Mari Pinardo | Insurance companies, particularly the European ones, are up against a rock and hard place due to the low interest rate environment, the need to look for long-term profitability, the lack of investor appetite and the impact of Brexit on European fixed income markets.
According to a report by the International Monetary Fund, the insurers hold over $24 trillion in long-term assets and liabilities. Up to now, their business model has been based on investing their clients’ short-term insurance premiums in long-term instruments. But what happens when there are $11.4 billion of sovereign bonds in negative territory, including those which were considered to be safe havens like the German 10-year bond? In 2011, 40% of the insurance companies’ portfolios had an ‘AAA’ rating. In 2015, this dropped to 25%. So it’s no wonder that in February the IMF warned that contribution of the insurance sector to systemic risk has increased.
“The insurers have seen their margins affected, especially in the life insurance business,” says Iratxe Galdeano, partner responsible for insurance at Afi.
In the US, the situation is obliging many companies to rethink their investment policy and portfolio structure. According to Afi, “the relative weighting of stocks and other assets with greater credit risk and higher remuneration, as well as a longer duration, is increasing.”
And Afi believes that the changes “mean an increased risk profile/capital consumption for the insurers themselves.” And those companies with limited capital could have problems in guaranteeing their obligations with their clients. “The smaller insurers or those with fewer resources will have to manage them well to obtain the capital they need or they will be swallowed up or disappear,” says Galdeano.
Rethinking their business models
French insurance company Axa has launched a new product with the aim of limiting the impact of inflation and the interest rate risk. And the current environment is likely to drive many other insurance firms to find a way of dodging the fall.
Property investment, which can offer higher yields, has become an option, despite the greater risks involved. In the UK, for example, 80% of new investments by companies like Aviva have been earmarked for property assets. Germany’s Allianz – the owner of PIMCO, the biggest sovereign bond investment fund in the world – has also gone into property and has invested 4.2 billion pounds in British infrastructure.
Eduardo González Ercoreca, from the Spanish insurance sector association Unespa, also flags the importance of the Junker Plan for insurers. “The insurance sector may be interested in the investment options offered by this plan. But how involved they get will depend on the treatment the supervisors give these kind of assets.”
Mergers on the cards in Spain?
In Spain, insurance companies have 330 billion euros of assets, according to the report on the Insurance and Pension Funds Sector published by the Economy Ministry at end-2015. Of this total, 47% is invested in Spanish public debt – this debt has an average maturity of 6 years – which currently offers no yield.
Even so, because of its structure, the sector in Spain is in a better position than its international peers. “In Spain assets and liabilities are very closely linked, which immunises the companies to a large extent against interest rate movements,” explains Iratxe Galdeano.
But the low level of profitability in their business is exerting greater pressure on Spanish insurers. This has driven them to seek growth in volumes, something which is very easy given the sector’s huge fragmentation. So are mergers on the cards? This is a debate which has been going on for a long time, according to Pascual Fernández, President of the Economists College in Madrid. Up to now, this consolidation process “has not been as intense as many analysts predicted. But that said, a significant number of companies have merged or been swallowed up in the last few years in Spain.”
Felipe López, analyst at Self Bank, is convinced there will soon be mergers and acquisitions in the sector, with companies “taking advantage of synergies and reducing fixed costs.”