World Economy

Low Interest Rates Means Saving Impossible in Europe

Low Interest Rates Means Saving Impossible in EuropeLow Interest Rates Means Saving Impossible in Europe

While borrowers rejoice at the ultra low and even negative interest rates in Europe, savers fret and life insurance companies and pension funds face what is virtually a mission impossible.

Despite a spike in sovereign bond yields in the past couple of weeks, levels still remain ultra-low. The rate of return to investors on benchmark 10-year German and French bonds has stayed below one percent in recent months and the yields on long-term Swiss debt even went negative, AFP reported.

Sovereign bonds are very important for long-term investors as they are a safe investment that allows them to lock into guaranteed returns.

For life insurance companies and pension funds which are investing the savings of others, the safety of sovereign bonds has led regulators to require them to place certain percentages of their investments in bonds. But the unprecedented rock bottom interest rates are posing a problem as many life insurance policies offer guaranteed interest higher than current bond yields. In France last year, life insurance contracts paid on average 2.5 percent.

Life insurance companies can temporarily dig into investment funds to continue to pay high rates and attract investors, but this is a strategy experts said cannot continue if rates remain low.

The level of interest rates has been worrying the industry for months, and analysts and ratings agencies are concerned about the industry.

“Low interest rates in the euro area pose substantial challenges to the life insurance industry,” said IMF staff in a blog post earlier this month.

 Collateral Damage

German insurers, which offer much higher guaranteed returns than their French counterparts, have been particularly critical of the European Central Bank’s ultra-low interest rate policy, and its 1.1-trillion-euro ($1.2-trillion) bond buying stimulus program that has driven down bond yields.

“The problem with German insurers is that not long ago they guaranteed returns on (products) like long-term euro contracts. These yields must be respected every year, even as rates fall,” explains Chassain.

According to Karsten Eichmann, president of German insurer Gothaer, that situation has left companies like his caught in an agonizing pinch.

Pension funds are also sounding the alarm. Pensions Europe, the trade organization for European pension institutions, warned regulators in a report in late April that “pension funds cannot be considered collateral damage of the ECB’s (quantitative easing policy) when the problem involves retirement savings of millions of Europeans”.

Chassain says low interest rates like those currently in place are destined to make life difficult for any insurer with long-term guarantees on return.

For insurance companies, the strategy is to invest in high-risk assets like corporate bonds, stocks and infrastructure projects. Meanwhile, most also encourage clients towards options that do not guarantee savings invested, such as unit-linked plans. That same trend has already taken hold in Japan, where interest rates have remained low for quite some time.