Quotes of the Day
Earlier this month, the Belgian-Dutch financial-services giant Fortis made a startling announcement: For the first time in its history, the value of its equity portfolio had dropped below the €12.5 billion the company paid for it.
Under accounting rules the firm will have to write off the difference of about €2.1 billion. The main culprit was the group's insurance operations, whose investments have been ravaged by the cratering stock market. "We've not seen such volatility in the history of the world," says Jozef de Mey, chief executive of the Fortis AG insurance subsidiary.
Wait a minute — aren't insurers supposed to be the stodgiest, most conservative investors around? Even if they can't forecast the future, they are, after all, the companies that other people turn to for protection against risk. Like Fortis, the entire European insurance industry has got ill from the stock market bug it caught a decade ago — and everyone who owns European stocks is feeling their pain. When interest rates dropped in the early 1990s, insurers began to load up on equities at the expense of real estate and their traditional investment mainstay, bonds. For almost a decade, rising stock prices brought substantial rewards, often helping to mask losses in core insurance operations. By the year 2000, European insurers' holdings of stocks collectively exceeded that of bonds. Insurers became the biggest investors in equity markets, alongside banks, holding more than 20% of the total European capitalization. Topping the list is Austria, whose insurers owned more than 50% of its domestic equity market in 2000.
With markets falling to 1997 levels, insurers are now caught in a downward spiral: the more equity prices fall, the more the value of their capital drops, creating intense pressure to sell. But unloading stocks simply makes prices fall, thus further depleting insurers' capital base. The alternative is to beg shareholders for fresh capital — as many insurers have been forced to do — and risk spooking investors. The result: a stream of bad-news announcements by insurers across Europe reporting losses, reduced payouts, layoffs, more than €5 billion in planned capital increases, denials of liquidity problems — and the replacement of half a dozen or so chief executives.
The repercussions of the crisis currently shaking the insurance industry, which has a whopping €850 billion in annual premium income, are correspondingly huge. Yet the insurers' financial crisis is partly self-inflicted, and raises serious questions about the security of an industry whose very job is to manage and mitigate risk.
How did insurers get into this mess? Holger Dock, the chief executive of AP Pension, a small Danish insurer with 47,000 clients, has a typical explanation: his company's problems stem from the high life insurance payouts that consumers were guaranteed twenty years ago. Back then, interest rates were in double digits and a Danish life policy carried a 4.5% after-tax rate. That was cut to 2.5% in 1994 and again to 1.5% in 1998, but AP Pension, for one, still has about 80% of its liabilities on the basis of the guaranteed 4.5% rate. With interest rates falling through much of the 1990s, the firm had little choice but to chase higher returns on the stock market. Not all European nations mandated minimum rates, but all insurers had to adapt to the sharp, sustained drop in interest rates during the 1990s. At the same time, to entice new customers, they had to offer returns that would compete with giddy stock markets.
By any standard, the results have been calamitous. European insurance stocks have fallen by 58% this year — even worse than the 50% drop in European telecommunications stocks — compared with an overall market decline of about 35%. Many analysts say the equity sell-off by insurers is a key reason why European markets have performed worse than the U.S. stock market, which is down about 27% so far this year. American insurance companies are big equity investors, too, but have been careful not to let their holdings rise above about 25% of their total investments, compared with a 2000 average of 37% for the Europeans. Their stock sales also don't punch as hard, since insurers hold just under 7% of the total U.S. stock market, according to Federal Reserve statistics. Huge equity losses for the Europeans haven't translated into catastrophe — yet. A couple of small insurers have encountered serious difficulties, including one German firm with ties to the Protestant Church, Detmold-based Familienfürsorge, which was rescued last month by a bigger insurer after regulators intervened. So far no major European insurer appears to be seriously at risk of failure, largely because of huge cash reserves that enable firms to meet required solvency levels with ease. Fortis, for example, has a j6 billion cushion and de Mey says that even if the value of its equity holdings drops to zero — a true disaster scenario — it would still have enough capital to satisfy legal minimum solvency requirements.
Still, the industry can't afford complacency. "If the markets fall by 15% from here, one or two companies will have problems," says David Nisbet, insurance analyst at Merrill Lynch. "If they fall by 30%, it's the regulators who will have the problems."
Most regulators aren't waiting idly for that to happen. "Reinforcing control of insurers is the order of the day," says André Laboul, head of the Financial Affairs Division at the Paris-based Organization of Economic Cooperation and Development. Nations whose insurers have the biggest exposure to the stock market have acted fastest. In Britain, the Financial Services Authority asked the 20 largest life insurers to assess their liabilities on a "realistic basis" — a tough standard that takes into account such uncertainties as discretionary future benefits and fluctuating options values. The exercise was so complex that not all 20 companies were able to conduct it fully, according to Howard Davies, the FSA's chairman. The agency nonetheless concluded that the firms "had significant ability to withstand further large falls in equity values."
For now, insurers are praying for the markets to recover. "We're still alive," Dock says, "but we look forward to seeing interest rates or equity values rise again." On that point, every European insurer is agreed. What they can't insure is how long they'll have to wait for it to happen.
- PETER GUMBEL/Paris
- Sector woes drag down the equity markets