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Year-End 2015 Foreign Exposure in the U.S. Insurance Industry
The U.S. insurance industry's foreign exposure has remained at 12% of total cash and invested assets since at least 2013. Canada and European Union (EU) countries accounted for 56% of the industry's total foreign investments at year-end 2015, unchanged from 2014, but down from 60% at year-end 2013. This report updates the NAIC Capital Markets Bureau's "Year-end 2014 Foreign Exposure in the U.S. Insurance Industry" special report that was published on Jan. 21, 2016.
Since the publication of the aforementioned report, Brexit came a step closer to reality with a "yes" vote on June 23, 2016. Additionally, oil prices collapsed from more than $100 per barrel in 2014, straining the budgets and economies of oil exporting emerging market countries. The International Monetary Fund (IMF) World Economic Outlook as of July 2016 estimates positive 2016 gross domestic product (GDP) growth of 3.1% worldwide, with 1.7% GDP growth in the United Kingdom (UK), and 1.4% GDP growth in Canada, the two countries with which the U.S. insurance industry has its largest total foreign exposure. Worldwide GDP growth was revised down from 3.2% to account for potential downside risk from Brexit. The Eurozone is also expected to experience positive GDP growth, while emerging market economies are estimated to grow 4.1% in 2016 according to IMF estimates.
As of year-end 2015, the U.S. insurance industry reported total foreign exposure with a book/adjusted carrying value (BACV) of about $674.6 billion, a 3% increase from year-end 2014. (See Table 1 and Table 2.) Foreign exposure includes investments in bonds, common stock (affiliated and unaffiliated) and preferred stock. For bonds, approximately $82.9 billion (or 13%) of foreign investments were denominated in a foreign currency, down from $89 billion in 2014. The Japanese yen accounted for the largest portion at about $45 billion, followed by the Canadian dollar-denominated investments at about $18.4 billion, the British pound ($9.1 billion) and the euro ($8 billion). Foreign currency exposure is translated and reported in U.S. dollars as per Statement of Statutory Accounting Principles (SSAP) No. 23 — Foreign Currency Transactions and Translations.
For purposes of this analysis, foreign exposure is defined as exposure to any entity domiciled outside of the U.S. It excludes structured securities that are technically domiciled in foreign countries (such as Bermuda, Cayman Islands and Ireland) for legal and tax reasons, but where there is no obvious exposure to the economy of the respective country. Other structured securities where the domicile is not so apparent are included.
Table 1: 2015 Foreign Holdings Summary ($ Mil. BACV)
Table 2: 2014 Foreign Holdings Summary ($ Mil. BACV)
In terms of industry type, property/casualty (P/C) companies reported the largest percentage decrease (10%) in BACV of foreign investments to $107.4 billion as of year-end 2015 from $118.9 billion at year-end 2014. Life companies increased foreign exposure by about 6% to $545.3 billion at year-end 2015 from $515.2 billion at year-end 2014. Life companies accounted for 81% of total industry foreign exposure at year-end 2015.
U.S. Insurer Exposure to Foreign Bonds
The bulk of the U.S. insurance industry's foreign investments at year-end 2015 was in bonds at $630.1 billion (or 93% of total foreign exposure). The largest single sector exposure was to foreign financial institutions at $94.3 billion, or 15% of total foreign bond exposure. (See Table 3 and Table 4.) The BACV of foreign government bonds decreased 13% from $80.4 billion at year-end 2014 to $69.6 billion at year-end 2015, while exposure to "other" sectors (i.e., corporates) increased 21% to $527.9 billion.
Table 3: 2015 Total Foreign Bond Exposure by Sector ($ Mil. BACV)
Table 4: 2014 Total Foreign Bond Exposure by Sector ($ Mil. BACV)
U.S. insurers' exposure to below-investment grade foreign bonds increased at year-end 2015 from year-end 2014. Conversely, bonds designated NAIC 1 and NAIC 2 decreased to 92% of foreign bond exposure from 94% at year-end 2014. U.S. insurers reported exposure with a BACV of $321.3 billion in foreign bonds designated NAIC 1, and $260.8 billion were designated NAIC 2. Exposure to foreign bonds designated NAIC 3 (below investment grade) increased (by 34%) to $36.2 billion at year-end 2015 from $27 billion in 2014.
Largest Foreign Country Bond Exposures
The 10 largest countries accounted for 74% of total foreign bond holdings as of year-end 2015, which was about four percentage points lower than 2014. (See Table 5.) Canada remains the largest single country exposure at about 19% of total foreign bond exposure, unchanged from 2014. (See Table 6.) The UK accounted for the second largest country exposure at 17% of total foreign bonds. Mexico, at $14.2 billion, was relatively unchanged from the year prior and was last of the 10 largest country exposures for U.S. insurers. Overall, corporate bonds accounted for about 2%, or $620 billion, of the top 10 foreign countries' bond exposure.
Table 5: 2015 Top 10 Foreign Bond Exposures by Country ($ Mil. BACV)
Table 6: 2014 Top 10 Foreign Bond Exposures by Country ($ Mil. BACV)
On July 30, 2014, Argentina, the third-largest Latin American economy, defaulted on $13 billion of interest payments on government bonds due 2033. (See the NAIC Capital Markets Bureau Hot Spot "U.S. Insurance Industry Exposure to Argentine Sovereign Debt Is Small as Default is Possible," published July 30, 2014, for greater detail.) As of year-end 2015, U.S. insurers had exposure with a BACV of $59 million to these government bonds, which was held at 98% of par value. Since the 2014 default, $16.5 billion in sovereign debt was issued by Argentina in April 2016, followed by an additional $2.8 billion on Oct. 5, 2016, despite an expected contraction of the Argentinian economy in 2016. Argentina's sovereign debt is currently rated B/B- (Standard & Poor's [S&P]/Fitch Ratings [Fitch]). As of year-end 2015, U.S. insurer overall bond exposure to Argentina was $195 million, up from $110 million at year-end 2014; government bonds accounted for about $114 million, and $82 million were in corporate bonds.
Oil Exporting Country Bond Exposure
Oil has been under price pressure since 2014. The initial catalyst for falling oil prices was declining worldwide demand (or at least the fear of it). Since then, the inability of oil exporting nations to implement and enforce production cuts, increases in U.S. oil production, and continued falling demand due to weak (or negative) economic growth led to downward price pressure. Oil prices, as measured by West Texas Intermediate Crude (WTI), fell from a high of $107.62 a barrel on July 23, 2014, to a low of $26.21 on February 11, 2016. Since the February 2016 low, the WTI has traded between $53 and $40 a barrel through September 2016.
In a research reported titled "2016 Mid-year Sovereign Review and Outlook," published July 2016, Fitch reported downgrades of 15 sovereign ratings (mainly in emerging market countries) with 22 on Negative Outlook. A Negative Outlook indicates the potential for a negative rating action (downgrade) within a two-year time frame if currently observed trends continue. Lower commodity prices were highlighted as the "single most important factor responsible for downward ratings momentum." The recovery of oil prices from its 2016 lows and continued strength in commodities are a credit positive for oil exporting countries, such as Brazil, Mexico, Russia or Venezuela, lessening the likelihood of default on government debt obligations.
As of year-end 2015, U.S. insurers reported a total exposure of $151.8 billion (or $126.7 billion, excluding sovereign bonds) to oil exporting countries. The exposure (excluding sovereign bonds) was comprised of $119.5 billion in bonds (mainly corporate bonds, $117.9 billion) and $7.3 billion of stock. While potential default on foreign government bonds is unlikely, it could affect corporate bond exposure. In addition, about 68% (or $16.9 billion) of the oil-exporting country exposure was to bonds issued by Canada (AAA, Fitch/S&P). The second largest exposure was to Mexico (BBB+, Fitch) at 10%, or $2.5 billion.
EU Bond Exposure
Table 7 and Table 8 show a category breakdown (i.e., financial, sovereign and "other" non-financial corporate) of the U.S. insurance industry's exposure to EU countries, particularly the Eurozone, as of year-end 2015 and year-end 2014, respectively. The percentage of foreign bond holdings concentrated in EU countries was about 40% total foreign bonds at year-end 2015, which was relatively consistent with year-end 2014. Total EU bond exposure (which includes Eurozone and other EU members) was $252.7 billion as of year-end 2015 versus $248.1 billion as of year-end 2014. From 2014 to 2015, U.S. insurers decreased exposure to EU sovereign bonds and those in the foreign financial sector. Most EU bond exposure was within the "other" bond category, at 83%. Furthermore, exposure to countries under the euro currency (Eurozone) increased slightly to $136.8 billion in 2015 from $133.6 billion in 2014. Overall, EU exposure increased only about 2% year-over-year (YOY) as of year-end 2015.
Table 7: 2015 Bond Exposure to Eurozone Countries by Sector ($ Mil. BACV)
Table 8: 2014 Bond Exposure to Eurozone Countries by Sector ($ Mil. BACV)
Note: The EU is comprised of 28 member states. The result of this analysis reflects only 25 member states as insurers did not have any exposure to Bulgaria, Cyprus and Estonia. The Eurozone consists of 19 member states that use the euro as their sole currency. The nine other EU members do not use the euro as their currency.
Foreign Common Stock and Preferred Stock Exposure
Equity market volatility, as reflected by the STOXX 50 Volatility Index (which tracks volatility in the European local equity markets), experienced a mid-December 2015 spike to a reading of 30, followed by an immediate retreat to about 22 by Dec. 23, 2015; it has been on the rise again since the beginning of 2016, but as of Sept. 30, 2016, it was about 19.76. The market turbulence was mainly driven by diverging prospects for worldwide economic growth. While U.S. equity investors were anticipating a shift to rising rates from the Federal Reserve, the EU pronounced the continuation of zero or negative rate policies and continued quantitative easing in the form of sovereign bond purchases. Additionally, market concern was rising as many questioned the effectiveness of monetary policy given that EU asset prices were falling rather than rising. In fact, equity market performance was negative in the Eurozone, Switzerland and Japan following their respective negative interest rate policy announcements. (See Chart 1.)
Chart 1: Regional Equity Performance Since Negative Interest Rate Policy (NIRP) Announcement
Despite market concerns, the non-U.S. equity markets performed well as of year-end 2015. The worst performer (as measured in U.S. dollars) was the Shanghai Composite Index (a stock market index of all Chinese stocks traded on the Shanghai Stock Exchange), with a 6.7% return. The MSCI Emerging Market Index was the worst performer at negative 13.1%. The STOXX 600 (an index of stocks traded across the European stock markets) performed well in 2015 with 13.9% but fared poorly in 2016, returning negative 6.9% in Q1 2016 and negative 9.7% in Q2 2016.
In 2015, U.S. insurers increased their overall foreign stock exposure by 2%, YOY, to about $46 billion at year-end 2015. (See Table 9 and Table 10.) Unaffiliated foreign common stock for the U.S. insurance industry was $24.7 billion (or 65% of total foreign stock exposure) as of year-end 2015.The largest share of unaffiliated foreign common stock was held by property/casualty (P/C) insurers at 79%, or $19.6 billion of total unaffiliated foreign common stock. Life companies followed at about 16%, or $4 billion.
Table 9: 2015 Foreign Stock Exposures by Industry ($ Mil. BACV)
Table 10: 2014 Foreign Stock Exposures by Industry ($ Mil. BACV)
Unaffiliated foreign stock domiciled in Canada comprised 18% of total unaffiliated foreign stock exposure at year-end 2015, followed by UK-domiciled unaffiliated stock, which comprised 15%. (See Table 11.) The five largest exposures were to companies based in Canada, China, Ireland, Switzerland and the UK. The 10 largest countries' exposure to unaffiliated foreign stocks accounted for about 79% of total unaffiliated foreign stock exposure ($23.5 billion) held by U.S. insurers as of year-end 2015, down from 82% ($28.8 billion) in 2014.
Table 11: 2015 Top 10 Unaffiliated Foreign Stock Exposures by Country ($ Mil. BACV)
As of year-end 2015, EU unaffiliated stock exposure was 36% of total unaffiliated foreign stock exposure, with BACV of $10.6 billion, compared to $11 billion (or 38%) in 2014. (See Table 12.) The UK accounted for 42% of total EU exposure, followed by Ireland at 22%. As of year-end 2015, consumer noncyclical and financial comprised the largest two unaffiliated foreign stock sector exposures.
Table 12: 2015 Unaffiliated Foreign Stock Exposures by EU Country ($ Mil. BACV)
The low interest rate policies of central banks have benefited U.S. insurer foreign stock exposure as equity prices, especially those of dividend paying companies, were higher than they were at the start of the current policy regime. When rates begin rising, insurers will have to pay close attention to how that trend may affect the value of their foreign stock exposure. If the policy shift is to one of gradual rate increases, the negative impact may be modest. Overall, foreign stock exposure is 7% of U.S. insurers' total stock exposure, and about 1% of total cash and invested assets. At such low levels of exposure, the potential risk of large losses from falling stock prices is minimal to U.S. insurer portfolios.
As of year-end 2015, U.S. insurers' total foreign exposure increased $18.9 billion (from year-end 2014) to $674.6 billion but remained at 12% of the insurance industry's total cash and invested assets (as it was in 2014). Positive worldwide economic growth, a rebound in commodity prices and equity markets rebounding from Brexit losses should contribute to positive performance in U.S. insurers' cash and invested assets. A potential adversary to those positives is the ongoing geopolitical turmoil that exists in different parts of the world, which could, in turn, cause U.S. insurers to reduce foreign exposure in those particular countries.
The ultimate impact of Brexit is still not fully known. Central bank reaction (continuation of low rate policy and quantitative easing) suggests that central banks are cautious about the potential impact. However, given the size of the U.S. insurance industry's total foreign exposure (12% of total cash and invested assets) and that 56% of the exposure is to Canada and EU countries (with the UK being the largest EU exposure), any negative impact to insurer portfolios likely would be minimal. The NAIC Capital Markets Bureau will continue to monitor the insurance industry's foreign exposure, as well as developments within the aforementioned regions that could affect these exposures; we will provide updates as deemed appropriate.
Questions and comments are always welcome. Please contact the Capital Markets Bureau at CapitalMarkets@naic.org.
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