The low interest rate environment represents a significant challenge for insurers, according to a report published by A.M. Best.
“European insurers are struggling to generate investment income as the majority of their invested assets are held in high-quality fixed-income securities,” said the report titled “Low Interest Rates Good News for Debt Issuers but a Drag on Insurer Earnings.”
Yields have fallen significantly in virtually all asset classes and industry sectors – to such an extent that A.M. Best cautions, the investor returns in many cases are not adequate for the risks they are taking.
A.M. Best based this report on an analysis of over 90 billion euros ($100.2 billion) of debt issued by a representative sample of European insurers between 2005 and 2014.
Another ramification of the low interest rate environment is that it also has ushered in favorable market conditions for insurers to raise capital, the report said, noting that life and non-life companies are taking advantage of suppressed yields to opportunistically issue debt securities, while making early redemptions.
Indeed, the ratings agency said a significant amount of debt has been issued over the past few years, mostly as a result of opportunistic refinancing at low rates to reduce the cost of capital, and in order to restructure terms so as to receive regulatory capital credit under Solvency II.
More of a Curse Than Blessing
Stefan Holzberger, managing director, analytics, said, the extremely low interest rates in today’s market are more of a curse than a blessing for insurers. “While insurers have been able to refinance maturing debt at very low rates (thus reducing their cost of capital and improving financial flexibility), a distinctive negative factor of this environment is that investment income has been on a sharp decline.”
While insurance companies will initially benefit from a temporary boost to capital reflecting an increase in the value of bond portfolios, proceeds from bonds held to maturity must be reinvested, the report said. Consequently, continued investment income declines are anticipated due to the low reinvestment rates.
Solvency Pressures for Life Insurers
The problem of low interest rates is most acute for life insurers writing with-profits savings business with generous guarantees, products that are particularly popular in Germany, Switzerland and Austria, the report said.
Yvette Essen, director, research & communications, added, “Many insurers in these markets are consequently experiencing a squeeze in margins between investment yields in their fixed-income portfolios and their average guarantees on in-force books of business. A.M. Best expects if rates remain low for an extended period, some European life insurers could be under significant solvency pressure.”
Source: A.M. Best
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