Debt restructuring to ease investment, liquidity risks on insurance firms: Fitch

• Cites proposed debt restructuring plan having no impact on local currency govt. debt as key reason
• At present, Sri Lankan insurers’ ratings are still under observation with a Rating Watch Negative
• Says sparse foreign currency liquidity in local banking system to continue to limit insurers’ ability to meet foreign currency obligations

Fitch Ratings yesterday said the government’s debt restructuring plan is likely to reduce investment and liquidity risks for domestic insurers, as the proposed plan would not have a direct impact on the local currency government debt holdings of insurers, banks and non-banking financial institutions (NBFIs).

However, the rating agency pointed out that the proposal forms just part of the sovereign’s debt sustainability plan.  At present, Sri Lankan insurers’ ratings are still under observation, with a Rating Watch Negative (RWN) status, due to the elevated investment and liquidity risks, regulatory capital pressures and a less favourable financial outlook.

Fitch noted that these factors have the potential to weaken insurers’ credit standings in comparison to other entities assessed on the national rating scale.

Fitch expects insurers’ holdings of Sri Lanka Development Bonds (SLDBs), which are foreign currency-denominated but governed by local law, to be affected by the debt restructuring proposal.

However, restructuring of the sovereign’s foreign debt, including international sovereign bonds (ISB), is yet to be finalised.  Among Fitch-rated insurers, only a few have exposure to SLDBs or ISBs, which accounted for less than 5 percent and 0.2 percent, respectively, of the total invested assets of Fitch-rated insurers at end-March 2023. 

“The government has presented three treatment options for SLDBs, with the impact of any present value losses on capital dependent on the treatment each insurer chooses. However, we believe that the satisfactory capital buffers maintained by Fitch-rated insurers would help to cushion any negative impact from the losses,” Fitch said.

“The investment and liquidity risk profiles of Sri Lankan insurers are closely linked with the sovereign, banks and NBFI, as their investment portfolios are dominated by fixed-income securities issued or guaranteed by the government (47 percent of invested assets at end-March 2023), corporate debt (21 percent) and deposits with local banks and NBFIs (10 percent),” it added.

The government’s domestic debt restructuring proposal excludes banks’ holdings of Sri Lankan rupee-denominated treasury securities, which will ease pressure on banks’ already stressed credit profiles.
Fitch continues to maintain all ratings on domestic banks and NBFIs on RWN, due to the heightened near-term downside risks to their credit profiles from capital, funding and operating environment risks. 

“We expect the sparse foreign currency liquidity in the local banking system to continue to limit insurers’ ability to meet foreign currency obligations, such as reinsurance payments and claim obligations arising from the small portion of foreign currency-denominated policies.

Fitch-rated insurers’ foreign currency insurance contract obligations are mostly reinsured. Fitch-rated insurers also have foreign currency deposits with local banks to support their foreign currency obligations,” the rating agency said.