Re/insurers should better manage results volatility caused by FX

The Brexit vote result caused a drop in the value particularly of sterling in relation to the dollar, but also the euro weakened against the US currency.

Quite a few re/insurers and brokers were caught off the guard.

Sompo Japan Nipponkoa, for example, reported a 24.6 percent year-on-year drop in attributable net income between April-June to ¥19.98 billion (£151.58) as net losses on foreign exchange caused by a strong yen drove investment profit down to ¥20.7 billion from ¥38.1 billion in the same period of 2015.

Aon posted a year-on-year decline of 1 percent in revenues for the second quarter of 2016 to $2.8 billion partly driven by a 2 percent unfavourable impact from foreign currency translation.

Everest Re also  reported a fall in second-quarter results as unfavourable foreign exchange movements impaired its performance — net income declined to $155.7 million in the second quarter compared to $209.1 million in the same period of 2015. Unfavorable effects of foreign currency fluctuations knocked off two percentage points of gross written premiums growth in the quarter.

Africa Re's gross written premiums   shrank by 5.7 percent year over year in the first half of 2016 to $348 million due to fluctuations in currency exchange rates. It blamed a 29 percent depreciation in Nigeria’s naira currency for the result, stressing that the country is its third largest market.

Negative foreign-currency effects also hit Allianz’s growth in the second quarter. Its gross premiums written for its property/casualty insurance segment decreased by 2 percent year-over-year in the second quarter to €11.6 billion.

Re/insurers could make their results more predictable in the currency they are reporting in by hedging their foreign exchange exposure, Paul Langley, managing director at OSTC FX, said. If you are earning in foreign currency you will obviously need to convert that money back into the currency you are reporting your results in, he explained.

While sterling is likely to remain under pressure as the UK negotiates the departure terms with the EU, the euro may also show further weaknesses due to economic and political developments in Greece, Langley said. In addition, large volumes of bad assets at Italian banks are also a concern in the region which may weigh on the euro, he noted.

Re/insurers should hedge their exposure based on statistical figures, Langley suggested. They should know statistically how much they are looking to earn in a quarterly or annual basis and they should look to hedge a share of that income, Langley said.

This would, however, also mean that re/insurers would not benefit from currency movements that have a positive effect on their income.

The business operating profit at Zurich Insurance Group’s general insurance business, for example, increased by $40 million year-over-year to reach $1.2 billion in the first six months of 2016 as it benefited from currency gains of $92 million.

Tokio Marine & Nichido Fire Insurance Co. increased underwriting profit by 16.3 percent year-over-year to ¥36.4 billion between April and May, partly driven by the appreciation of the yen.

While re/insurers would not benefit from such currency movements in the future, hedging FX exposure would, at the same time, make their results better reflect their actual operating performance as well as make the results more transparent, Langley said.

“If you are working on a certain margin, you want to know that that’s not being eroded by currency movements. It can be enhanced or eroded, but if you know what you are good at, what your margin is, you should always hedge that position,” Langley explained.

One deterrent for re/insurers to hedge their earnings in foreign currency could be that they are not sure what their income is going to be, he explained. “It’s very difficult to hedge an unknown number,” Langley noted.

But there might be other reasons. “Firms have different risk appetites, and some have limited appetite for volatility and choose to hedge it, with the associated costs. Others will choose to keep the risk on their balance sheet,” Caroline Jones, communications officer at the Association of British Insurers, said.

Allianz, for example only hedges its income selectively. “We don’t systematically hedge currency risks. We do so only where significant sensibilities exist,” Daniela Markovic, Allianz spokesperson financial communications, said.

Currency risk is monitored and managed at the operating entity and group level, according to Allianz's 2015 full year report. “The major part of foreign currency risk results from the economic value of our non-euro operating entities. If non-euro foreign exchange rates decline against the euro from a group perspective, the euro-equivalent net asset values also decrease.

“However, at the same time the capital requirements in euro terms from the respective non-euro entity also decrease, partially mitigating the total impact on the capitalization,” according to the document.

Re/insurers should hedge their exposures when their liabilities are not correlated to the currency of the assets they hold to cover those exposures, said James Morris, head of UK insurance at Barclays Corporate.

In this way, the companies can protect some or all of the potential downside with forwardFX protection which should be part of prudent risk management, he explained. “Unmatched currency positions on insured liabilities lead to increased currency risk and further exchange losses may arise. When reporting results this may impact profitability and solvency capital,” he said.

When catastrophe events arise in locations and in currencies where insurers wouldn’t normally hold matching assets, FX hedging routes should be immediately reviewed and followed up to help protect the extent of loss reserves, Morris noted.