Impact of Low Interest Rates on European Insurers

Dermot Corry

June 8th 2015

• Context• UK/Ireland• Germany• Non Life• Solvency II

Agenda

European Insurance Assets (€m)

Bonds Loans incl Mortgages

Other -

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

Non-LifeLife

“Weak European midsized life insurers face a high and rising risk of distress”

IMF – April 2015

“24 percent of insurers may not be able to meet their solvency capital requirements under a prolonged low interest rate scenario”

EIOPA Stress Test

Bundesbank Discussion paper 2014

Financial Times – April 2015

ECB Financial Stability Review – May 2015

“Despite the solid profitability reported so far, euro area insurers are facing growing challenges as the low-yield environment has tested their traditional reliance on fixed income assets as a means of generating portfolio returns.”

Long term rate context

10 year bond yields

Jan-93

Aug-93

Mar-94

Oct-94

May-95

Dec-95

Jul-96

Feb-97

Sep-97

Apr-98

Nov-98

Jun-99Jan

-00

Aug-00

Mar-01

Oct-01

May-02

Dec-02

Jul-03

Feb-04

Sep-04

Apr-05

Nov-05

Jun-06Jan

-07

Aug-07

Mar-08

Oct-08

May-09

Dec-09

Jul-10

Feb-11

Sep-11

Apr-12

Nov-12

Jun-13Jan

-14

Aug-14

Mar-15

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

UK 10 year German 10 yearSource: ECB

10 year Eurozone AAA rate

6/1/2

005

9/7/2

005

12/14/2

005

3/22/2

006

6/28/2

006

10/4/2

006

1/10/2

007

4/18/2

007

7/25/2

007

10/31/2

007

2/6/2

008

5/14/2

008

8/20/2

008

11/26/2

008

3/4/2

009

6/10/2

009

9/16/2

009

12/23/2

009

3/31/2

010

7/7/2

010

10/13/2

010

1/19/2

011

4/27/2

011

8/3/2

011

11/9/2

011

2/15/2

012

5/23/2

012

8/29/2

012

12/5/2

012

3/13/2

013

6/19/2

013

9/25/2

013

1/1/2

014

4/9/2

014

7/16/2

014

10/22/2

014

1/28/2

015

5/6/2

0150.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Source: ECB

• Generally well matched• Primarily SP business• So little ALM loss• However

– Attractiveness of Annuities– Government action– Alternative options

• Impact on Longevity capital • Search for yield

Implications for Ireland/UK

Need to live for ? Years to get return of capital

A: 15-17B: 18-20C: 21-23D: 24+

At Age 65

Need to live for ? Years to get return of capital

24

So investment return earned after age 89

At Age 65

• €90bn premium per annum (life only)• €868bn in assets (life)• 560 insurers • 212,000 employees• Heavily dependant on guaranteed business

Focus on the German market

Market Shares – IMF report

• Regular Premium• Long duration – often pension• Guaranteed return on net premium

– Guarantee set at outset and applies for duration• Assets invested in bonds

– Shorter than liabilities– Don’t deal with reinvestment risk, though larger

insurers use swaptions • Excess of earned investment return paid out as

annual bonus

Typical German with profits

Guarantee based on 10 year average

Jan-93

Jul-93Jan

-94Jul-9

4Jan

-95Jul-9

5Jan

-96Jul-9

6Jan

-97Jul-9

7Jan

-98Jul-9

8Jan

-99Jul-9

9Jan

-00Jul-0

0Jan

-01Jul-0

1Jan

-02Jul-0

2Jan

-03Jul-0

3Jan

-04Jul-0

4Jan

-05Jul-0

5Jan

-06Jul-0

6Jan

-07Jul-0

7Jan

-08Jul-0

8Jan

-09Jul-0

9Jan

-10Jul-1

0Jan

-11Jul-1

1Jan

-12Jul-1

2Jan

-13Jul-1

3Jan

-14Jul-1

4Jan

-150.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Average prior 10 years

Guarantee based on 10 year average

Jan-93

Aug-93

Mar-94

Oct-94

May-95

Dec-95

Jul-96

Feb-97

Sep-97

Apr-98

Nov-98

Jun-99Jan

-00

Aug-00

Mar-01

Oct-01

May-02

Dec-02

Jul-03

Feb-04

Sep-04

Apr-05

Nov-05

Jun-06Jan

-07

Aug-07

Mar-08

Oct-08

May-09

Dec-09

Jul-10

Feb-11

Sep-11

Apr-12

Nov-12

Jun-13Jan

-14

Aug-14

Mar-15

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Average prior 10 years 60% of Average

Guarantee based on 10 year average

Jan-93

Aug-93

Mar-94

Oct-94

May-95

Dec-95

Jul-96

Feb-97

Sep-97

Apr-98

Nov-98

Jun-99Jan

-00

Aug-00

Mar-01

Oct-01

May-02

Dec-02

Jul-03

Feb-04

Sep-04

Apr-05

Nov-05

Jun-06Jan

-07

Aug-07

Mar-08

Oct-08

May-09

Dec-09

Jul-10

Feb-11

Sep-11

Apr-12

Nov-12

Jun-13Jan

-14

Aug-14

Mar-15

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Average prior 10 years 60% of Average Guaranteed Rate

Guarantee based on 10 year average

Jan-93

Jul-93Jan

-94Jul-9

4Jan

-95Jul-9

5Jan

-96Jul-9

6Jan

-97Jul-9

7Jan

-98Jul-9

8Jan

-99Jul-9

9Jan

-00Jul-0

0Jan

-01Jul-0

1Jan

-02Jul-0

2Jan

-03Jul-0

3Jan

-04Jul-0

4Jan

-05Jul-0

5Jan

-06Jul-0

6Jan

-07Jul-0

7Jan

-08Jul-0

8Jan

-09Jul-0

9Jan

-10Jul-1

0Jan

-11Jul-1

1Jan

-12Jul-1

2Jan

-13Jul-1

3Jan

-14Jul-1

4Jan

-150.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

Average prior 10 years 60% of Average Guaranteed Rate 10 year German Bond yield

• Assets held at book value• Liabilities held at retrospective value• Bonus paid from

– Earned interest– Realised gains/losses– Profits from mortality/expense

• Squeeze as earned rates decline– Supported by realised gains

Reserving

ERGO sample figures

Source: Munich Re Analysts Conference March 2015

• Conveniently called ZZR• Introduced in 2012 • Aims to reserve for prospective issues• €21bn across the market• NPV of guarantees in excess of reference rate for

next 15 years• Reference rate based on average of last 10 years

AAA rate• Funded to date by Unrealised gains

Zinszusatzreserve

• Reference Rate will fall even if rates rise

• Ergo expect ZZR to increase by €900m this year

Possible reference rate path

Source: ERGO/Munich Re

• Further rate hedging• Search for yield• Greater share of mortality profits to

policyholders• Restrictions on new business• Withdrawal from with profits• Focus on UL/other products• Limits on dividends out of profit sharing account

Some actions taken

• Issues not as significant• However reduced yield increases pressure

– Assets are 3.4 time premiums– 1% fall in yield requires 3.4% increase in COR to

compensate– Falls to date imply 10% increase in COR

• PPOs will accentuate the issues

Non-Life

• Some exceptional circumstances• Reduces real yield for calculation of lump sum

payment from 3% to 1%• Substantial increase to reserves as a result• But actual real yield at end of March 2015 was

close to -1.00%

Russell Judgement

Huge impact from low yields

Real Yield 3% Real Yield 1% Real Yield -1% -

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Value of 100 per annum for 50 years with different real yields

• Will look at three key points:– Interest Rate shock– Ultimate Forward Rate/Last Liquid Point– Transitionals

Solvency II

• Shock is a proportional shock up or down to interest rates

• At 10 years the shocks are– Up 42%– Down 31%

• 1.3%/1% when Solvency 2 designed• At Q1 2015 0.19%/0.14% (Risk free rate 0.46%)• Since Q1 rate has increased by 0.63%!

Interest Rate Shock

• LLP – Last Liquid Point• UFR – Ultimate Forward rate (4.2%)• Discount rate converges to UFR after LLP• LLP and convergence period vary by currency

Ultimate Forward Rate

Currency Euro Dollar Sterling Swedish Krona

LLP 20 50 50 10

Convergence 40 40 40 10

At Q1 2015 impact is large

1 2 3 4 5 6 7 8 9 1011121314151617181920212223242526272829303132333435363738394041424344454647484950

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

Market Rates UFR/LLP

Table shows Spot Rate for appropriate duration

Impact on liability of 100

Duration 20 years 30 years 40 years 50 years

Value with no LLP/UFR

86 79 73 69

Value with UFR/LLP

86 68 46 31

% Reduction 0% -14% -36% -55%

All based on Euro at end March 2015

• Solvency II is being implemented gradually• Can use transitional

– Blend in rates over 16 years; or– Blend in TP over 16 years

• Means that we will not have completely comparable figures until 2032

Transitionals

• There are real guarantee issues in Europe• This is on the radar of key global bodies• Some recognition in German regulatory

accounts• But not market consistent• Solvency II fudges the long term guarantees

Summary

Dermot.corry@milliman.com+353 1 6475910

Questions?