TEXT-S&P report: Low interest rates test German insurers

(The following statement was released by the rating agency)

Oct 10 - Low yields from investment income as a result of lastingly low interest rates could drag on the financial strength of German insurers, says Standard & Poor's Ratings Services today in the report "Low Interest Rates Are Testing The Financial Strength Of German Insurers."

Although insurance companies in Germany are still proving fairly resilient to adverse financial market conditions and we are maintaining an average rating of 'A' on the sector, our outlook for the life-insurance segment is negative, the report says.

"We believe life insurers are more vulnerable than their non-life counterparts because they are more dependent on investment results," said Standard & Poor's credit analyst Christian Badorff. "Low yields are eroding the spread between investment income and guaranteed rates on life insurance policies. We estimate a reinvestment coupon of between 2.6% and 3.2% for 2012, which is very close to, or even below, the average guaranteed interest that we estimate at about 3.1% calculated on the basis of total invested assets."

Life insurers are adopting various defensive measures to maintain their financial strength in this adverse environment, such as increasing the average duration of their bond portfolios to stabilize returns amid prolonged low yields, adopting higher credit risk investment strategies, lowering policyholder bonus rates, and increasing underwriting profitability. Many are also aiming to shift new business away from traditional products that offer guaranteed returns to policyholders. However, these measures will take time to bear fruit, the report says. "Consequently, we believe German life insurers are likely to use their main short-term lever, which is to continue to reduce their policyholder bonuses considerably for 2013," said Mr. Badorff.

Our outlook for non-life insurers is stable because we believe they are generally better capitalized, better able to generate earnings, and less reliant on investment returns, the report says.

Nevertheless, in 2011, underwriting profitability stagnated, reflected in a virtually unchanged reported gross combined ratio of 98% for the industry. Prospectively, we think that non-life insurers' ability to implement adequate pricing will be the most effective way to improve their operating performance, helped by sound claims' management and cost efficiencies.

The report concludes that some life insurers might well have to implement profound changes to their business model, particularly in terms of product offers. "This task is not becoming any easier, in our view, in the current environment characterized by low customer confidence and increasing competitive pressures in less interest-rate sensitive product lines," said Mr. Badorff.

German insurers' financial strength will also very much depend on financial market developments, the report says. An intensification of the eurozone sovereign crisis could affect both profit-and-loss statements and balance sheets in the short term. A return to more stable financial market conditions, on the other hand, could support the financial strength of the industry, especially if bond yields do not recover too quickly.

((Bangalore Ratings Team, Hotline: +91 80 4135 5898 swati.ray@thomsonreuters.com,Group id:BangaloreRatings@thomsonreuters.com,Reuters Messaging: swati.ray.thomsonreuters.com@reuters.net))