Bond yields have jumped since the start of the year as central banks changed course. This improvement in bond securities, the main asset of the portfolio of funds in euros, will only have a very limited impact on their remuneration in 2022.
Bond rates have been soaring for several months. Ten-year bonds issued by the French State, for example, posted an annual yield close to 2% at the end of June 2022, versus 0.17% in June 2021, an increase of nearly 1.8 points. A push caused by the drastic change in monetary policy announced by the European Central Bank, which followed in the footsteps of the United States Federal Reserve (Fed). While they kept their key rates at their lowest to boost economic growth for many years, here are the main monetary institutes today engaged in a reverse strategy, motivated by the objective of reducing inflation. By raising their key rates, which set the tone for market interest rates, they increase the cost of credit and thus draw de facto bond rates up. Let us recall it here for neophytes: a bond is similar to a loan granted to a State or a company.
The end of the erosion of guaranteed life insurance returns?
A priori, this is good news for the many holders of a fund in euros, the secure compartment of life insurance. Bonds are, in fact, the main asset in which these capital-guaranteed funds are invested. In erosion for more than 10 years, their average yield stood at 1.30% in 2021. The perked up bond rates are therefore likely to reverse the trend, by boosting their performance.
Fans of the fund in euros will however have to be patient before reaping the rewards of this new rate environment. Because the managers are renewing the bond securities in their portfolio at a slow pace. In other words, they replace old bonds with new ones that are more profitable as the first ones mature. Why not resell the old products with less remunerative rates to replace them with newer ones offering a better return? Because this would expose the portfolio to a capital loss incompatible with the guarantee due to the saver on a fund in euros.
To understand, it is necessary to know that at the time of its issue, a bond displays a face value, a duration and an annual interest rate (its yield). At the agreed term, its issuer redeems it at its face value, therefore at the price at which it was subscribed. On the other hand, if the holder of this security sells it before its maturity to another investor, while the yields of the new bonds are higher, he will have to concede a sale price lower than the face value of this title. Insurers are therefore forced to keep a preponderant part of their obligations until their maturity in order not to suffer a capital loss.
Slow renewal of bonds
“We renew only 10 to 15% of our bond securities in our portfolio each year,” confirms Eric Le Baron, managing director of SwissLife Assurance et Patrimoine. The beneficial impact of the rise in bond rates on the return paid out on funds in euros will therefore inevitably undergo a dilution effect over time.
“Since the beginning of the year, we have been investing in new bond securities with an average yield of 2.5%. Levels that we had not seen for 8 years, comments Eric Dubos, financial director of MACSF. The performance of our portfolio is on an upward trend and should maintain this course, if rates remain at their current level for the long term, but this additional return will only be reflected positively in the rate of the fund paid to policyholders gradually in the years to come. This relative inertia is inherent to the rate of renewal of the bond securities of our assets, only 15 to 20% of them maturing each year.
Reserves equivalent to an annual return of 12.1%
Still, insurers have another lever to boost the remuneration of their guaranteed funds. For ten years, the majority of them have earned reserves. The law authorizes them to keep each year 15% of the financial profit made on their funds, on condition that these gains are returned to the insured within 8 years. These provisions for profit sharing (PPB) are valued by the firm Goodmoneyforvalue.eu at 173 billion euros, corresponding to 12.1% annual return !
Companies could be tempted to tap into this woolen stocking to maintain the competitiveness of euro funds. In fact, these investments could be challenged in the coming months by the more attractive remuneration of short-term guaranteed products, such as the Livret A or term accounts. These investments for liquidity are based on assets that benefit very quickly from the rise in key interest rates.
“Rates would have to rise sharply to 2 to 3% to eventually encourage our customers to make massive withdrawals from the fund in euros. This scenario is unlikely, but we are nevertheless able to cope with it”, comments Eric The Baron.
Before a hypothetical desertion of funds in euros by savers, insurers will not be inclined to dip significantly into their reserves. These are favorably taken into account in the solvency ratios imposed on them by prudential regulations. Lowering their PPB would therefore force them to tie up more equity, a costly strategy. In chorus, they warn their policyholders: if the increase in remuneration for 2022 is there, it will be very limited.
“Suravenir has accompanied the fall in bond rates over the past ten years in a measured way, by very gradually passing it on to the return paid to policyholders on our euro funds, comments Thomas Guyot, Chairman of the Board of Suravenir. Today, as bond rates rise it is very likely that the majority of life insurers will adopt a similar pace to revalue their fund rates. We will gladly follow this market movement, seeking to maintain a competitive rate level with our competitors , in a prudent and reasonable manner over time. We should therefore not expect a sudden rise in life insurance yields in euros, but an increase which should be limited to around 20 or 30 basis points per year “. Savers would be wrong to hope for a marked improvement in 2022 returns, which will be announced in the first weeks of 2023. Euro fund rates will remain well below inflation.