Insurance debt investing attractive with Solvency II levels high: Plenum

Investors should be looking at subordinated insurance debt bonds as with spreads elevated the opportunity to invest into the bonds issued by highly capitalised companies with high Solvency II ratios is an attractive opportunity, according to Plenum Investments.

This year, while many other bond markets have been affected by spread related issues, but at a time when fundamentals have been worsening, the insurance and reinsurance market has been seeing higher rates and growing capital levels, making their subordinated bonds particularly attractive versus other segments.

In a recent paper, Rötger Franz, Partner, Plenum Investments Ltd., explained that, “Current valuations in the insurance sector do not reflect fundamentals in our view. Compared to other industry sectors, the capitalization of the insurance sector has further increased since the beginning of the year.”

Insurance and reinsurance company debt looks particularly high-quality as the sector largely reported decent earnings for 2021 and have enabled firms to reduce debt, buy-back shares and re-issue in some cases.

Plenum believes that higher interest rates will support the already decent Solvency II levels of insurance bond issuers, even though some could face markdowns on investments in the current climate as they report their Q2 results. Impairments on investments to-date have been manageable so far.

One area of uncertainty was the war in Ukraine, but the disclosure of losses so far by insurance and reinsurance firms is not cause for concern about their debt issues, Franz explained.

Even with the aviation claims that may potential come to the market from Russia’s war in Ukraine, Franz explained, “Any adverse development is unlikely to turn into a capital event.”

The primary issuance market for private insurance debt and bond issuances came back to life in May, Franz said.

“All new is- sues performed positively in the first days of trading and outperformed the market allowing investors – unlike in the previous months – to realize a good new issue premium,” he further explained.

“In our view, the recent new issues remove a backlog that piled up over the last weeks and that backlog had to be cleared before the mar- ket can return to business as usual,” Franz continued, saying, “In addition, we note that many funds sit on elevated cash levels to be prepared for redemptions.”

On the investment opportunity, Franz explained that spreads are high and given the quality of issuers and their solvency levels, the opportunity attractive as a result.

“Spreads of Insurance Bonds have reached levels not seen since the dip in March 2020, when a sell- off occurred across markets due to the pandemic.

“The yield levels on a EUR-hedged basis are close to 4% in the Bloomberg Insurance Subordinate To- tal Return Index and are much higher in certain sub- segments of the market such as restricted Tier 1. We consider this level attractive bearing in mind that most issues on this index are rated investment grade.

“These elevated spread levels should give additional comfort to investors and will serve as protection against potential further spread widening. Investors are now able to benefit from higher spreads at higher Solvency II ratios compared to the beginning of the year,” Plenum’s Franz highlighted.