Low interest rates make saving nearly mission impossible

While borrowers rejoice at the ultra low and even negative interest rates in Europe, savers fret and life insurance companies and pension funds face what is virtually a mission impossible.

Despite a spike in sovereign bond yields in the past couple of weeks, levels still remain ultra-low. The rate of return to investors on benchmark 10-year German and French bonds has stayed below one percent in recent months and the yields on long-term Swiss debt even went negative.

Sovereign bonds are very important for long-term investors as they are a safe investment that allows them to lock into guaranteed returns.

For life insurance companies and pension funds which are investing the savings of others, the safety of sovereign bonds has led regulators to require them to place certain percentages of their investments in bonds.

But the unprecedented rock bottom interest rates are posing a problem as many life insurance polices offer guaranteed interest higher than current bond yields.

Last year in France, life insurance contracts paid on average 2.5 percent.

Life insurance companies can temporarily dig into investment funds to continue to pay high rates and attract investors, but this is a strategy experts said cannot continue if rates remain low.
"This drop in rates and the uncertainty that has accompanied it is affecting life insurance returns," said Claude Chassain, an actuarial expert at Deloitte.

The level of interest rates has been worrying the industry for months, and analysts and ratings agencies are concerned about the industry.

"Low interest rates in the euro area pose substantial challenges to the life insurance industry," said IMF staff in a blog post earlier this month.

"Mid-sized insurers with guaranteed returns and long-dated liabilities that are not matched by similarly long-dated assets face a particularly high and rising risk of failure," they said.

- Collateral damage -

German insurers, which offer much higher guaranteed returns than their French counterparts, have been particularly critical of the European Central Bank's ultra-low interest rate policy, and its 1.1-trillion-euro ($1.2-trillion) bond buying stimulus programme that has driven down bond yields.

"The problem with German insurers is that not long ago they guaranteed returns on (products) like long-term euro contracts. These yields must be respected every year, even as rates fall," explains Chassain.

According to Karsten Eichmann, president of German insurer Gothaer, that situation has left companies like his caught in an agonising pinch.
"The insurance sector in Germany is currently facing a considerable degree of damage, in the order of several billion, provoked by the European Central Bank's policy of very low rates," Eichmann wrote in the Sueddeutsche Zeitung in early May.

The result, he noted, is "it is clear that in an environment of rates close to zero, life insurance becomes a money-losing activity in all its forms".

Pension funds are also sounding the alarm.

PensionsEurope, the trade organisation for European pension institutions, warned regulators in a report in late April that "pension funds can not be considered collateral damage of the ECB's (quantitative easing policy) when the problem involves retirement savings of millions of Europeans".

Chassain says low interest rates like those currently in place are destined to make life difficult for any insurer with long-term guarantees on return.

"In the United Kingdom, pension funds abandoned fixed-yield agreements quite a while ago in favour of fixed-contribution schemes that allow them to take economic conditions into account at the time (the client) retires," Chassain says.

For insurance companies, the strategy is to invest in high-risk assets like corporate bonds, stocks and infrastructure projects. Meanwhile, most also encourage clients towards options that do not guarantee savings invested, such as unit-linked plans.

That same trend has already taken hold in Japan, where interest rates have remained low for quite some time.

Insurers have restructured their portfolios to reduce investments with fixed rates of return and replaced those with plans tied to demographic risk, such as term life insurance or provident funds, Chassain says.

In France, payments into unit-linked plans increased 38 percent in the first quarter of 2015 compared to the same three-month period the previous year.