Smaller, unrated insurers may also be more exposed due to weaker capital and lack of business diversification.
German firms have historically offered customers guaranteed investment returns as high as 4%. These have steadily reduced, to 1.25% at the start of this year, but the very long duration of the guarantees means the average guaranteed credit rate of a typical portfolio is 3.1%. Investing ongoing premiums and reinvesting maturing assets in the environment of low or negative sovereign benchmark rates makes it ever harder to meet these guarantees.
But only around 15% of the average portfolio is invested in bunds. The rest is in higher-yielding investments, with covered bonds the biggest single asset class. We estimate that insurers were able to achieve yields of 2.5%-3% on new investments in 2014, while the 10-year bund yield averaged roughly 1.2%. The 10-year bund yield is currently around 0.1% and risk premiums have also declined, but we believe reinvestment yields of 1%-1.5% should still be possible.
We have calculated several run-off scenarios for a typical life insurance book. With a reinvestment return of 1.5% and the portfolio entirely invested in fixed-income assets, we estimate the portfolio's return on investment would not fall below the return required to pay the guarantees until 2027. The crossover occurs in 2024 with a 1% reinvestment return, and with a 0% return it occurs in 2020.
Even if investment income were insufficient 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 also inevitably squeeze insurers' profits, even if guarantees remain affordable, and would continue to eat away insurers' capital buffers. Between 2008 and 2013, capital buffers in relation to actuarial reserves gradually dropped from 8.8% to 7.4%. We expect this ratio to have declined to about 7.1% in 2014, and to fall further in 2015.
Together, these risks make low rates the main underlying threat to German life insurers' ratings, which could come under pressure if current investment returns persisted for more than another year or if the 10-year bund yields turned firmly negative.
We plan to publish a more detailed analysis of the impact of low rates on German insurers' guaranteed-return portfolios and financial performance in the coming weeks.
|
