Standard & Poor's Ratings Services examines the sensitivity of European life insurance markets to changes in interest rates. Titled "Why Some European Life Markets Are More Sensitive To Interest Rate Movements Than Others," the report identifies factors that either increase or reduce a sector's interest rate sensitivity.
The rating agency comments "The report is based on a thematic review in which we examined how sensitive life insurance markets are to movements in interest rates. We assessed the effects of a significant upward or downward deviation from our current base-case scenario. Our review focused on life insurers operating in markets we consider to be most susceptible to changes in interest rates, based on our insurance industry and country risk analyses (IICRAs).
The life insurance industry's sensitivity to interest rates centers on the prevalence of guaranteed rates in insurers' back books that require an annual minimum returns from investments or other sources and the resulting dependence on investment results. Most life insurers would likely benefit from an increase in interest rates in line with our base-case scenario because it would take away some of the pressure on net investment returns. This, in turn, could help to achieve stable or even increasing margins on guaranteed rates where they exist.
In all countries in our study-Austria, Denmark, Finland, Germany, The Netherlands, Norway, Sweden, and Switzerland-policymakers have a significant influence over the business models life insurers are able and willing to follow. We observe that policymakers in different countries follow very different approaches in dealing the current low yield challenge. Another differentiating factor is the general shape of the market and the competitive environment in particular. Diversification across business lines or regions is more prevalent for insurers in some markets than in others and we believe that a larger degree of diversification is a clear positive for an insurer's financial strength.
We also observe that life insurers are trying to move their new business away from savings products with minimum guaranteed rates. Instead, companies are looking to savings products with no, lower or alternative kinds of guarantees, and to risk products that exclude a savings component such as disability and term life policies. However, customers are more risk averse, with the result that insurers have had varying success in accomplishing this product shift.
In terms of how companies manage their back book, we see that across the board insurers have adjusted their crediting rates to the current financial market environment. Companies in all sectors we reviewed have improved their asset-liability management, usually as part of their efforts to strengthen their enterprise risk management (ERM) processes. We believe this has in part been spurred by the arrival of Solvency II. As a result, life insurers have managed to close or significantly reduce the gap between the duration of their assets and liabilities.
A closer look at the European life insurance sectors that in our view have in common a relatively high sensitivity to movements in interest rates brings to light meaningful differences in their respective market environments and business models. However, not all of these factors can be controlled by insurers' stakeholders (management, regulators, policymakers, and policyholders). And the long-term nature of traditional life insurance makes it difficult to accommodate short-term swings within business models. Nonetheless, we believe that stakeholders will have to take action to deal with the current challenge of low yields, even if a slight recovery in interest rates continues to appear the most likely scenario.
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