LONDON -- European insurers find themselves needing to adapt, or die.
Insurers are likely to retreat from traditional insurance products as they concentrate on managing their reserves and as tax incentives for insurance products are cut back.
Market analysts remain concerned about the financial health of continental European mutual insurers that rely heavily on insurance-linked products and do not have the financial resources of their larger stock-market listed competitors.
Equitable downgrade
In Britain, for example, Moody's Investor Services Ltd., London, recently downgraded the financial strength rating of Equitable Life Assurance Society, London, to A1 from Aa3 as the rating agency was concerned about increased pressure on the firm's minimum solvency requirements, said Nicholas Holmes, senior analyst, Moody's Financial Institutions Group.
All U.K. life offices are required to keep in reserve the full amount of their outstanding guaranteed annuity options regardless of when they will be exercised.
"The solvency rates of the quoted European insurers are very, very comfortable. Those that might get into trouble are the mutual companies. Consolidation is the obvious solution for the smaller companies," said Patrick Lemmens, global financial institutions analyst for ABN-AMRO Asset Management, Amsterdam, Netherlands.
Investors beat a hasty retreat from the insurance sector early this year after reports that insurers in the Netherlands and Belgium in particular might have difficulties meeting the guaranteed returns they are obliged by law to provide to policyholders.
Moody's analyst Mr. Holmes believes many life companies are well-capitalized because of healthy returns from their equity portfolios. But smaller firms will have to manage their reserves carefully, as they might not have the resources on which to fall back if interest rates were to soften again.
Risks apparent
Even though Dutch companies have not had to restate their reserves for existing business guaranteeing a 4% return, they may face considerable reinvestment risk when the long-term bonds they hold mature, he said. Unless European bond rates continue to rise, it may be difficult to find fixed income products with yields to match the 4% guaranteed rate.
But continued strength in the equity markets has meant many companies have been able to offset falling bond prices with increased returns from the stock market.
ING, during the first quarter of this year, and Fortis, at the end of last year, set aside additional reserves of E150 million ($156 million) and E471 million, respectively, to take account of the expected fall in interest rates and the impact it would have on reserves. In hindsight however, that provisioning looks conservative and may dampen profit growth at Fortis over the next few years, said Mr. Lemmens.
Insurance regulators in the Netherlands and Belgium were so concerned about the financial impact of lower interest rates that they stepped in to assist the industry by lowering the guaranteed return rates insurance companies have to provide to policy holders by around one percentage point.
This year, the Dutch Insurance Chamber reduced the guaranteed return rate for domestic insurers on new business to 3% from 4% because of the lower interest rate environment. It further calmed industry concerns by announcing in August that domestic investors would not have to restate existing reserves to take account of the new rate.
When insurers are required to guarantee returns to policyholders, they tend to match the premium with the guaranteed rate they are expected to provide.
In Belgium the guaranteed interest rate was reduced to 3.2% from 4.7% at the beginning of this year.
But the fall in guaranteed rates should be seen as short-term respite from more fundamental problems in the industry.
Mr. May remains concerned that lower interest rates continue to pose a significant challenge to the life industry. To withstand this pressure, life companies need to focus on improving efficiencies, streamlining distribution and adapting their product lines to provide more equity-based and unit-linked policies.
Interest rates and short dated yields are now at levels where it is difficult for life insurance companies to make sufficient returns to cover their expenses. Profit margins have fallen as a result.
