By raising interest rates, the ECB is attempting to stem the surge in inflation in the euro zone (Image credit: 123RF)
The ECB (European Central Bank) announced on Thursday 21st July a 0.50% increase in its key interest rates. What are the consequences of this decision for life insurance?
ECB rate hike
This hadn’t happened since 2011. On Thursday, July 21st, the ECB raised interest rates by 0.50%, a much larger than expected increase as it was expected at around 0.25%. By raising interest rates, the ECB is attempting to stem the rise in eurozone inflation, estimated at 8.6% (annual) in June 2022, in a context marked by the war in Ukraine, the slowdown in economic growth and marked the political crisis in Italy . In fact, the increase in key interest rates should lead to an increase in lending rates for private individuals and thus dampen consumption and thus price increases.
According to the European Commission, inflation in the euro zone is set to fall to 4% next year, a level that is still far from the ECB’s target of 2%. It is therefore likely that the ECB will make further rate hikes by the end of the year.
However, by raising interest rates, the institution must be careful not to worsen the situation of the most heavily indebted countries too much. Since the announcement of a tightening of ECB policy in June, European government bond rates have risen: for example, the 10-year Italian government bond rate on 22.07. at 3.45%. Christine Lagarde, President of the ECB, explained that the Governing Council could, if necessary, resort to the “IPT” (Transmission Protection Instrument) programme, which provides for potentially unlimited debt purchases to protect states in difficulty.
What are the consequences for life insurance?
On average, 80% of life insurance funds in euros are made up of government and corporate bonds. The rise in interest rates should therefore affect the performance of funds in euros, even if only gradually, as insurers only buy new bonds when the bonds in the portfolio mature. Yields on euro funds are likely to rise, but at a slower rate than bond yields.
The remuneration for issue A, which is particularly dependent on inflation, must be reduced to 2% by August 1st. Savers might be tempted to switch funds in euros to savings accounts. If this were the case, it could get insurers into trouble as they would then be required to liquidate bonds on hand (bonds that are low yielding and therefore depreciated) and post capital losses. However, in the event of excessive difficulties, the Sapin-2 law authorizes the HCSF (Haut Comité de Sécurité Financière) to limit the ability for savers to make deposits in euros of their contract into the fund and the ability to withdraw their savings, suspend or limit them or limit the payment of dividends.