European insurers, which hold about 8 percent of southern euro-zone sovereign debt, may survive writedowns without raising capital by passing losses onto customers.
Life policyholders will shoulder about two-thirds of the potential losses insurers face on their 235 billion euros ($335 billion) of Greek, Italian, Irish, Portuguese and Spanish debt, according to Bloomberg calculations based on data compiled by JPMorgan Chase & Co.
“Policies are written against the general account of the insurers, so basically they have all the flexibility they want to assign any losses on assets to policyholders,” said Guillaume Prache, managing director of the Brussels-based European Federation of Investors, which represents two million retail investors. Customers “are very badly informed on the exposure and the risk that represents.”
Most government bonds held by insurers back so-called with-profits life policies in which the customers and sellers share any gains or losses on their investments. While that will help pan-European insurers to weather a write-off of Greek, Portuguese and Irish bonds, defaults or losses on Italian and Spanish debt will have more severe repercussions for insurers’ balance sheets, analysts say.
Banks Versus Insurers
Equity markets rallied yesterday after European leaders persuaded bondholders to take 50 percent losses on Greek debt and boosted the firepower of the region’s rescue fund to 1 trillion euros. Insurers’ ability to pass losses to policyholders make them more attractive investments than banks, investors say.
“Insurers have fallen like banks all the way through this crisis,” said David Moss, who helps manage 8 billion pounds ($13 billion) in European equities at F&C Asset Management Plc in London. “We think that’s unfair because they can share a proportion of any losses with policyholders.”
The Bloomberg Europe 500 Insurance Index dropped 24 percent from Aug. 1 to its low for the year on Sept. 22, while the Bloomberg Europe Banks and Financial Services Index fell 29 percent in that time. The insurance index dropped 1.5 percent today while the bank index was down 0.2 percent.
“The net loss that life insurance companies will take as a result of a Greek government default could be considerably lower than the gross amount of debt the company holds,” Jeremy Carter, a managing director at Fitch Ratings Ltd. wrote in a note published today. “Life insurers could pass a large proportion of the losses to policyholders.”
Most insurers have “manageable exposure” to Greek debt and wouldn’t be downgraded if they accepted the 50 percent write down offered by European leaders, Fitch said. French life insurers are a “notable exception” because of their southern European investments, the ratings agency said.
CNP Assurances SA, a French life insurer, Italy’s Assicurazioni Generali SpA and Groupama SA, a French mutual insurer, hold the most Greek, Irish and Portuguese debt as a proportion of their shareholders’ equity, according to JPMorgan. While customers will take a proportion of losses, the details of exactly how much are “opaque” because of the complexity of the products sold, according to a Morgan Stanley research note published in September.
Tamara Bernard, a spokeswoman for Paris-based CNP Assurances, and a Generali spokeswoman declined to comment. Groupama spokeswoman Aneta Lazarevic didn’t respond to an e-mail and telephone call seeking comment.
Almost three-quarters of life insurance products sold to Europeans have a savings element that offers minimum returns or capital guarantees, according to Brussels-based CEA, the European insurance and reinsurance federation. The majority of the investment risk is borne by the policyholder.
While policies differ across product lines and countries, they are typically sold as low-risk investments that pay a return every year and a lump sum either upon the policy maturing or when the customer dies. Insurers maintain the right to withhold annual payments and may be unable to meet guarantees should their solvency come under threat, according to Prache of the European Federation of Investors.
Generali typically offers guarantees at maturity meaning “during the life of the product, there is no obligation to pay any guarantee,” Raffaele Agrusti, chief financial officer of Italy’s biggest insurer, said on a conference call with analysts Aug. 5. The long-term nature of these products should help the insurer manage any bond losses, he said.
In Germany, the U.K. and Switzerland, customers’ share of the investment risk on these products is 90 percent while in Italy their share is 80 percent, with insurance companies making up the remainder, according to Morgan Stanley.
When Allianz SE, Europe’s biggest insurer, wrote down the value of its Greek bonds in the second quarter of this year, policyholders took 73 percent of the 279 million-euro impairment, reducing the company’s operating profit by just 76 million euros.
Chief Executive Officer Michael Diekmann said Aug. 5 he’s “confident” of meeting his full-year operating profit forecast of 7.5 billion euros to 8.5 billion euros.
Insurers’ gross holdings in Greek, Irish and Portuguese debt is valued at 9 percent of their capital, according to Moody’s Investors Service. After customers take losses on their policies, insurers’ potential deficit drops to less than 3 percent, the ratings company said.
Should Greek bonds require further writedowns or Ireland and Portugal face impairments, policyholders will continue to provide a buffer for insurers’ shareholders.
“Profit-sharing is a legitimate mechanism that for many decades has enabled insurers to offer long-term products,” CEA, the industry lobby group, said in an e-mail. “European policyholders make informed choices about the products they buy, which are closely regulated.”
CNP’s investments in Greek, Irish and Portuguese bonds are 61.5 percent of its shareholders’ equity, while Generali’s is 41.2 percent and Groupama’s is 40.3 percent, according to JPMorgan. CNP’s net exposure, which removes policyholders’ share, is equivalent to 2.6 percent of its capital, Groupama’s 10.7 percent and Generali’s 7.5 percent, the data show.
Letting customers bear the losses of any sovereign debt defaults may backfire for insurance companies in the long run, according to Trevor Moss, a London-based European insurance analyst at Berenberg Bank.
“The companies that think they can just freely pass it onto the policyholders are maybe living in Never-Never Land because they may be killing their business model,” he said. “There could be potential legal implications and mis-selling claims down the line.”
There are also discrepancies as to the amount of losses policyholders can bear. CNP Assurances, France’s biggest life insurer, said its shareholders’ net exposure is just 4.1 percent of the 1.5 billion euros of Greek bonds it held on June 30. By contrast, French rival Axa SA, France’s largest insurer, said its shareholders’ net unrealized losses were 20 percent of the 766 million euros of Greek bonds held on June 30.
In France, customers’ share of the investment margin on life insurance products is typically 85 percent with the insurer picking up the rest, according to Morgan Stanley.
The difference between Axa’s and CNP’s reporting may be because CNP only sells life insurance while Axa also writes property-casualty policies, which cannot absorb losses, according to Pierre Flabbee, a Paris-based insurance analyst at Kepler Capital Markets.
Most European insurers wrote down their Greek bonds due for maturity before 2020 to market value, JPMorgan said, referring to its universe of 27 insurance companies. CNP and Groupama were the only two to mark their Greek debt down by 21 percent rather than to market value, citing the deal brokered in July by the Institute of International Finance, according to JPMorgan. Allianz and Munich Re were the most conservative, impairing all their Greek bonds to market value, JPMorgan said.
“We can withstand default of one or several of the other peripheral countries, but the major issues are around secondary effects, which are much more difficult to gauge,” said Patrick Frost, chief investment officer of Swiss Life Holding AG.
The scenario that most concerns the industry is if Italy and Spain, the euro zone’s third- and fourth-biggest economies, restructured their debt, according to Moody’s. Insurers domiciled in those countries would be the most affected and their ratings would track those of their sovereign because firms typically invest in their home nations’ debt, the ratings company said in a report this month.
“Writedowns or even write-offs of Portugal, Greece and Ireland’s sovereign debt will be manageable for European insurers,” said Antonello Aquino, a London-based insurance analyst at Moody’s. “But Italy and Spain is a different situation altogether.”