The low interest rate environment has ushered in favourable market conditions for insurers to raise capital, with life and non-life companies taking advantage of suppressed yields to opportunistically issue debt securities, whilst also making early redemptions. However, the current yield environment is a double-edged sword, with anaemic investment income representing a significant offsetting factor for insurance groups.
In-depth analysis by A.M. Best of over EUR 90 billion of debt issued by a representative sample of European insurers between 2005 and 2014 shows the changing coupons offered for debt and the more favourable debt financing achieved by insurers in recent years. In its new Best’s Special Report, titled, “Low Interest Rates Good News for Debt Issuers but a Drag on Insurer Earnings,” A.M. Best notes that a significant amount of debt has been issued in 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.
Yields have fallen significantly in virtually all asset classes and industry sectors – to such an extent that A.M. Best feels in many cases, the investor returns are not adequate for the risks they are taking. Stefan Holzberger, managing director, analytics, said: "In A.M. Best’s opinion, the extremely low interest rates in the market today 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."
A.M. Best considers the artificially low interest rates a significant challenge for insurers. European insurers are struggling to generate investment income as the majority of their invested assets are held in high-quality fixed-income securities. 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. Consequently, continued investment income declines are anticipated due to the low reinvestment rates.
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. 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."
To access a complimentary copy of this report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=238564.
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