The risk to insurance companies of consumers demanding their money early on guaranteed savings products is increasing as early surrender penalties reduce and households' disposable income is squeezed by the tough macroeconomic environment, Fitch Ratings says.
If European households, stretched by cuts to public expenditure, increased tax rates and low growth, demand their money back on life insurance products, insurers may have to sell assets to fund that repayment. In many cases these assets are bank and sovereign bonds of peripheral eurozone countries, whose prices have declined since June 2011 and which may be trading well below their book value.
If the number of clients who pull their insurance products increases significantly, insurers may need to eat into their capital to fund the repayments. This would put pressure on insurers' credit profiles.
The problem is becoming more pressing because penalties for redeeming life insurance products early are falling. In recent years, life insurance companies have reduced early redemption penalties to make their savings products more attractive to customers. Guaranteed interest products in the 1990s paid much higher guaranteed returns and as a result could include less favourable redemption terms without reducing demand for such products.
Low interest rates mean that savings products with investment guarantees have put pressure on insurance companies' profitability and capital. However, the increase in lapse rates is unlikely to come with an offsetting gain because it is the lower guaranteed return policies that clients will redeem, with lower surrender penalties, not the high-rate products from the 1990s.
The impact of large-scale redemptions is reduced if a life insurer has its own agency network because the agent will often move the client into a new more suitable product. This leaves the capital with the life insurance company and removes the need to sell assets.
In addition to the risk of increasing lapse rates, life insurers are seeing subdued growth in life insurance product sales because of the limited attractiveness of savings products in the current low interest rate environment.
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