European markets see outlook revisions trending upward as interest rates fall

Ratings agencies make segment revisions, partly due to investment returns providing a life, amid the start of interest rate cuts and speculation for more to come.

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AM Best has made multiple sector rating changes - many of which were partly based on the health of the investment returns of insurers.

Three of Europe’s largest economies have had new rating agency outlooks published with revisions to their non-life and life segment outlooks.

The revisions came as the European Central Bank cut interest rates for the first time in the current high inflation cycle, which has led to speculation that other central banks – such as the Bank of England – will follow suit over the next few months.

The ratings also take place among economic and political difficulties in Europe. The UK and now France are both in campaigns after snap elections were called.

Among the rest of the continent, the recent EU elections have also shown wildly different views on how its economy should be handled.

Other major EU economies have also been given slightly improved outlooks by the ratings agency recently – in May, AM Best said the Spanish insurance market has seen “profitability expected to improve, driven by higher investment returns and better technical margins”.

What countries saw change?

Fitch Ratings revised its German non-life insurance sector outlook to ‘improving’ from ‘neutral’ on the prospect of better underlying profitability due to strongly rising premium rates, it said this week.

“Price rises to offset high claims inflation and reinsurance costs have lagged those in some European markets, but there are signs that the German market is starting to close the gap,” said the press release on Europe’s biggest economy.

 “We have raised our forecasts for sector premium growth to 7% in 2024 (from 6%) and 6% in 2025 (from 5%) to reflect the stronger pricing momentum,” it said.

Fitch said it also expected the price increases and easing claims inflation to lead to marginally improving underwriting profitability in 2024 and a fuller recovery in 2025. Currently, The inflation rate in Germany, measured as the year-on-year change in the consumer price index (CPI), stood at 2.4% in May 2024. The rate of change was 2.2% in both April and March 2024, according to Statistisches Bundesamt’s latest press release.

“This follows the worst results in recent times, with the sector’s net combined ratio (claims and expenses to premiums under German GAAP) likely to have peaked just above 99% in 2023, barely better than breakeven (100%). Higher fixed-income investment yields should support an improvement in overall sector profitability.

The investment return rate for the German non-life sector was forecasted at 2.5% for 2024, said Fitch. This builds on 2023’s 2.3% return – in 2025 it forecasted a 2.8% return, which would be significantly higher than results seen for several years.

“The German non-life sector now looks set to follow a similar trend to those in the UK and Italy, where insurers were already pushing through strong price rises and where the sector outlooks were already ‘improving’,” said Fitch.

For Italy, fellow rating agency AM Best has said it has revised its outlook on Italy's non-life insurance segment from ‘Negative’ to ‘Stable’ in June. The following factors were considered:

          ·        Growth momentum supported by tariff adjustments and stabilisation of the economic environment

          ·        Segment-wide underwriting profitability sustained by improving motor business

          ·        Elements of the 2024 Budget Law pose a challenge for property business

For the Italian life insurance segment outlook, however, the company is maintaining its outlook on the at ‘Negative’, owing to the following factors:

          ·        Net volumes still under pressure

          ·        Investment returns are expected to improve, benefiting policyholders and issuers, though volatility may be an issue

          ·        Shift to capital-light products reversed

The risk of a mass lapse event was said to be one of the main reasons for the negative outlook. “The risk of a mass lapse event has lessened and is not expected to materialise,” said AM Best. “However, competition from other investment products offering higher returns will likely continue to constrain growth in 2024. Moderate levels of lapses are likely to maintain pressure on net volumes for the segment.”

AM Best said the outflow recorded by Italy’s Associazione Nazionale per le Imprese Assicuratrici (ANIA) - Italy’s National Association of Insurance Companies – rom the life segment was €22.7 billion during 2023, which compared to a net inflow of €14 billion in the year prior.

However, overall, the improved investment returns were likely to benefit policyholders and insurers.

AM Best expects profitability in Italy’s life segment to remain healthy in 2024, supported by increased investment returns in the insurer's own portfolios. However, potential volatility in financial markets could impact the segment’s results.

The Eurozone saw cuts already and on 6 June the European Central Bank cut the key interest rates by 25 basis points in a move that surprised - and dismayed - some.

“Since the Governing Council meeting in September 2023, inflation has fallen by more than 2.5 percentage points and the inflation outlook has improved markedly,” said the ECB’s statement on the cuts. “Underlying inflation has also eased, reinforcing the signs that price pressures have weakened, and inflation expectations have declined at all horizons.”

On this, Am Best said at the end of 2022 the ‘lower for longer’ period of rates had come to an end, and now it looks as though the ‘higher for longer’ rate period may also be on the way out.

“Insurers faced several difficulties during the transition period following the sharp uptick on interest rates, which translated into significant investment losses, although these remained mainly unrealised.

The Italian life segment is expected to benefit from high returns in 2024 both in their own portfolios and savings books. The higher interest rate environment should allow insurers to offer improved returns to policyholders and to enhance attractiveness of their savings products.

They added that in other areas – such as alternative investments in government bonds and bank deposits these returns may lag.

What about in the UK?

Elsewhere in Europe, AM Best is maintaining its outlook for the UK life segment as ‘Stable’ largely down to performance of investments.

They said the supporting factors were a strong pipeline for pension risk transfers (PRT) as higher interest rates have improved the funding of defined benefit schemes. The PRT market has been doing exceptionally well in recent times – US based research house Cerulli Associates said “The PRT market has expanded significantly over the past decade, hitting record-high volume in 2023. A combination of regulatory changes, rising interest rates, and improved funding statuses were allowing defined benefit (DB) plans to de-risk and pursue PRT transactions”, and the PRT market is showing high amounts of growth on both sides of the Atlantic.

In February, Legal & General said that, according to its research, 2023 had seen “record-breaking global PRT market activity”, which totalled over £85 billion in the UK and the US. It was the second-largest year on record in the US.

AM Best said that in the UK, as well as the PRT market, the improved interest rate environment was also expected to support investment yields and the investment opportunities are likely to broaden after prudential regulatory changes.

They added that higher interest rates should have a positive impact on insurers’ returns. “[The] higher interest rates [will] allow insurers to reduce their reliance on illiquid assets to support investment earnings, as assets mature and are reinvested in higher yielding securities. Nevertheless, AM Best expects illiquid assets to remain a material proportion of UK life insurer’s investments”, especially considering the long-term liability profile of the segment.

In fixed income, the higher interest rate has also led to unrealised losses for UK life insurers, they said. This was because fixed income instruments “constitute the bulk of their investments”.