The Sri Lankan government’s proposed debt restructuring plan is anticipated to mitigate investment and liquidity risks for domestic insurers, according to analysis by Fitch Ratings.
Fitch predicts that pressure on insurers’ investment and capital profiles will diminish as a result of the proposed plan, which is not expected to directly impact the local-currency government debt holdings of insurers, banks, and non-banking financial institutions. However, it’s important to note that the proposal is just one facet of the sovereign’s debt sustainability plan. Ratings on Sri Lankan insurers remain on Rating Watch Negative (RWN) due to persistently high investment and liquidity risks, along with pressure on regulatory capital positions and a subdued financial performance outlook.
While insurers’ holdings of Sri Lanka Development Bonds (SLDBs) will be affected by the debt restructuring proposal, the restructuring of the sovereign’s foreign debt, including international sovereign bonds (ISBs), is yet to be finalized. Among Fitch-rated insurers, only a minority have exposure to SLDBs or ISBs, representing less than 5% and 0.2%, respectively, of the total invested assets of Fitch-rated insurers as of end-March 2023.
The government has outlined three treatment options for SLDBs, with the impact of present-value losses on capital contingent upon the treatment chosen by each insurer. However, Fitch Ratings believes that the adequate capital buffers maintained by Fitch-rated insurers would help mitigate any adverse effects from the losses.
Sri Lankan insurers’ investment and liquidity risk profiles are closely intertwined with the sovereign, banks, and non-bank financial institutions (NBFI), as their investment portfolios predominantly consist of fixed-income securities issued or guaranteed by the government (47% of invested assets at end-March 2023), corporate debt (21%), and deposits with local banks and NBFIs (10%).
The government’s domestic debt restructuring proposal excludes banks’ holdings of Sri Lankan rupee-denominated treasury securities, which is expected to alleviate pressure on banks’ already strained credit profiles. Despite this, Fitch maintains all ratings on domestic banks and NBFIs on RWN due to heightened near-term downside risks to their credit profiles from capital, funding, and operating environment risks.
“We anticipate that the limited foreign-currency liquidity in the local banking system will continue to restrict insurers’ capacity to meet foreign-currency obligations, such as reinsurance payments and claim obligations arising from the small portion of foreign currency-denominated policies,” stated the ratings agency.
“Fitch-rated insurers’ foreign-currency insurance contract obligations are primarily reinsured, mitigating direct exposure to foreign-currency liquidity risks.”