High volatility and falling asset valuations in financial markets can have a significant impact on insurance companies’ balance sheets.
These companies’ investment portfolios are dominated by fixed income securities. A sharp increase in risk premiums on these securities has a direct impact on their valuation, which falls sharply, all the more so the longer the durations of the bonds they hold in the portfolio. It should be noted that risk premiums may be affected by various influences, the two main factors being the state of liquidity of the financial markets and, closely related to this, the perception of a possible credit or insolvency risk affecting the counterparties involved in bond investments.
In jurisdictions with a risk-based solvency regulation system, such as the European Union, there are mechanisms to correct the effects of occasional bouts of market volatility on insurance companies, given their character as long-term investors. These mechanisms seek to prevent them from having to make forced sales in times of financial market turbulence, with their consequent pro-cyclical effects. The business model of insurance companies leads to the maturities of their investment portfolios being largely aligned with the estimated payment path derived from the commitments assumed in their insurance contracts, so that these assets can be conserved until they themselves reach maturity.
The measures taken by the major central banks worldwide are largely helping to solve the problems of liquidity shortages in bond markets, allowing these markets to continue to function properly. Issuing companies and states can thus continue to place their issued products in order to gain access to the liquidity needed to deal with the situation they face and, most importantly, to be able to refinance their debts at a reasonable cost.
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