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European insurers, whose profits are being eroded by Mario Draghi’s quantitative-easing program, face a stress-test headache that risks requiring them to set aside more capital, further hurting their ability to make money.
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The timing of the regulator’s “stress test couldn’t be worse as the results will be rather negative,” said Lutz Roehmeyer, who helps oversee about $12 billion as director of fund management at Landesbank Berlin Investment. “Should it reveal a need to plug capital shortfalls at some insurers, that would be a major setback for the industry as a whole.”
The impact of low and negative interest rates in Europe will be a key concern during the stress tests, regulator Eiopa said ahead of the submissions this week. Insurers could face lower profitability and dividends after the results are published at the end of the year because a need for additional capital buffers would weigh on earnings.
Insurers’ investment income is already being affected by the European Central Bank, which has pushed down yields on government and corporate bonds through unprecedented asset purchases, forcing the industry to look for riskier investments or re-invest at lower returns.
German and Dutch insurers are worst affected by the quantitative-easing program and low interest rates because they sold more products with guaranteed payouts, Moody’s Investors Service analyst Benjamin Serra said in an interview. The guarantees were as high as 4 percent for policies sold in the second half of the 1990s in Germany. A life-insurance contract can run for 30 years or more, so it’s difficult to meet these obligations with the country’s 10-year government bonds yielding less than zero compared with 5.4 percent at the end of the 1990s.
“If this situation continues, we’ll have a state of emergency, in particular for life insurers,” said Rene Locher, an insurance analyst at MainFirst Bank AG. “Low rates, or negative rates, in combination with a central bank that is buying assets on a large scale, putting pressure on yields, is bad for investment income.”
In the search for yield, some insurers have already been hit by the move into the riskier assets. Munich Re lowered its profit target for the year after losses in its equity portfolio as well as restructuring costs. Zurich Insurance AG’s hedge fund investments lost $63 million in the first quarter. Aegon NV lost 358 million euros ($397 million) on investments in hedge funds and commodities as well as hedging mismatches.
“The temptation has been to increase exposure to higher-yielding assets but you have to understand what you’re doing and can’t just chase yield for the sake of it,” said Guy Miller, Zurich Insurance’s chief market strategist.
Property Reliance
Other insurers are increasingly relying on returns from property to boost profits, said Edmond Christou, an analyst at Bloomberg Intelligence. “Life insurers like Swiss Life, Helvetia and Ageas tend to rely on harvesting real estate gains to pay off guarantees on back-books,” said Christou. “Any sudden decline in the Swiss property market may hit their earnings power.”
Investment income at U.K. insurers will also come under pressure this year as a rising proportion of their assets, such as short-term corporate bonds, are reinvested at lower returns, Fitch Ratings said in April. The U.K.’s vote to leave the European Union will also affect the industry, as it impacts the pricing of assets from real estate to bonds.
“European insurers were in dire straits already before the Brexit, with record-low interest rates and much tighter regulation,” said Roehmeyer at Landesbank Berlin Investment. That, “topped with hits on their equity holdings and a setback for economic growth, will limit top-line growth.”
The Eiopa stress tests are an unnecessary expense for insurers, particularly after the introduction of Solvency II, which also measures capital buffers, said Immo Querner, Chief Financial Officer at Talanx AG, Germany’s third largest insurer.
“Solvency II is a permanent stress test of an insurer’s capital by design, so we are now literally stress-testing a stress test,” Querner said in an interview.
Eiopa “considers the low yield scenario extreme and severe enough to assess the vulnerabilities of the life insurance sector,” according to an e-mailed statement. The regulator plans to publish the test’s results in December without providing data on individual companies.
By Jan-Henrik Foerster and Oliver Suess (Bloomberg)
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