EU Insurers Could Shift Losses to Life Policyholders

Moving debt write-downs to policyholders can help insurers avoid raising capital

European life policyholders may be in for an unpleasant surprise. European Union (EU) insurers could be planning to shift losses they are being compelled to accept from euro zone sovereign debt to customers who hold policies, rather than be forced to raise additional capital.

The total? Policyholders could be on the hook for approximately two-thirds of a whopping 8% of southern European sovereign debt, or approximately 235 billion euros (USD $335 billion).

A majority of bonds held by insurers, according to a Bloomberg report Friday, are used to back what are called “with-profits” life insurance policies, in which gains and losses on investments are shared by both customers and insurers. That means that insurers can shore up their positions by passing along losses from Greek, Spanish, Portuguese, Italian and Irish bonds—and customers will be vulnerable.

Guillaume Prache, managing director of the Brussels-based European Federation of Investors, an organization that represents two million retail investors, was quoted in the report saying, “Policies are written against the general account of the insurers so basically they have all the flexibility they want to assign any losses on assets to policyholders.” Customers, he added, “are very badly informed on the exposure and the risk that represents.”

An added irony is that this ability to pass along losses to customers makes insurers more attractive to investors than banks, which also are suffering through the debt crisis. David Moss, who helps manage 8 billion pounds ($13 billion) in European equities at F&C Asset Management Plc (FCAM) in London, said in the report, “Insurers have fallen like banks all the way through this crisis. We think that’s unfair because they can share a proportion of any losses with policyholders.”

Brussels-based CEA, the European insurance and reinsurance federation, says that nearly three fourths of all life insurance products bought by Europeans include a savings feature that offers minimum returns or capital guarantees. The policyholder carries the greatest share of investment risk in these products, which typically are sold as low-risk investments that offer a yearly return and a lump sum, either at policy maturity or the death of the insured. Insurers, however, retain the right not to make annual payments and could fail to meet guarantees if solvency becomes an issue, according to Prache.

Moody’s Investors Service puts insurers’ gross holdings in Greek, Irish and Portuguese debt at 9% of their capital. After customer losses on policies are figured in, it said, insurers’ potential deficit falls to below 3%. If there is a need for further writedowns on Greek, Irish or Portuguese debt, policyholders will continue to stand between insurers’ shareholders and losses.

CEA, the industry lobby group, was quoted in the report saying, “Profit-sharing is a legitimate mechanism that for many decades has enabled insurers to offer long-term products European policyholders make informed choices about the products they buy, which are closely regulated.”

Trevor Moss, a London-based European insurance analyst at Berenberg Bank, warned in the report that allowing policyholders to bear the brunt of losses could backfire, saying, “The companies that think they can just freely pass it onto the policyholders are maybe living in Never Never Land because they may be killing their business model. There could be potential legal implications and mis-selling claims down the line.”

If Italy and Spain join the writedown parade, customers may suffer even more, particularly those who are insured by companies domiciled in those countries. Moody’s has said that insurers’ ratings would track those of their home countries, since usually they invest in sovereign debt from their own domiciles.

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