Fitch: French Life Insurer Pay-Out Rates Will Pressure Margins

Generous annual policyholder pay-out rates announced by French Life insurers over the last several weeks will add to the pressure on their margins, but should help protect business volumes, Fitch Ratings says. The decision to cut pay-out rates by much less than the decline in sovereign yields shows that low rates are a key risk for life insurers, even when they are not constrained by minimum guaranteed pay-outs.

In France, life insurers have greater flexibility than in many other European countries to reduce pay-outs because payments to policyholders are well above the average minimum guaranteed rate of about 1%. However, even after the head of the French central bank called for substantial cuts, insurers have cut pay-out rates only by an average 30 basis points to 2.5%.

This is in line with the annual reduction since 2008, but follows a year in which the yield on French 10-year government bonds dropped by around 160 basis points to less than 0.8% at the start of January. This will compress margins as firms have to reinvest at rates below their pay-out rate, although this is partly offset by increased investment in corporate debt and other higher-yielding holdings. The decision to maintain relatively high pay-outs also limits insurers' ability to build buffers that would be useful in case of rapid rises in interest rates. In this scenario, consumers might redeem their policies and switch to more attractive banking products. In the worst case, insurers might have to sell bonds at a loss to meet large redemptions.

The reason pay-out rates have not been cut further is insurers' concern that bigger cuts would hurt their competitiveness, damaging volumes and earnings. Insurers believe they will be able to persuade some policyholders to switch their policies towards unit-linked investment vehicles, which are less risky and more profitable for insurers. Customers' choice of home for their investments depends on the attractiveness of expected and guaranteed returns, as well as tax benefits and rates offered by bank savings accounts.

Since mid-2013, very low short-term interest rates have led French consumers to favour long-term life savings products with significantly higher yields over short-term and liquid banking products. However new business volumes are more volatile than they have been historically and reversal in consumer preferences would increase competition and add earnings pressure.

The drag on profitability from low interest rates is the key factor behind our negative sector outlook for the French life insurance. The rating outlook for the sector is stable, however, as these pressures have already been factored into ratings.