The screen was not a pretty sight this morning.
There was an interesting article last week in the Actuarial Post about the impact of the crisis on life insurers. Unfortunately they got the main point wrong, arguing that the asset side would be hit by “declines in bond yields”.
That’s completely wrong. As equities tank, the loss-absorbing buffer of equity capital is eroded, the perceived risk to debt capital rises, so bond yields rise, rather than fall. Insurers with long dated exposures will be unaffected, so long as the fixed cash flows on the bonds are maintained.
However there are two other toxic effects of the market crash. First, there is the possibility that bond issuers will default if unable to refinance, in which case the insurer loses the entire value of the bond that is not recoverable. Second, and this may well be a much worse effect, is that lower investment grade bonds will be downgraded into sub-investment grade, meaning the insurer will be forced to sell – either because of regulatory rules or because of internal covenants – and buy higher rated bonds at a higher price. This causes a realised loss that can never be recovered.