Europe's Insurers Are Full of Holes

The risk-assumers are at risk themselves

Who would have thought it could end this way? Germany's Familienfürsorge insurance company survived two World Wars and the Great Depression. But the 150-year-old life underwriter couldn't make it through this year's stock market downturn. Buffeted by plunging equity prices and shrinking reserves, Detmold-based Familienfürsorge (Family Welfare) admitted earlier this year that its investment portfolio wasn't generating enough revenue to cover the 5.25% guaranteed return it had promised policyholders.

Fearing a public crisis of confidence in the industry, regulators were quick to move in. On Aug. 27, they engineered the sale of Familienfürsorge to HUK-Coburg Insurance Group. "The question now is, how many other insurers will be forced down the same path?" says Julia Münchschwander, who follows the sector for Metzler, a private bank in Frankfurt.

The problem is not confined to Germany. Across Europe, the portfolios that underwriters depend on for the income they need to pay policyholders are being hammered by rock-bottom share prices, a deteriorating corporate bond market, and the unexpectedly large fall of the dollar against the euro earlier this year. As a result, insurers' profits are being slashed, their capital eroded, and their ability to generate new business undermined. On Aug. 14, insurance rating agency A.M. Best Co. downgraded eight British life companies--including such blue-chip names as Pearl Assurance and Scottish Widows--because it was concerned about the slumping value of the assets that back their liabilities. Many insurers on the Continent have also seen their ratings cut.

No insurer is threatened with insolvency--and if any were, regulators would likely step in to rescue policyholders' retirement savings, which are frequently invested through insurance-linked instruments such as annuities. But even the soundest companies are taking a pounding. Holland's Aegon, for example, though known for its prudent management, was forced to issue the first profit warning in its 19-year history on July 22, as a result of what CEO Donald J. Shepard calls "unprecedented adverse conditions in the financial markets." Experts are convinced that the turmoil of recent months will force wrenching change. Weaker underwriters will be pushed into mergers or compelled to sell off businesses. Others will have to go cap in hand to shareholders for fresh capital.

Of course, insurers worldwide have been hurt by this year's market turbulence, with Japanese life carriers hard hit as well. But European insurers have had a particularly rough time, in part because they often offer savers generous guaranteed returns on premium payments--a practice that dates back to the post-war period. In Switzerland and the Netherlands, insurers are required by law to provide a 4% minimum annual return. In Germany, the legal minimum is 3.25%. And fierce competition forces most underwriters to offer more. Berlinische Lebensversicherung (Berlin Life Insurance), for example, pays 7%. As income from their investment portfolios falls, insurers find it hard to keep those promises.

To make matters worse, European life companies had plowed more of their investment portfolios into equities in the past decade than their counterparts in other regions. That's because in the low-interest-rate environment of the 1990s, they needed the better returns that equities traditionally generate to pay policyholders. British underwriters have an average of 70% invested in shares, while Continental nations have around 22%. That compares with an average of 4% for U.S. life insurance carriers. When stock markets boomed, European insurers did very nicely. But the 40% slump in indexes since January, 2001, has put the good times to rest. The stock portfolios of some companies, including Belgian-Dutch giant Fortis, are now worth less than their purchase price.

And there has been no safety in the bond markets. Equities account for just 6% of Aegon's portfolio, but its earnings stream from its big holdings of U.S. government and corporate bonds has weakened because the dollar has fallen 10% against the euro so far this year. Aegon also has suffered from some bad investment decisions; the collapse of WorldCom Inc. cost it $200 million in bond write-downs.

For many smaller insurers, such as Familienfürsorge, the combination of all these ills has been fatal. Analysts say that at least three other German insurers--Mannheimer, Gutingia, and BHW Insurance--also are in trouble. And bigger, better capitalized insurers, such as Germany's Allianz and France's AXA Group, are said to be trolling for acquisitions.

Meanwhile, investors have been fleeing the sector. European insurance shares have lost some 40% of their value so far this year. The atmosphere is so bad that Henri de Castries, chief executive of AXA, has gone out of his way to allay investor fears. When the company issued its first-half results on Sept. 4, de Castries stressed to investors that "we have excess [capital] of $7.84 billion. If you take the European solvency [requirement], we are at 179% of what is required."

The trauma of the past few months has many insurers retrenching. Fortis has sold Fortis France to Swiss Life. Britain's largest insurer, Prudential PLC, has put a hold on plans to expand its business on the Continent. On Sept. 5, Zurich Financial Services, the embattled Swiss insurer that lost a record $2 billion in the first half of this year, unveiled plans to ax 4,500 staffers as part of a $1 billion cost-savings plan.

Executive heads are rolling. On Aug. 29, Credit Suisse Group replaced Erwin Heri, head of investment management at its Credit Suisse Financial Services unit, with Thomas Amstutz, a private banking veteran. CSFS's insurance branch, Winterthur, lost $600 million in the first half, forcing Credit Suisse to support it with $1.1 billion of new capital. The word in London is that Royal & Sun Alliance CEO Robert V. Mendelsohn's head could be on the block. Royal & Sun's share price has fallen 70% in the past year.

A number of underwriters--among them Zurich and Winterthur--recently have announced plans to hive off some noncore businesses. They are also gearing up to raise fresh capital. Zurich's new chief executive, James J. Schiro, plans to raise $2.5 billion in additional equity to see the company through its radical restructuring. On Sept. 10, Legal & General, Britain's fourth-largest insurer, said it would ask shareholders for $1.2 billion. CEO David Prosser says he wants the money so that he can keep expanding L&G at a time when tumbling stock prices are eroding the capital needed to underpin new business.

All these changes should lead to a leaner, fitter sector. In some countries, lawmakers are doing their bit to help by reducing guaranteed returns. Swiss parliamentarians plan to push the minimum down to 3.5%. Germany reduced its guaranteed rate from 4%, to 3.25% in July, 2001, and may reduce it further.

Whether the flurry of activity will be enough to restore customers' and investors' confidence in insurance companies remains to be seen. It's hardly reassuring when the companies that manage the public's risks prove so inept at managing their own.

By David Fairlamb in Frankfurt

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