Fitch: Lower Guarantee Rate Won't Cut Risk for German Life Firms
OREANDA-NEWS. A reduction in the maximum guaranteed returns that German life insurance companies are allowed to offer their clients would not have any significant impact on their exposure to the risks of sustained low interest rates, Fitch Ratings says. We see the possibility of a long period of low interest rates as the biggest risk for European insurers and believe that German firms are the most exposed because of their previous widespread use of guaranteed returns.
BaFin President Felix Hufeld recently highlighted the prospect of lowering the maximum 1.25% rate when he said in a newspaper interview that it is not sustainable if interest rates stay low, although any decision will be made by the Ministry of Finance.
A lower maximum would further reduce the attractiveness of these products to customers but we believe the relevance of the guaranteed rate has already diminished significantly and that only a small proportion of products are sold with a guaranteed return of the maximum allowed. This change was partly driven by the introduction of solvency II, which has significantly increased the capital requirements for guarantees and made companies reluctant to offer them. We expect that new business will increasingly shift towards products with lower capital requirements, such as products with reduced guarantees and unit-linked products.
A reduction in the maximum guaranteed rate would have no impact on products that were sold when guarantees were higher. We estimate that the average effective guarantee rate of a typical German life insurance portfolio is 2.7% (including the impact from additional reserving requirements), which is above the yields that insurers are able to achieve on new investments. This is gradually squeezing the investment margins of the companies as investments mature and have to be reinvested at lower rates.
We have calculated a run-off scenario for a typical life insurance book, which assumes the portfolio is entirely in fixed-income assets and that proceeds of maturing bonds are reinvested at 1.5%, which is the rate that we expect firms to have achieved in the first quarter. Under this scenario, the return on investments would fall below the rate required to cover guarantees in 2026. With a 1% investment return the crossover occurs in 2022.
But even if investment income were not enough to cover the guarantees, they could still be met for some time from other sources of income, such as underwriting profits. If these additional sources are included in the calculation, the return on investment would stay above the required return until beyond 2033 in our 1.5% investment return scenario.
We therefore expect insurers to continue to meet guarantees, but the risk they will be unable to do so will rise if rates remain low. Low yields will inevitably squeeze insurers' profits, even if guarantees remain affordable, and would continue to eat away insurers' capital buffers.
The risk presented by low rates is reflected in our negative sector outlook for the German life insurance industry and was also a key driver in our downgrades of Stuttgarter Lebensversicherung and Volkswohl Bund Lebensversicherung as part of a portfolio review in March.