Worries that rising defaults will damage corporate bond portfolios will keep pressure on the shares of British life insurers even if they are strong enough to withstand further hefty stock market falls themselves.
Shares and credit default swaps (CDS) in Britain's insurers have been battered this month, due to concerns that their weakening investment performance could erode solvency and force them to raise new capital.
"The main concern is the solvency issue. The lower the solvency, the less room for manoeuvre the insurer has," said John Raymond, a credit analyst at CreditSights.
Aviva has said it would still have a surplus of £1.2 billion ($1.75 billion) - as measured by the European Union Directive on Insurance Groups - if equity markets were to fall a further 40 per cent from end-2008 levels.
Rival company Prudential said it can endure the same level of stock market decline and Standard Life says its surplus would remain at £2.9 billion after such a drop.
Such cushions are relatively resilient to falls in equity markets, however, because insurers have reduced exposure and hedged their positions.
Analysts are fretting more about an expected sharp rise in corporate bond defaults.
"The insurers are holding a lot of bonds and uncertainty over defaults is not going to go away for quite some time. Share prices may well remain close to current lows until the recession is over," said Matt Lilley, an insurance analyst at Nomura.
The DJ Stoxx insurance index, which covers European life and non-life insurers, has declined nearly 53 per cent in the last 12 months, and 22 per cent year-to-date.
Big annuity providers such as Prudential, Legal & General and Aviva have the biggest exposure to corporate bonds.
"This is where the key potential risk for solvency lies," said Fitch Ratings analyst David Prowse, senior director in Fitch Ratings' insurance group.
"We've seen every company announce a strengthening of its provisioning for defaults on corporate bonds. That reduces its surplus, although on the other hand it is building in caution and we recognise that as a good thing."
Moody's forecasts the European speculative-grade default rate - or the percentage of the lowest-graded corporate bonds that default - to rise sharply to 22.5 per cent by the end of the year from around 2.7 per cent now.
Credit markets have shown rising concern about insurers' financial strength, with credit default swaps on Aviva almost doubling to 470 basis points in March, while its low-ranking subordinated CDS have blown out to 760 basis points.
By comparison, five-year CDS on Prudential are at 810 basis points, while they are 1,020 basis points on Legal & General and 350 basis points on Friends Provident.
Prudential said last week that it had sufficiently strong credit reserves to withstand defaults on its investments similar to those experienced in the 1930s depression.
Yet bankers are concerned that insurers' solvency surpluses are small in comparison to the sheer volume of assets the insurers hold on their balance sheets.
"These companies have a surplus of £1 to 3 billion and perhaps as much as £200 billion of assets on balance sheet," said one banker, who asked for anonymity because of client sensitivities.
"People are sceptical about their ability to withstand more volatility."
Insurers have some comfort against mark to market losses on their bonds under International Financial Reporting Standards accounting rule IAS39, which allows them to reclassify bonds as loans and hold them until maturity. But that rule no longer applies if the issuer defaults.
Even so, they have indicated that their solvency is in good shape, ruling out the prospect of rights issues as well as the graver possibility of government bailouts.
"Aviva's solvency position is robust and solid. Even in these extraordinary times we're a profitable business," chief financial officer Philip Scott told Reuters.
"I can see no circumstances where there will be need for a systemic bailout of (British) insurers."
Still, Scott added that recent share price volatility would continue for some time because there is often an opportunity for traders to make money shorting industry stocks.
Shares and credit default swaps (CDS) in Britain's insurers have been battered this month, due to concerns that their weakening investment performance could erode solvency and force them to raise new capital.
"The main concern is the solvency issue. The lower the solvency, the less room for manoeuvre the insurer has," said John Raymond, a credit analyst at CreditSights.
Aviva has said it would still have a surplus of £1.2 billion ($1.75 billion) - as measured by the European Union Directive on Insurance Groups - if equity markets were to fall a further 40 per cent from end-2008 levels.
Rival company Prudential said it can endure the same level of stock market decline and Standard Life says its surplus would remain at £2.9 billion after such a drop.
Such cushions are relatively resilient to falls in equity markets, however, because insurers have reduced exposure and hedged their positions.
Analysts are fretting more about an expected sharp rise in corporate bond defaults.
"The insurers are holding a lot of bonds and uncertainty over defaults is not going to go away for quite some time. Share prices may well remain close to current lows until the recession is over," said Matt Lilley, an insurance analyst at Nomura.
The DJ Stoxx insurance index, which covers European life and non-life insurers, has declined nearly 53 per cent in the last 12 months, and 22 per cent year-to-date.
Big annuity providers such as Prudential, Legal & General and Aviva have the biggest exposure to corporate bonds.
"This is where the key potential risk for solvency lies," said Fitch Ratings analyst David Prowse, senior director in Fitch Ratings' insurance group.
"We've seen every company announce a strengthening of its provisioning for defaults on corporate bonds. That reduces its surplus, although on the other hand it is building in caution and we recognise that as a good thing."
Moody's forecasts the European speculative-grade default rate - or the percentage of the lowest-graded corporate bonds that default - to rise sharply to 22.5 per cent by the end of the year from around 2.7 per cent now.
Credit markets have shown rising concern about insurers' financial strength, with credit default swaps on Aviva almost doubling to 470 basis points in March, while its low-ranking subordinated CDS have blown out to 760 basis points.
By comparison, five-year CDS on Prudential are at 810 basis points, while they are 1,020 basis points on Legal & General and 350 basis points on Friends Provident.
Prudential said last week that it had sufficiently strong credit reserves to withstand defaults on its investments similar to those experienced in the 1930s depression.
Yet bankers are concerned that insurers' solvency surpluses are small in comparison to the sheer volume of assets the insurers hold on their balance sheets.
"These companies have a surplus of £1 to 3 billion and perhaps as much as £200 billion of assets on balance sheet," said one banker, who asked for anonymity because of client sensitivities.
"People are sceptical about their ability to withstand more volatility."
Insurers have some comfort against mark to market losses on their bonds under International Financial Reporting Standards accounting rule IAS39, which allows them to reclassify bonds as loans and hold them until maturity. But that rule no longer applies if the issuer defaults.
Even so, they have indicated that their solvency is in good shape, ruling out the prospect of rights issues as well as the graver possibility of government bailouts.
"Aviva's solvency position is robust and solid. Even in these extraordinary times we're a profitable business," chief financial officer Philip Scott told Reuters.
"I can see no circumstances where there will be need for a systemic bailout of (British) insurers."
Still, Scott added that recent share price volatility would continue for some time because there is often an opportunity for traders to make money shorting industry stocks.