Located above 1.9% as of Friday June 10, 2022, the level of the 10-year OAT brings life insurance and more specifically euro funds into the vigilance zone. To date, the lights are not (yet) red; they are flashing orange.
The method of financial management of funds in euros, composed on average of 79% of bonds, in fact, contrary to the message delivered by insurers, an attractive investment vector for savers in a cycle of falling interest rates. This is what has generally happened over the past 50 years, during which today’s investor has benefited from the attractive level of bonds purchased during the previous 10 years.
The problem today is that this story has come to an abrupt end. The end of the health crisis, the war in Ukraine and its consequences on energy and food prices, caused a sharp rise in both inflation and interest rates. Who would have imagined a jump of nearly 200 basis points on the OAT in less than a year? Especially since it’s probably not over. This is at least the message clearly announced by the European Central Bank.
By way of illustration, the stress tests carried out by insurance companies in their solvency reports are limited to rate variations of plus or minus 100 basis points, which is already considerable. In the current situation, we have moved away from school assumptions and mathematical models. We must act in anticipation, if we do not want to put the sector and savers at risk.
The frog syndrome
Initially, the rise in rates was good news for all operators. Lastly, it offered life insurers the possibility of buying bond investments whose financial return made it possible to provide the minimum return guaranteed to savers without any problem. We went from a situation of an icy lake (OAT in negative territory) to that of a lake with fresh water allowing you to swim almost comfortably (thawed lake with water at 18°C).
As soon as the 10-year OAT approaches a level of 2%, the waters clearly start to heat up. Bathing in water at 36°C becomes much less comfortable. Concretely for life insurance, the sector is torn between:
- general assets whose current financial yield is around 1.80%,
- a stock of bonds purchased at far too low rates and now in a situation of unrealized capital losses,
- the ability to now buy good quality bond investments at an average level of around 2.75%.
Getting hot water into a tub that is too cold is comfortable at first. Bringing in too much hot water becomes (very) unpleasant.
The life insurance sector will also be faced with the likely rise in the Livret A rate to a level of 2% on August 1st. While it is obvious that wealth savers have already saturated their Livret A, this nevertheless provides benchmarks in terms of investment performance.
For us, the real subject is that of the hypothesis of a continuation of the rise in rates with the achievement of levels of around 2.50 to 3.00% by the end of the year. . The spread between the current return on the general assets of the funds in euros and that offered by the bond investments then available would then become considerable.
Our proposal to safeguard the sector and savers
Our recommendation is to act in advance. A cold situation is better managed by anticipation than hot with the multiple more or less competent interveners who get involved. Let us remember the many so-called covid-19 specialists who appeared on television sets, when in reality they did not have any particular skills on the subject.
The Sapin 2 law authorizes the blocking of outflows on funds in euros, the objective being to prevent insurance companies from having to sell bonds at a loss and thus find themselves in a situation of bankruptcy. To avoid the implementation of this system, with the risk of a real movement of panic and loss of confidence in this savings medium, we are offering both to savers, to our governments and to players in the sector the system next :
- 1/ Allow insurance companies to confine (by closing them) their funds in euros whose assets now have a financial yield that is too far out of step with the current financial yield of bond investments.
- 2/ Authorize insurance companies to transfer all of the reserves created to date to these ring-fenced funds, namely: the provision for profit-sharing, the capitalization reserve, all the assets backed by this fund (in particular all real estate investments with good levels of unrealized capital gains).
- 3/ Allow companies to manage the inflows and outflows of these now ring-fenced euro funds by themselves (with all their reserves) and authorize them to regulate outflows according to the ability to have the appropriate liquidity without having to sell bonds at a loss.
- 4/ Let companies launch new funds in euros (probably partially guaranteed in order to provide financial flexibility) with bond investments in line with current market levels.
- 5/ Authorize companies to set investment rules in these new euro funds in connection with the liquidation of old euro funds.
If some might consider that our proposal is against the saver, we believe on the contrary that it allows the preservation of the fund in euros, the solvency of the insurance companies and the interests of the policyholders. Faced with this rapid rise in rates, the crime would on the contrary be to do nothing.
One of the strengths of our proposal is to give each company the necessary flexibility to best manage its situation with regard to the financial reserves available on its “old” funds in euros on the one hand, and the inflows / outflows of its savers on the other hand.
It is better to allow a situation at best locally rather than to impose a rigid framework on everyone.
The legislator has the power to set up this type of device, knowing that the current regulatory framework does not allow it (except to activate the Sapin 2 atomic weapon). We are open to participate in the reflection in order to adjust it as well as possible, as well as to contribute to the educational effort vis-à-vis savers.