THE LOW INTEREST RATE ENVIRONMENT AND ITS IMPACT ON INSURANCE MARKETS. Mamiko Yokoi-Arai

Transcription

1 THE LOW INTEREST RATE ENVIRONMENT AND ITS IMPACT ON INSURANCE MARKETS Mamiko Yokoi-Arai

2 Current macro economic environment is of Low interest rate Low inflation and nominal wage growth Slow growth Demographic challenges Together with quantitative easing in the major financial markets

3 What happens to the promise that was made? Long-term promises made by insurers, in particular life insurers, could be difficult to achieve under such circumstances. Products with built in guarantees could be most problematic if they are promised over the long-term Could this cause solvency issues for life insurers?

4 18 Yields of 10-year government bonds in selected OECD countries, (per cent) France Japan Netherlands United Kingdom United States

5 AA corporate bond yields (10-yr) 7 Euro zone Japan United Kingdom United States

6 Real long-term interest rates 25 % Germany Greece Japan Mexico Spain United Kingdom United States

7 Annual variation of prices, CPI, France Japan United Kingdom United States

8 10 Real yields on 10-year government bonds, France Japan United Kingdom United States

9 Search for yield? Given this backdrop, there have been questions of whether life insurers (and DB pension funds) might resort to a search for yield Has this been realised?

10 Turkey Hungary Italy Israel Slovak Mexico Portugal France Spain United States Austria Australia Ireland Iceland Japan Czech Greece Chile Norway Belgium Poland Switzerland United Slovenia Korea Estonia Luxembourg Sweden Germany (1) Denmark Netherlands Finland Singapore Malaysia Latvia Indonesia South Africa Uruguay Colombia Puerto Rico Peru Costa Rica (2) Argentina El Salvador Panama Investment portfolio allocation: Life insurers (2013) Bonds Shares Real estate Other Selected OECD countries Selected African, Asian and European countries Selected Latin American countries

11 Variation in life insurers' asset allocation in selected OECD countries, Bonds Shares Real estate Other France (1) Germany (2) Ireland (1) Italy (1) Korea Switzerland (1) United Kingdom United States

12 How duration matching between assets and liabilities is impacted by the low interest rate Investments in long dated bonds with high yield, held to maturity: enable meeting promises on future liabilities However, lack of good quality, very longterm government bonds, which may only have a duration of 10 years. Generally, liabilities have a longer duration than assets

13 Duration gap On the liabilities side, life insurers will have long-dated interest rate sensitive liabilities, which, unless hedged, will result in a negative duration gap an increase in interest rates will have a positive effect, while a reduction in long-term interest rates will have a negative effect

14 Duration gap Current low-yielding assets may not be able to meet the return assumptions made in the past Coupon payments from fixed income instruments and principal from maturing debt must be rolled over into lower-yielding debt (reinvestment risk) Policyholders tend to remain with their generous contracts, unless they can be convinced to switch to new contracts

15 Hungary Turkey Italy Mexico United States Japan Slovak Republic Czech Republic Poland Israel Ireland Korea Spain Portugal Greece Luxembourg Netherlands Canada Switzerland Austria United Kingdom Estonia Norway Chile Latvia South Africa Uruguay Costa Rica Guatemala Colombia Argentina Honduras Peru El Salvador Nicaragua Puerto Rico Panama Paraguay Portfolio allocation to bonds, public and privatesector bonds (2013)(%ge of total investment) Public sector bonds Private sector bonds

16 Nature of insurance contract promise Generally, a fixed promise or guarantee related to interest rates. Life insurance products with a minimum interest rate guarantee promise an ex ante level of guarantee to the policyholder and in some cases an additional share in profits Germany: saving accumulation period of over 40 years US: some policies and guarantees can last for more than 50 years

17 The minimum guarantees for guaranteed saving products with guaranteed interest-rate returns of guaranteed minimum income (annuity) streams cannot be changed during the lifetime of the contract. In addition, the surrender option may be a major challenge for insurers in times of volatile financial markets, as policyholders may opt for more attractive investments

18 The proportion of contracts with high guarantees relative to the yield of investments will determine the capacity of insurers to keep the promise

19 German life insurance contracts Average duration of contract 28 years Minimum investment return guarantees and minimum profit participation ratios Regulators decide on maximum of allowed minimum return according to presently achievable interest rates Average weighted guaranteed return 3.12% in 2013

20 Stock of German life insurers contracts Relative weight of portfolio with respective rate (%) Relative weight of portfolio with the respective guaranteed rate Guaranteed rate of return Guaranteed rate of eturn (%)

21 Level of guarantees Netherlands: 60% of life insurers portfolio are individual life contracts with guarantees and group life with guarantees, with the risk-free interest rate lower than the average level of guarantees since 2009 Average guaranteed rate is a little below 4%, with conditional profit sharing France and UK: interest rate guarantees between 0 to 1%

22 Stock of Japanese life insurance contracts Group annuities: new business Group life insurance: new business Individual annuities: new business Individual life insurance New business Group annuities: business in force Group life insurance: business in force Individual annuities: business in force Individual life insurance Business in Force 2,500 Gross premiums (Yen trillion) 2,000 1,500 1,

23 UK stock of life insurance contracts Premium income (GBP billion) Income protection & other business: premium income Individual pensions: premium income Life & annuities: premium income

24 Guarantees being maintained because Competitive pressure Premium income for guaranteed products being used to cover fixed cost base Possibly at the detriment of capital base

25 Performance of life insurers remain relatively stable Annual net investment return has not experienced a general downturn Return on equity appear volatile, but without a clear trend

26 Average real net investment return (%, ) Selected OECD countries Australia Belgium Chile Czech Republic Estonia Germany Hungary Iceland Ireland Israel Italy Japan Korea Luxembourg Netherlands Norway Poland Portugal Spain Switzerland Turkey Selected African, Asian and European countries Indonesia Latvia Malaysia Singapore Selected Latin American countries Argentina Colombia Costa Rica El Salvador Peru Puerto Rico (1) Uruguay -10.0

27 100.0 ROE (%) Selected OECD countries Australia Belgium Canada Chile Czech Republic Denmark Estonia Finland France Germany Greece Hungary Iceland Ireland Italy Japan Korea Luxembourg Mexico Netherlands New Zealand Norway Poland Portugal Slovak Republic Spain Switzerland Turkey United Kingdom United States Selected African, Asian and European countries Indonesia Latvia Malaysia Singapore South Africa Thailand Selected Latin American countries Argentina Colombia Costa Rica El Salvador Peru Puerto Rico Uruguay

28 The case of Japanese life insurers Japanese life insurers faced with low domestic fixed income yields Failure of small- and medium-sized insurers during the 1990s and early 2000s with unfavourable equity and real estate developments Reliance on high premium income and cost cutting cross subsidisation between products

29 Negative spread turning positive in recent years through allocation to foreign securities (bonds) Currently 18% of asset allocation Subject to forex risk, although being hedged Japanese insurers have remained relatively profitable High mortality risk assumption appear to be offsetting low investment returns

30 "Negative spread" for selected Japanese life insurance companies JPY billions Insurer A Insurer B Insurer C Insurer D Insurer E Insurer F Insurer G Insurer H Insurer I March -06 March-07 March-08 March-09 March-10 March-11 March-12 March-13 March-14

31 Breakdown of profit margin of Japanese life insurers 2000 Negative/Positive spread Expense profit Mortality profit Base Profit (with amounts) Billion JPY FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013

32 Action by life insurers to offset low interest rates Capital gains from equity and bonds Increased holding of corporate bonds and reinvestment in SMEs (US, France) ILSs being purchased by life insurers Lengthen duration of investments (8-9 years) by investing in infrastructure Shift of products being offered (guaranteed saving products to protection policies) Renegotiating policies (in particular group contracts) or offering better profit sharing in exchange for new policy Insurer failure allow renegotiation of policy

33 Regulatory action Risk-based capital regime: look through valuation Possibility of discouraging investment in certain asset classes Solvency II: interest rate guarantees to not exceed 60% of rate of return on government debt Allowing deviation from valuation of liabilities for periods of low interest rate (Switzerland) Additional reserves for high guarantee products (Germany, Japan) Limiting sharing of valuation reserves with policyholders upon expiry of contract

34 Conclusion A search for yield has not been realised A number of countries have taken action to address low interest rates and their fixed promise However, some countries continue to provide high guaranteed products A correction from low interest rates may also pose issues