Germany: Where Negative Rates Are Lethal
Life insurers feel pain of negative interest rates
By Madeleine Nissen and Paul J. Davies
Updated April 14, 2016 5:30 a.m. ET
German life insurers are caught in a pinch that could eventually threaten their survival. Regulators are forcing them to boost capital levels at the same time that low rates make it hard to make money with their investments.The question is how long before the ride gets bumpy enough to shake out the weakest firms.
German regulators are so concerned about the impact of negative interest rates on the country’s life insurers that they have said they can only be sure the sector is safe through 2018. Even today, half the industry would be short of capital without the help of special measures.
The trouble lies in the promises insurers made to policy holders years ago, when nobody would have guessed central banks around the world would send interest rates barreling toward zero, only to remain there for years on end and even break into negative territory.
The German life industry is particularly badly affected by very low or negative interest rates because companies have historically offered what now look like high levels of guaranteed returns over very long periods.
Some insurers need to earn a continuing investment yield of more than 5% to meet guarantees to their policy holders, a report from Germany’s central bank found in 2014. In a world where 10-year German government bonds yield less than one-quarter of 1%, that looks very hard to achieve.
Falling interest rates also increase the size of the liabilities on insurers’ balance sheets, which can reduce their capital if assets don’t increase in valuation enough to match.
Large European insurers such as Allianz SE, ALIZF 2.64 % AXA SA, AXAHY 2.41 % Assicurazioni Generali G 0.91 % SpA and Munich Re MURGY 1.51 % all have big German life businesses, but regulatory concerns are more immediately focused on smaller insurers mainly unknown outside of the country. German life insurers earned gross written premiums of €89.9 billion ($101.4 billion) in 2014, according to the most recent statistics from German financial regulator BaFin.
The German industry association, GDV, says the country’s life insurers are fit enough to remain solvent for up to a decade or longer. But Frank Grund, head of insurance supervision at BaFin, said he could only be certain of the sector’s safety through 2018.
One thing insurers can’t rely on is a respite on interest rates soon. The European Central Bank is struggling to boost inflation to its desired target, and one of its primary levers is to send interest rates lower. That leaves an open question as to where insurers can find investments with the right combination of yield and risk that will allow them to make good on their promises
Munich Re, whose unit Ergo Leben is Germany’s seventh-largest life insurer with €3 billion in gross written premiums, is watching monetary policy “with great concern,” said Chief Executive Nikolaus von Bomhard.
“What is dangerous is that the return on many investments is no longer reflective of the underlying risk involved,” Mr. von Bomhard told The Wall Street Journal. “Many investors feel forced into taking higher risks.”
Some policy holders are already losing out on money they should be getting, according to an association representing customers, because of the regulator’s efforts to bolster the companies’ balance sheets and survival prospects.
All European insurers are also adjusting to a new set of capital rules, known as Solvency II, which make the valuation of their commitments to policy holders more sensitive to markets, putting pressure on their capital levels.
The German life industry has been given 16 years to fully meet their capital requirements under the new European rules. Without the help of this staged introduction, almost half the industry wouldn’t have enough capital today, BaFin found in a survey last year. Even with the helpful measures, 1% of the industry is short of capital under Solvency II.
BaFin is trying to protect policy holders over the longer term by forcing life insurers to build up a special reserve based on prevailing interest rates, known as the Zinszusatzreserve, or ZZR, which is meant to help meet policy-holder guarantees in future.
When this was introduced in 2011, it was thought the industry could build this reserve through ordinary investment income. However, as investment returns have tumbled, companies have been forced to sell older assets that pay higher income because they are worth more than what insurers paid for them.
Insurers then use the realized profits from these sales to build up the ZZR. The problem with this strategy is that insurers have to reinvest more in similar assets that pay much lower yields, or take on more risk. Insurers are doing a bit of both, but their average running investment yield still is falling faster than it would without this harvesting of profits to build up the ZZR.
“It’s an acceleration of the recognition of their problems,” said Benjamin Serra, a senior credit officer covering German insurers at Moody’s Investors Service, the ratings firm.
Axel Kleinlein, chairman of the policy holders association, the BdV, said that the ZZR already means policy holders get less than they were promised.
“This additional interest provision is diverting money away that should go to the company’s own policy holders,” Mr. Kleinlein said.
In the long term, the industry needs to raise more capital. But many of the weaker insurers are mutuals, owned by policy holders rather than shareholders, so they don’t have access to equity markets. They can sell junior bonds, but this may be costly if they don’t have a program in place. Or they can get private loans from investors with a high risk appetite, which some are doing.
The industry as a whole could suffer if the weaker players are unable to raise more capital and fail.
Failed insurers may have to be bought out by a national rescue vehicle called Protektor, which is funded by healthy insurers and was created to bail out a company called Mannheimer in 2002.
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