A significant spike in interest rate in the first half of year has pressured profits of the largest listed insurers who have incurred record fair value loss on financial instruments.
And that is double whammy for an industry already reeling from deteriorating underwriting income caused by mounting obligations from policy holders as combined ratio has far exceeded the 100 percent threshold.
With the inflationary pressure, currency devaluation and high cost of doing business becoming increasingly arduous, analysts say insurers must be resilient in the pursuit of long-term value-focused growth and deepen business transformation that will help lift their margins and generate more stable future cash inflows.
 The combined net income of the largest companies, which have released Half-Year results, declined by 37.88 percent to N11.96 billion as at June 2021, according data gathered by MoneyCentral.
That compares with 47.48 percent increase in 2020; 2.05 percent uptick in 2019; 5.10 percent reduction in 2018, and 9.52 percent expansion in 2017.
The sharp reduction at the bottom line (profit) was largely driven by huge fair value loss on bond investment  caused by the vagaries of both short- and long-term government securities.
However, double-digit growth in premium income ensured companies remain profitable, which means they are still in a position to reward their owners in the form of dividend payment.
The yields on the one- year Sovereign instruments, treasury yields and bonds have been rising significantly from low levels seen in December 2020.
 For instance, yields on the one year treasury bills, which bottomed out at near 1 percent in December rose to 9 percent by June 2021. Similarly, bonds such as the 20-year benchmark bond traded at 7 percent in December 2020 spiked to over 12 percent level in June 2020.
“As the yield rises, prices on instruments plunge, thus explaining the market-to market losses on financial instruments held by institutions such as insurance companies,” said an industry analyst who doesn’t want his name mentioned.
“The valuation losses are unrealized and may be accounted for through the profit and loss account or owners’ equity depending on the classification of the assets in the books of respective companies,” said the analyst.
It is worth noting that AIICO Insurance Plc, Mutual Benefit Assurance Plc, and Linkage Assurance Plc, collectively incurred N39.92 billion net losses on financial instruments through the profit and loss.
AIICO Insurance wrote down N33.08 billion, however, a write back in change in life fund led to underwriting profit spiking by 71.71 percent to N31.96 billion and net income rising by 13.17 percent to N3.25 billion.
Mutual Benefit was not so lucky because fair value loss on financial assets of N5.51 billion wiped out underwriting profit of N5.52 billion, and that explained the N1.98 billion loss after tax.
Linkage Assurance was hardest hit as it had already recorded underwriting loss on the back of deteriorating combined ratio and foreign exchange loss of bond investment of N1.33 billion was the straw that broke the camel’s back as it posted a loss after tax of N2.09 billion.
Financial assets that are held for trading are always classified as financial assets at fair value through profit or loss. A financial asset is held for trading if the entity acquired it for the purpose of selling it in the near future or is part of a portfolio of financial assets subject to trading.
The “fair value” concept had prompted a crisis among a number of  banks and insurers  in the United Kingdom (UK) and the United States (USA) who privately lobbied regulators to relax the rules. They complained that the strict system had overstated their likely losses and risked pushing the entire financial system into chaos.
Yields on fixed income instruments which were depressed last year (due to the central bank’s dovish monetary policy amid the pandemic) have been on an upward trajectory in 2021 amidst strong local demand for higher yields and the need to attract foreign interest in Nigerian securities amid a dollar shortage.
The Nigeria 10 Years Government Bond has a 11.715 percent yield as at 24 Aug 2021, according to data from world government bonds.
The Nigeria 10 Years Government Bond reached a maximum yield of 15.856 percent (4 December 2018) and a minimum yield of 4.048 percent (3 November 2020).
There are concerns that the growth yields may not be strong enough to underpin investment income, and that could pressure future profitability.
When margins are down on underwriting and an expectation that combined ratios will rise, insurers are materially reliant on investment returns to make a profit.
A protracted squeeze in profit margin, abysmally poor dividend payout, and lack of clear-cut strategic direction have strengthened investors’ apathy for insurers shares.
Nigerian insurers have poor valuation compared to peer rivals in Sub-Saharan Africa. Their industry price-to-book ratio of 0.43x is abysmally subpar when compared with South Africa (1.99x), Egypt (1.65x) and Kenya (0.64x).
“It shows the vulnerability of these companies’ earnings stability to market risks as changes in interest rate environment and broader macro volatility may impact earnings,” said the analyst.