Prolonged low interest rates in Europe would threaten the viability of savings products with investment guarantees, traditionally a fundamental part of many life insurers' business models, Fitch Ratings says. The impact of low rates was highlighted as a key concern recently when the European Insurance and Occupational Pensions Authority called for feedback from local regulators on the scale of the risk.
The investment guarantees that insurers can offer to new customers are driven by the yields on the bonds that they can invest in. Low yields make these products unattractive to customers, hitting sales volumes and potentially making the business unviable. Some insurers have told us that they plan to shift their business towards protection products and annuities, where profits are driven by pricing for insurance risks, rather than by financial markets.
A prolonged slowdown in sales could also make insurers' existing books of guaranteed-return business increasingly uneconomical as declining books become insufficient to support their fixed costs. Ultimately, insurers are likely to put the legacy business into run-off in closed funds, which they may then offload to consolidators. We expect further consolidation of closed with-profits funds in the UK and significant closed-fund consolidation in the Netherlands, where there has been a dramatic fall in insurers' savings business due to tax changes that allowed banks to compete on equal terms with insurers.
A prolonged period of low interest rates would also hurt life insurers by cutting the returns available when they reinvest assets backing their existing guaranteed-return business. However, this impact would vary significantly depending on how closely they have matched the duration of their assets and liabilities. Insurers often hold assets with a shorter duration than their liabilities because of a lack of assets available with duration long enough to match the liabilities, which may be 20-30 years or more.
We believe good risk management, close regulatory scrutiny and a supply of long-duration assets means assets and liabilities are relatively well matched in some markets, for example the UK and the Netherlands. Moreover, the running yields on many insurers' existing asset portfolios, together with other non-investment earnings from mortality and expense loadings in policyholders' premiums, are more than sufficient to cover investment guarantees on the existing blocks of business.
For German life insurers we have simulated a run-off scenario for a typical life insurance book, with the assumption the investment portfolio is wholly in fixed-income assets and that proceeds of maturing bonds are reinvested at 1.5%. Under this scenario it would take until 2027 for the return on investment to fall below the required rate.
Insurers in the Nordic region may have less closely matched assets and liabilities because of the relative scarcity of longer-term assets in the region. Some have addressed this through buying sovereign bonds from other countries such as Germany, although this leads to further complications such as foreign exchange risk.
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