjust an insurer’s available capital in Best’s Capital Adequacy Ratio (BCAR), if using the unadjusted available capital significantly affects the BCAR assessment or if the need to sell fixed-income assets at a loss is not sufficiently captured. In addition, discussions with the insurer about its views of the risks associated with rising interest rates, in addition to any stress testing and mitigation plans in effect, are part of the enterprise risk management component of AM Best’s rating process.

Financial leverage is another metric that can be distorted by the impact of rising interest rates. Essentially, financial leverage represents the amount of debt an entity has outstanding relative to its total available capital. To reflect any accounting differences, AM Best will review financial leverage metrics using available capital that includes and excludes the impact of rising interest rates. Significant divergence in these calculations may require additional dialogue with the insurer.

AM Best does not expect that many of its ratings will be affected negatively by the rising interest rates given the strong starting capital of most insurers, as well as positive cash flows, additional sources of liquidity, strong risk management and their ability to hold fixed-income assets to maturity.

To access the full copy of this commentary, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=325623 .