The outlook for the UK life insurance sector has been changed to ‘stable’ from ‘negative’, Moody's Investors Service said in a new Industry Outlook that is based on a projection of stable earnings, conservative capital management and increasing income diversity from captive asset managers.
However, the rating agency cautioned that these factors are counterbalanced by potential short-term disruption from the Retail Distribution Review (RDR), the risks posed by insurers' expansion into "new" investment areas and the UK's weak economic growth outlook for the next several years.
"The profitability of the UK life industry is stable and supported by growing cash generation. We expect that the industry's earnings will remain healthy overall, whilst earnings quality will improve given the focus on cash generation," said Antonello Aquino, author of the report.
"The low interest-rate environment will gradually reduce profitability, but only marginally, given the industry's relatively low sensitivity to interest rates," he added.
Capitalisation has improved and Moody's expects continued conservative capital management. The introduction of Solvency II, although postponed, has kept capital in check. Capitalisation has rebounded from its lows in 2008 and is higher than pre-financial crisis levels. In addition, the industry's exposure to peripheral euro area investments is minimal.
The rating agency added that captive asset managers have helped insurers to capture significant growth, provided income diversity and helped some UK life insurers to expand and partially offset historical cash flow erosion in the life insurance market. Over 2013, Moody's expects that this trend will continue.
However, short-term disruption is likely to arise from the introduction of RDR at the end of 2012 which will reduce the number of Independent Financial Advisors (IFAs) and, consequently, life sales are likely to decline over the outlook period.
Insurers are increasing their credit exposure to new asset classes such as lending to commercial property companies, SME and infrastructure projects, albeit in modest amounts thus far. The retrenching of the UK banking system and the low interest-rate environment has meant that insurers are increasingly expanding their investment activities into the realm of banks.
"The operating environment for UK insurers remains challenging, given the weak economic growth prospects and high level of household indebtedness, although some pockets of growth exist, particularly in the annuity and protection lines", Aquino added.
Moody's said it also expects long-term growth from the expanding pensioner population, and the continued lack of an adequate level of private pension provision.
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