Euro funds, the « star » investment vehicle[1] of life insurance, have been offering increasingly low returns to their holders in recent years. According to the French Insurance Federation (FFA), the average net return on euro funds halved between 2013 and 2020: from 2.8% in 2013 to 1.3% in 2020. This trend is expected to continue in the coming years (particularly if interest rates remain close to zero). This slow and steady decline in returns on savings is the result of a significant drop in interest rates. Life insurers invest around two-thirds of their assets in bonds (sovereign or corporate), which are financial investments directly affected by negative interest rate movements.
Historically, this investment vehicle has been extremely popular with the French for its tax and inheritance advantages, but also for its simplicity, liquidity, profitability, and financial security. It also had the advantage of accommodating very large amounts of savings that were not limited by law (unlike regulated savings accounts). As such, it perfectly met the needs of a significant portion of the French population, which has traditionally been risk-averse and relatively uneducated in financial matters.
However, the low interest rates observed in recent years could threaten the survival of euro-denominated funds, or at least their economic relevance. Indeed, without changes in the asset allocation of life insurers, this new financial situation could lead to structurally negative real returns[2] for savers, resulting in a loss of purchasing power and an « impoverishment » of savers.
In order to mitigate this possibility and strengthen its regulatory solvency ratios, the life insurance market is currently significantly reorienting its investments towards unit-linked (UL) products. Savers then receive all (excluding the insurer’s and management company’s fees/commissions) of the financial returns on the UC products in which they invest, but also bear all of the financial risks taken (which vary depending on the type of fund they select). However, this type of financial product is not suitable for all profiles (particularly older people, those with limited financial knowledge, and « small » savers).
This is why, from a societal perspective, it seems inconceivable that euro funds should disappear or result in significant losses in purchasing power for their holders. They are therefore forced to reinvent themselves, without compromising their fundamental principles of return and security. With this in mind, one of the solutions available to life insurers could be to simultaneously:
- Increasing their investments in equities in order to finance the French economy and the energy transition
- Increasing their equity capital in order to maintain the same level of financial security
- Limit redemptions by savers temporarily in times of financial crisis.
Especially at a time when inflation is picking up again, insurers are looking for higher returns than those offered by sovereign bonds. With this in mind, insurers must necessarily accept higher risk and/or lower liquidity, for example by investing in unlisted equities, particularly when markets are low. Furthermore, in line with savers’ increasingly stringent requirements in terms of Socially Responsible Investment (SRI), insurers have made numerous public commitments in this area.
This is why they could provide massive and continuous equity financing (without creating a bubble) to entrepreneurs promoting activity in the regions, socially-oriented projects, and green infrastructure . The companies benefiting from these investments would mainly be start-ups with innovative projects and small and medium-sized companies with objective growth potential, particularly internationally. Nevertheless, insurers would ensure that the management costs of these investments are kept to a minimum so as not to « consume » the additional remuneration generated by the extra risk taken. For example, they could rely heavily on new technologies, digitalization, and the industrialization of processes. They could also minimize the use of intermediaries and capitalize on their existing territorial networks to identify financing needs and opportunities for equity investments.
By making such changes to their asset allocation, life insurers would automatically see a significant increase in their capital requirements as set out in Solvency II. However, this prudential insurance regime is currently under review. The European Commission has recently put forward proposals aimed in particular at reducing the capital burden applicable to long-term equity investments. However, as discussed below, life insurers would need to significantly increase their capital at the same time in order not to reduce the financial security provided to their policyholders.
By supporting such a proactive investment policy based on the long term and SRI, insurers would then meet the capital needs of entrepreneurs and the challenges of sustainable development while offering a simple, secure savings product accessible to all French people. Ultimately, through this mechanism, euro fund holders would give greater meaning to their savings, life insurers would perpetuate the product that has made them successful, and entrepreneurs would be able to develop their businesses over time, generating wealth and savings, and so on.
However, the increase in risk-taking aimed at generating additional returns must not be at the expense of the financial soundness of insurers. That is why, in order to be able to absorb larger financial shocks in the future, insurers should first increase their capital. Several solutions are available to them. In particular, they could retain a larger share of their annual profits as equity capital in order to invest in the future. Although this strategy is beneficial in the long term for all stakeholders, it could prove contrary to the short/medium-term profitability requirements of their shareholders, as it would require for-profit insurance companies to temporarily reduce their dividends. Furthermore, while taking advantage of the current low interest rate environment, life insurers could issue long-term subordinated debt. Recently, for example, major French insurers have raised funds at historically low rates and with strong demand. Nevertheless, insurers would need to convince rating agencies and investors of the economic relevance of this strategy. Therefore, even if changes in insurance prudential regulations were to lead to a reduction in capital requirements for equity investments, while the actual risks remain the same, this increase in capital appears to be necessary in relation to savers.
Finally, the strategy of significant (but not majority) investments by insurers in highly illiquid unlisted assets implies long-term holding of these assets. Therefore, in order not to put the community of policyholders in difficulty, all savers should adopt virtuous and responsible behavior over time (which is already the case on average). Savers should therefore also accept certain additional liquidity constraints in order to maintain an accessible, simple, relatively profitable, and secure savings product. With this in mind, in times of financial crisis when asset valuations are low and liquidity is weak, savers should not withdraw their savings for reasons of « comfort » or « panic. » Insurers could then encourage them to be « responsible » by, for example, temporarily and exceptionally applying significant fees in the event of a « voluntary » surrender (i.e., other than in the event of death, excessive debt, a drastic reduction in income, the purchase of a primary residence, the birth/adoption of a child, etc.).
The sustainability of euro funds appears to be threatened by the low/negative interest rates observed in recent years. Nevertheless, this popular, simple, and secure savings product represents, given its characteristics, significant added value for society (particularly for the most modest, elderly, and/or financially uneducated individuals). It is therefore imperative that it be reformed without compromising its fundamentals, in particular so that it can offer savers a positive real return over the long term. This objective could be achieved by insurers increasing their risk appetite. In particular, they couldmassively increase( by around €100 billion) their investments in unlisted equities financing the French economy, social projects, and the ecological transition. Companies would thus share part of the wealth created with savers. They could also develop more easily and quickly thanks to the injection of external capital, thereby strengthening French economic activity. Finally, in line with their recent public commitments, insurers would increase their share of SRI in accordance with the growing wishes of savers.
However, this strategy should not lead to a reduction in the security offered to policyholders. That is why it must necessarily be accompanied by an increase in the equity capital of life insurers. Finally, savers should also accept slightly lower liquidity by adopting « responsible » behavior in times of financial crisis.
[1] At the end of 2020, based on statistics published by the FFA, approximately 77% of savings deposited in life insurance contracts were invested in euro-denominated funds.
[2] Real return is equal to return minus inflation.
[3] Investments in unlisted equities should nevertheless remain in the minority and lower than bond investments.
