For the past six months, government bond rates have risen, after several years of stagnation or decline. This trend reversal, combined with galloping inflation, suggests an increase in the key rates of the ECB, which the European Bank did on July 21st. This change will not be without consequences for life insurance.
Insurers and banks have been repeating the same question for a few weeks: what will happen to euro-denominated funds if government borrowing rates rise sharply in a short period? All the analysts wanted to solve this enigma and some even came out with the most alarmist forecasts. Experts fear in particular a wave of massive withdrawals on investments, which could affect the liquidity reserves and the solvency of insurers. Others want to be reassuring and draw attention to:
- The financial strength of the companies;
- State safety nets.
A gradual improvement in the remuneration of contracts in euros
The rise in key ECB rates has a direct impact on the cost of credit for companies, individuals… and the State. However, 80% of assets in life insurance euro funds are made up of corporate and government bonds. In theory, the remuneration of these contracts should increase in the coming months. The reality is a bit more complex. Loans held by insurers were acquired at a time when rates were still very low, around 0.5%. In the immediate future, distributors cannot pass on these new rates to the performance of their contracts in euros.
This action will only be possible when their portfolio welcomes new, more profitable bonds. In other words, the return on euro contracts will change more slowly than bond rates. This delay logically leads a lack of attractiveness, at least temporary, of contracts in euros. Savers could decide to withdraw the money from their funds in euros and reinvest them in a super booklet or a regulated product such as the Livret A, for example. After all, these vehicles offer a rate of 2% from August 1, significantly better than the average yield of 1.3% on a commitment in euros.
If these arbitrages take place, insurers will be forced to liquidate their stock of old bonds and record more or less substantial capital losses. However, even at this stage, the risk of insurers collapsing is limited. The High Committee for Financial Security can activate the Sapin 2 law, a special device which makes it possible to limit savings withdrawals and dividend distributions when these operations pose an existential threat to banks and insurance companies.
More rate hikes expected this year
Despite its impact on savings products and on the financial markets, the increase in the key ECB rate is rather well received by insurers and governments. The observers hope that this decision slows inflation in Europe – and the sooner the better. The European Central Bank aims to keep consumer price inflation below 2% in 2023. This objective will be difficult to achieve.
Brussels forecasts inflation around 4% next year. This is significantly lower than the rate of 8.6% measured in June. Nevertheless, this value still exceeds the 2% ceiling associated with “under control” inflation, in the words of the ECB. To reach this level, further rate hikes could be considered. This measure could lead to the use of the IPT program. This emergency mechanism authorizes the ECB to buy the debts of the European States most in difficulty in the face of high borrowing rates.