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Fitch estimates that at today's low rates Fitch-rated insurers could continue to generate investment returns above the rates they have guaranteed to customers for almost a decade. But low rates also put pressure on capital and squeeze earnings, which could lead to downgrades. Smaller, unrated insurers may also be more exposed due to weaker capital and lack of business diversification.
German firms have historically offered customers guaranteed investment returns as high as 4%. These have steadily reduced, to 1.25% at the start of this year, but the very long duration of the guarantees means the average guaranteed credit rate of a typical portfolio is 3.1%. Investing ongoing premiums and reinvesting maturing assets in the environment of low or negative sovereign benchmark rates makes it ever harder to meet these guarantees.
Even if investment income were insufficient to cover the guarantees, they could still be met for some time from other sources of income, such as underwriting profits. If these additional sources are included in the calculation, the return on investment would stay above the required return until beyond 2033 in our 1.5% investment return scenario.
Fitch therefore expects insurers to continue to meet guarantees, but the risk they will be unable to do so will rise if rates remain low. Low yields will also inevitably squeeze insurers' profits, even if guarantees remain affordable, and would continue to eat away insurers' capital buffers. Between 2008 and 2013, capital buffers in relation to actuarial reserves gradually dropped from 8.8% to 7.4%. Fitch expects this ratio to have declined to about 7.1% in 2014, and to fall further in 2015.
Together, these risks make low rates the main underlying threat to German life insurers' ratings, which could come under pressure if current investment returns persisted for more than another year or if the 10-year bund yields turned firmly negative.