Extremely low interest rates ‒ together with the bond-buying scheme launched by the ECB ‒ brought relief for many actors in the financial markets.
At the same time, they also triggered serious problems for insurers and pension funds. One of the biggest challenges for institutional investors in recent days is to generate adequate investment returns. In order to guarantee profitability, the industry is allocating a significant part of their investments to low-risk securities, such as government and corporate bonds.
The recently observed negative yields on an expanding range of bonds are in fact symptoms of a wider problem. Finland – as the first Eurozone country ‒ offered to sell five-year government debt at negative yield.
The problem is particularly acute for life insurance companies in continental European countries that have sold policies offering annual guaranteed returns to policyholders. Of late, the industry has been reducing the guarantees, but they still need to meet obligations on policies sold previously. Pension funds are facing an even more troublesome situation as the fall in bond yields is forcing many schemes into deficit implying they cannot afford to pay their pensioners.
Insurers and pension funds are therefore being increasingly tempted to find alternative investments such as emerging market debt, infrastructure bonds, direct corporate loans or private equity. However, increasing the risks is giving rise to concerns. And not helping are more rigorous regulations, such as the forthcoming Solvency II regime for insurers, which is also preventing asset-buying diversification.