Impact of a low-yield environment for the main French … on end-2014 security by security porfolio : list and characteristics of assets (directly ... redemption price, dividends,

Research Directorate – Dominique Durant

Dominique DURANT

Deputy head of Research Directorate

EIOPA advanced seminar quantitative

techniques in financial stability December 8, 2016

Impact of a low-yield environment

for the main French insurers


Sommaire

1. Participation rates down since several years

2. Low guaranteed rates, at least on individual contracts

3. The profit sharing minimum requirements is still not binding

4. Interactions between return on assets and profit-sharing

5. A high level of economic wealth

6. Forward-looking: investment return rate projection

7. Macro-prudential measures

2 23/01/2017

Research Directorate – Dominique Durant 3 23/01/2017

A large majority of euro-denominated contracts

As at end 2015, the euro-denominated contracts represent nearly 80% of reserves against

less than 20% for the unit-linked

Insurers adapt to low yield environment by decreasing euro-denominated insurance

contracts to the partial benefit of unit-linked contracts

Net premium cumulated from the beginning of the year

euro-denominated contracts (left) – Unit linked contracts (right)

82%

18%

Top 12

Euro-denominatedreserves

Unit-linked reserves

215 bn

962 bn

0

2000

4000

6000

8000

10000

12000

14000

16000

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52

Mill

ions

d'E

uros

Collecte Nette depuis le 1er Janvier (Supports rachetables en euros)

2016

2015

2014

-2000

0

2000

4000

6000

8000

10000

12000

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52

Mill

ions

d'E

uros

Collecte Nette depuis le 1er Janvier (Supports rachetables en UC)

2016

2015

2014


4 23/01/2017

Bonus rates down

Average participation rates since 2007

But the decline is slower than the 10-year OAT rate

It is also slower than the rate of saving accounts, at least in 2015

Perimeter : TOP 12


5 23/01/2017

Significant dispersion of bonus rates

Dispersion of participation rates since 2006

A prisoners dilemma game with a leading role of the first announcer of the yearly

participation rate

Some important insurers, especially bank insurers, have a low bonus rate,

Perimeter : TOP 12


Technical interests

Limited to 75 % of the TME (10-year French government bonds rate ) since June 1st, 1995 (art. In 132-1) under 8 years and 60% above 8 years.

In 2015, the average technical interest is 0,42% on individual contracts (92% of PT) and 1,51% on collective contracts (8% of PT), with a global average of 0,51%

Other guaranteed rates

Possible to take additional commitments is limited to 2 years (art. A 132-2 et A 132-3) and marginal for the main insurers

6 23/01/2017

Low guaranteed rates, at least on individual contracts


Higher lapse rate on contract with high technical interest rates:

Either through benefits (subscribers are older)

Or through surrender (due to commercial incitation by insurers)

Net premium by contract type depending on the technical rate

•

• B

The case law permits a decrease in technical rates

On unilateral basis for non planned future premiums

For stocks when agreed with the subscribing association regarding collective contracts

7 23/01/2017

Technical rates are decreasing through time


Commitments embedded in individual contracts

Perimeter : TOP 12

Contractual commitments often specified in % of the financial incomes

Represent 0,5 points of % in 2015 for the main insurers

Less relevant when explaning the bonus rate than the regulatory profit

sharing minimum requirement which is defined globally (see next slide)


Obligation to distribute within 8 years 90 % of the technical balance if it is positive and 85

% of the financial incomes once deducted the technical interests

The insurer has several options:

realizing capital gains or losses on securities with variable income to increase or reduce the

financial incomes

distributing immediately or increasing the profit-sharing provision that has to be distributed to

policy holders within 8 years

The sum of the bonus rate and the allocation to profit-sharing provision is superior or

equal to the minimum profit-sharing for all the insurers

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The profit sharing minimum requirements is easily

respected

Perimeter : TOP 12


Interaction between return on assets and profit-

sharing

Perimeter : TOP 12

4.20 4.09 3.99 3.923.61

3.29 3.09 3.052.82

2.59

0.31 0.32

-0.43

0.30

0.18

-0.66

0.26 0.380.39

0.57

5.13

5.50

4.444.18

4.02

3.02

3.57 3.623.46 3.43

-1

0

1

2

3

4

5

6

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Policyholder rate Net allocation to profit sharing reserve Investment Return Rate

Pol icyholders'

earnings-sharing

Due to realized holding gains, the margin between return on assets and profit

sharing is stable

Insurers distribute less and increase the profit-sharing provision


Interactions between return on assets and profit-

sharing

Perimeter : TOP 12

A significant part of realised holding gains is used for increasing the profit

sharing provision


A high level of economic wealth

12 23/01/2017

Unrealized gains on bonds are significant since 2014 but aren’t available for

participation rate because they are put into the “capitalisation reserve”.

The “capitalisation reserve” increases since 2013: it can only decrease when

holding losses are realized on bonds

The profit-sharing provision rises since 2011 : 70% are allocated in the current

year and 19% in the previous year. Few amounts have to be distributed due to the

8 year limit

Unrealized gains on variable-income securities are volatile

Perimeter : TOP 12


The reinvestment of (amortizing) fixed rate bonds maturing and the investment of the new net

inflows into (amortizing) bonds with a fixed rate coupon of 0% reduce the return on

investment by circa 20 bps every year

The new inflows have a marginal impact on the return on assets

13 23/01/2017

*

Forward-looking: projection of return on investments

Main results

Return on investments projection for the aggregated 16 main French life insurers (in %)

(in %)

4,25

3,64

3,12

3,30

2,52

2,21

1,64

0,83

4,27 4,05 3,93

3,01

3,48 3,58 3,36 3,38

0,33

- - - - - - - -

3,07 2,95 2,73

2,52 2,36

2,17 1,99

1,81 1,67

1,51

3,07 2,94

2,71 2,49

2,32 2,13

1,95 1,78

1,64 1,48

3,69

3,43

3,04

1,44

1,19

0,91

0,00

1,00

2,00

3,00

4,00

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

10 year gov. Bond rate (historical)

Investment return rate (realised)

10 year gov. bond rate scenario

Investment return rate (projected with no net inflows)

Investment return rate (projected)

Amortising bonds with fixed rate coupon: invest. income (excl. invest. fees) divided by the mean of opening and closing net book values


projecting the investment return rates stemming from the investments excluding the unit-

linked contracts assets

over a period of 10 years

With a 10-year French government bonds rate of 0% over the projection period

Considering two-type of assets i: amortising bonds with fixed coupon rate and other assets

the definition of investment return rate is:

Based on end-2014 security by security porfolio : list and characteristics of assets (directly)

held by the insurer sourced from the annual regulatory reporting template « Tableau

Complémentaire à l’État des Placements »)

Could be done with S02.06, eventually complemented with CSDB

14 23/01/2017

*

Forward-looking: projection of return on investments Methodology: main features

Investment return of asset i in year 𝑛 =accounting investment income of assets i in 𝑛

12 ∗ (opening net book value of assets i in 𝑛 + closing net book value of assets i in 𝑛)


Forward-looking: projection of return on investments Methodology: assumption about investment of inflows

15

Reinvestment of fixed income amortizing bonds maturing in the same type of assets

Reinvestment of revenue stream generated by assets in portfolio: the cash flows (coupons,

redemption price, dividends, rents, etc.) are invested in the same type of asset they stem

from

Investment of net annual premium:

• Two scenarios: a zero annual premium or a net annual inflows equal to the realized

net inflows in non-UL contracts over 2016 first semester, multiplied by 2 (calculation in

Aug.16) – it is assumed stable over the projection period and is different for each

insurers

• Investment separated between the two asset types in proportion of their opening net

book value

• Negative net annual premiums in a year is deduced from other inflows

New securities investments:

• In 10-year government amortizing bonds with fixed coupon rate of 0%, bought at par

value (therefore their coupon is equal to their actuarial rate or return and they have a

constant net book value)

• In other assets with the same characteristics as those in portfolio (investment income

and net book value)

No sales and rebalancing of assets in portfolio

23/01/2017


Forward-looking: projection of return on investments Methodology: projecting book value of assets and investment income

16

Closing net book value in year 𝑛 = Coupon

1 + actuarial rate of return 𝑘−𝑛 years 𝑘∶n+1 to m

+Redemption price

(1 + actuarial rate of return)𝑚−𝑛

Amortising bonds with fixed coupon rate

Available data for each bond security:

•Net book value

•Redemption price

•Coupon rate

•Maturity date (retrieved by ACPR)

Under these assumptions, available information allows to project the (certain) investment income and net book

value of initial assets held and new assets invested in 0% 10-year bonds

For an amortising bond with fixed yearly Coupon paid on the 31/12, maturing on 31/12/m,

Other assets

Includes amortising bonds with variable coupon rate and non amortising assets (equities, property, etc.)

Assumptions: no sales, no depreciation, invest. income generated only by revenue stream, constant net book value

∝ being the mean of the estimated assets revenues in proportion of the net opening net book value in years 2014-2015 ∝ is insurer specific and stable along the whole projection period

Actuarial rate of return (yield-to-maturity)

Investment income𝑒𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡𝑠 in 𝑛 =∝ × closing net book value in 𝑛 − 1

Assumptions:

• non identified credit event

• bonds held-to-maturity

Investment income𝑒𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡𝑠 in 𝑛 = actuarial rate of return × closing net book value in 𝑛 − 1

23/01/2017

• Under French accounting standards, non UL contracts assets are recorded at historical cost

and are eventually amortized or depreciated. In particular, « amortizing assets » (i.e. bonds

with known maturity date) are amortized, and depreciated when the issuer is considered to

carry an identified credit risk


Forward-looking: projection of return on investments Methodology: treatment of investment costs

17

Investment costs as a proportion of the investment income is assumed to be constant

over the projection period (equal to its mean over 2014 and 2015)

Investment return of the portfolio over the projection period is given by:

• the projected investment income excluding investment costs of the amortising

bonds with fixed rate coupon and of the other assets,

• Less the assumption on investment costs.

Investment income in year 𝑛 = investment incomeexcluding investment 𝑐𝑜𝑠𝑡𝑠in 𝑛 + investment costs in 𝑛

=investment incomeexcluding investment costs in 𝑛

1 − investment costs in 𝑛investment income in 𝑛

23/01/2017


Share of amortising bonds with fixed rate coupon nearly stable over the projection

period

67,0

64,7 64,9 65,0 65,1 65,0 64,9 64,7 64,4 64,1 63,7 63,3

67,0

64,7 64,9 65,0 65,1 65,0 64,9 64,7 64,5 64,2 63,8 63,3

50

60

70

80

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Standard scenario No net inflows

18

*

Forward-looking: projection of return on investments Results – main numerical assumptions

Share of amortising bonds with fixed rate coupon

of the aggregated top 16 French life insurers (in %)

* realised

* *

Main numerical

assumptions for the top

16

Projection period

2015 2016-2024

Net annual inflows (in billion

euro): 7,28 9,12

Annual revenues of other

assets in proportion to their

opening net book value (in

%):

2,92 2,95

Share of investments fees in

the annual investment

income of all assets (in %):

-9,77 -9,35

Main numerical assumptions of top 16

Note: 2015 figures are known at the time of calculation

23/01/2017


Each of the 16 main life insurers are concerned by the drop

19

*

Forward-looking: investment return rate projection Results

Investment return rates projected for the 16 main French life insurers (in %)

2,21

1,64

0,83

0,33

3,58 3,36 3,38

3,07 2,94

2,71 2,49

2,32 2,13

1,95 1,78

1,64 1,48

0,00

0,50

1,00

1,50

2,00

2,50

3,00

3,50

4,00

4,50

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

10 year gov. Bond rate (historical) 10 year gov. bond rate scenario Top 16 (realised) Top 16

A B C D

E F G H

I J K L

M N O P

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ESRB proposals to improve insurers’ resilience :

The solvency II framework needs to be revised : especially UFR (Ultimate Forward

Rate),

The necessity of adopting macro-prudential tools should also be explored : e.g.

reviewing the minimum guaranteed rate, no dividend distribution even before breach

of the SCR, discretionary benefits reduction, etc.

Japanese failures in the 90s leaded to many reforms of Insurance

Business Act :

Failures due to high guaranteed rates, competition fro high revaluation, fall in asset

values

Introduction of a solvency ratio more comprehensive and risk-sensitive-based

The possibility of revising guaranteed rates downward for insurers in difficulty

A regulatory framework establishing a declining discount rate depending on the

subscription date (from 2,75 % in 1998 to 1,5 % in 2001)

In Germany:

Decrease in maximum technical interest (1,25 % for 2016) for new contracts.

limitations in the participation of policyholders in the reserves of revaluation, limitation

in dividends

the insurers have to complete reserves at the level of the technical reserves

discounted with the current interest rate.

20 23/01/2017

Some macro-prudential measures abroad


Take measures on the whole sector to face emergency situations

Purposes : protect the interest of the policyholders in case of significant threat on

insurers, especially in case of sharp increase in interest rates

Proposed solutions : the law Sapin II (article 49) allows macro-prudential national

authority (the Haut conseil de stabilité financière - HCSF) for 3 renewable months to:

Limit temporarily the activity

Suspend the availability of assets

Suspend the redemptions and the arbitrages

Limit the payment of dividends

Invite the insurers to increase provision today

Purpose : increase provision instead of bonus rate with the current high return on

investment. This provision will be released when the return on investment will become

lower than the commitments or when the market interest rates will increase

Proposed solutions:

The law Sapin II (article 49) allows the HCSF to modulate the rules of constitution and release of the profit-sharing provision

Discussion about creating a reserve which would reduce the net profits on investment and thus the profit-sharing contractual commitments and could be used to cover losses due to high technical interests

21 23/01/2017

Macro-prudential measures foreseen in France


Constraints:

No regulated rates

Allocation to profit-sharing provision, if constrained, should not result in a loss for

individual insurers

Options:

an ad-hoc reserve that would be deducted from the financial income would reduce

amounts distributable by contractual commitments and could cover losses due to an

excess of technical interest : it could thus provide additional room for manœuvre to

some insurers

In the event of rising interest rates, the reversibility of the measure can be obtained

either by a temporary decision of HCSF, or a formula for the calculation integrating

the reversibility

Sensitive points:

To show pedagogy is necessary in order to prevent surrenders

The measures have to fulfil consumer protection rules

22 23/01/2017

How to set a provision?


To make policyholders and insurers understand that past participation rates

are not sustainable in the long run with the current interest rates level while:

The return on investments and the capital gains remain at comfortable level today

Insurers are in very different situations in terms of guaranteed rates, contractual

clauses, investment return and level of economic wealth

The competition limits the decrease in revaluation

→ A choice to be made between binding rules or responsibilities of insurers?

Find the balance between long term solvency for the insurers and interest of

the policyholders and fulfilment of the contractual commitments:

The case law defined rules regarding revision of the guaranteed rates and contractual

commitments

A suitable information of the policyholders about the less profitable or more risky new

products is essential

→ Find the right balance between micro-prudential supervision, financial

stability and consumer protection

23 23/01/2017

What is at stake?

Documents

Impact of a low-yield environment for the main French … on end-2014 security by security porfolio : list and characteristics of assets (directly ... redemption price, dividends,