European life insurers are at risk of significant losses on bond

European life insurers are at risk of significant unrealised losses on their bond portfolios due to higher interest rates.

According to Moody’s, the risk of mass savings policy lapses, if customers switch to higher-yielding bank products, could force insurers to sell bonds at a loss.

The overall risk of higher lapses remains low in most countries, notably because the level of competition with banks remains moderate. The risk of realisation of losses is limited thanks to a low asset duration or an ALM approach that provides insurers with recurring strong liquidity flows.

Starved of yield in Western bond markets and at risk of defaulting on future payments to policyholders, Europe’s 10-trillion euro insurance industry is turning to emerging debt for the higher returns it desperately needs.

While emerging debt has lost investors money in recent years and brings its own risks in the form of higher default rates, a survey by the world’s biggest asset manager BlackRock found that half the insurers in Europe, Middle East and Africa planned to increase allocations to emerging debt.

Insurers that sell traditional savings policies without mechanisms such as market value adjustments or large surrender penalties are most exposed, as are those with low guaranteed returns and low remuneration to policyholders.

Companies with a high weight of long-duration fixed income securities in their asset portfolio also report the highest level of unrealised losses.

Insurers in France, Italy, Switzerland, and Norway have proprietary distribution channels and shorter asset duration, providing protection from asset losses.

French and Italian insurers are more vulnerable due to low surrender penalties, while German and Swiss insurers have higher penalties in place.

Banks in most European countries offer no yield advantage, limiting the incentives for policyholders to switch. Competition is increasing in all countries, and insurers with proprietary distribution channels and shorter asset duration are better protected.

The industry is also increasingly constrained from buying stocks. Pension funds, the other investor category reliant on higher yields, can boost equity investment but the European Union’s new Solvency II capital adequacy rules make it costlier for insurers to do so.

Insurers therefore have also fanned out into risky property bets such as car parks, or homes in provincial Britain.

Yana Keller   by Yana Keller