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Brexit vote prompts fears over U.K. insurers' capital strength

Brexit vote prompts fears over U.K. insurers' capital strength

(Reuters) — Market falls triggered by Britain's vote to leave the European Union will hit British insurers' capital, raising concerns over their ability to pay dividends or hand cash back to investors.

New European capital Solvency II rules introduced in January require insurers to account for investment risk, and solvency models to be regularly updated.

Life insurers in particular invest in bond markets to match their long-term pension liabilities, and have increasingly moved into corporate bond markets which offer higher returns.

But confidence in U.K. corporate bonds is dipping, and equity markets, in which insurers also invest, are weaker too.

"It is the market moves that are having the more significant impact. Solvency II models are sensitive to moves in credit spreads, equity markets, FX, interest rates, property prices and other markets," said Marcus Rivaldi, deputy head of analytics at specialist insurance investment manager Twelve Capital.

"The impact on the day-to-day operations of insurance companies in the U.K. should be relatively minimal," he said.

Legal & General Group P.L.C., which reassured investors earlier this year that it was not holding many junk energy bonds, was the worst performing FTSE 100 insurer on Monday.

It has lost nearly 30% of its value since Thursday's close and was trading at three-year lows at 166 pence ($2.27) at 1400 GMT.

Legal & General's solvency ratio would drop to 158% if there is a fall in interest rates after a Brexit vote, from 169% reported at end-December, ratings agency Moody's Investors Service Inc. estimated last month.

Analysts at JPMorgan Chase & Co. estimated L&G's solvency ratio currently at 150%.

A ratio of 100% means insurers have enough capital to cover underwriting, investment and operational risks, but some analysts think life insurers should have a ratio of as much as 160%, given their long-dated liabilities.

"If the volatility continues then we believe that Prudential, Legal & General and JRP would struggle on capital," JPMorgan said in a note.

Prudential's shares have dropped nearly 20% since the vote, and mid-cap insurer JRP is down 35%.

Legal & General also invests heavily in U.K. property, a sector that has taken the largest drubbing since the vote.

Aviva P.L.C., which fell as much as 30% at one point on Friday to its lowest in nearly four years, said on Monday its capital position was resilient.

Shares in Aviva, which has a target range for its solvency ratio of 150% to 180%, rose briefly at the open, and analysts at Macquarie said the sell-off was overdone. But it quickly reversed and was down 7.4% to 346.8 pence ($4.74) by 1405 GMT.

Ratings agency Fitch Ratings Inc. warned on Friday that life insurers were at risk of downgrades if there was "sustained economic weakness leading to intensified competition and material deterioration in the market values of assets."

However, some investors and analysts were more upbeat, saying the lower pound could be a boon for some insurers, boosting earnings from overseas operations.

"In situations like this, there are often opportunities," said Nick Martin, who runs an insurance fund for Polar Capital.

For more of Business Insurance's ongoing coverage of the historic 'Brexit' vote, click here.

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