At zero interest rates, it is very difficult for the German insurance industry to remain solvent, says Wolfgang Münchau.
Much of what could go wrong in the eurozone did. Among the few things that did not has been the unreformed financial sector in Mitteleuropa. That may now be about to change.
The apparent stability of the sector is on some level surprising: Germany, the Netherlands and, to a lesser degree, Austria have been running persistently large savings surpluses — money they invested abroad. In Austria, one conduit for such outbound flows was Hypo Alpe Adria, a bank that was nationalised in 2007 after suffering heavy losses in central Europe. Last week the bad bank into which Hypo’s non-performing assets were folded declared a moratorium on its €11bn of debt.
Germany, too, has its share of dodgy banks. But the real risk there lies elsewhere: in the life insurance sector. Moody’s, a rating agency, already warned in late 2013 that an environment of low interest rates would be very dangerous for the German life insurers. At that time, the yield on 10-year German government bonds was still a respectable 2 per cent. They were at 0.34 per cent last Friday. For five-year paper, the rate is even negative.
Today’s scheduled start of quantitative easing by the European Central Bank could lead to a further fall in market interest rates for as long as the programme goes on — at least until September 2016.
To see the impact of low rates on the life insurance sector, one needs to understand their business model. These companies sell insurance products and annuities with guaranteed returns. They invest the money they receive from their policyholders in government and corporate bonds. For this to work, the average return on the bonds they hold in their portfolio has to be higher than the guaranteed rate they pay out.
To make matters worse, this is all happening at a time when the insurance industry itself is subject to tightening domestic and European regulation. Since 2011, German insurance companies have to hold a reserve to protect themselves against falling bond yields. And a new European regulatory regime will impose stricter capital requirements and solvency rules from 2016.
At zero interest rates, it is very difficult for the industry as a whole to remain solvent. In anticipation of the difficulties ahead, German insurers have begun to diversify into other assets, such as property or private equity, taking on more risk in the process. But all this is small-scale stuff.
One of the best analyses on this subject is from two authors at the Bundesbank. They simulated three scenarios — baseline, small stress, and big stress. In the severe scenario, the average return is between 1 and 2 per cent, which is more than the return on German government bonds you can buy today.
© Financial Times
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