Insurance

Life / France

French Life Insurance

Rating Outlook Revised to Negative
Outlook Report
Rating Outlook

Rating Outlook
Revised Sector Outlook: Fitch Ratings has revised the rating outlook for the French life insurance sector to negative from stable. A negative sector outlook indicates that the agency believes that a material portion of life insurer ratings could be downgraded as they are reviewed over the next 12-24 months. Challenging Operating Environment: The French insurance industry is facing a number of challenges, which have been amplified by the financial crisis. Although the sector has shown some resilience, the challenging interest rate environment and unfavourable business mix will continue to penalise life insurers' profitability and solvency. Profitability Under Pressure: Fitch expects net collections to decrease materially in 20112012 due to lower premiums and higher lapses, which indicates that the market is becoming increasingly mature. Life insurers' profitability remains under pressure. Margins on eurodenominated products are weak, mainly due to the low interest rate environment, which should lead the majority of life insurers to further reduce returns offered to policyholders. Capital Adequacy Under Pressure: Financial market volatility is putting pressure on sales of unit-linked (UL) policies, which typically generate high margins in France. Capital adequacy is also being affected by unfavourable trends in Southern European government bonds, although exposure is not spread equally over the sector.

NEGATIVE

What Could Change the Outlook

Improved Asset Returns: Higher asset returns, especially interest rate, would allow insurers to rebuild margins and, as such, possibly improve retained earnings. This could prompt a revision of the outlook to stable. Recovered Solvency: Stronger solvency would be viewed by Fitch as a favourable rating trend. Such trend would be likely to come from improved profitability and better lower-risk asset mix.

Related Research
Other Outlooks
www.fitchratings.com/outlooks

Analysts
Marc-Philippe Juilliard +33 1 44 29 91 37 marcphilippe.juilliard@fitchratings.com Vanessa Flores +33 1 44 29 92 77 vanessa.flores@fitchratings.com

www.fitchratings.com

3 October 2011

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Key Issues
Fitch believes that improvements in life insurers' profitability and capital adequacy will depend on the extent to which they reduce the returns offered to their policyholders for 2011, assuming deterioration in the earned investment return as a central scenario. The still significant gap between guaranteed interest rates on life products (1% on average) and actual returns credited by life insurers (3.4% on average for 2010) gives them flexibility to adjust the bonus rates they pay for 2011. The agency notes that, if substantial, this reduction in bonus rates would be beneficial for insurers' profitability and solvency, both of which are suffering from the low yields on most Northern European government bonds and the deteriorated credit quality of several Southern European government bonds. In addition, profitability and solvency will both remain adversely affected by business mix, which is biased towards euro-denominated products, to the detriment of unit-linked policies. In terms of gross premiums, Fitch expects an annual average single-digit percentage drop in the foreseeable future, although this will be highly dependent on the financial and economic environment, notably interest rates and competition from banking products. In addition, premiums collected on UL policies are likely to continue to be hampered by volatility in equity markets. Lastly, as the life insurance market gradually reaches maturity, benefit payments will continue to increase, putting significant pressure on net collections. Fitch considers that the major challenge for life insurers in the coming years will be to gradually reduce their reliance on traditional euro savings-type life insurance and focus more on selling products that deliver healthier margins, such as protection policies.

Sector Overview
Life premiums rose just 3.5% yoy to EUR143bn in 2010, indicating that the significant recovery experienced in 2009 (+13%) after the financial crisis was not a trend. This growth rate is significantly below the historical average and, as a consequence, Fitch believes the market should increasingly be viewed as mature. At the same time, net collections (defined as premiums collected less benefits paid to policyholders) remained stable on 2009 at around EUR50bn. However, this amount remained below pre-crisis levels. Life insurance products continue to penetrate the addressable market and account for a large part of French households' financial savings (around 40% in 2010 compared with only 4.5% in 1980). In addition, life insurance accounted for about 70% of new money invested in financial assets in 2010 (64% on average over the past 10 years).
Figure 1

Life Insurance in France: Increasingly Mature Market

(EURbn) 1,400 1,200 1,000 800 600 400 200 0

1146

1990

128

1991

157

1992

190

1993

232

1994

275

1995

325

1996

386

1997

456

1998

508

1999

576

2000

636

2001

676

2002

711

2003

771

2004

840

2005

957

2006

1053

2007

2008

1142

2009

1233

Source: FFSA-GEMA

Related Criteria
Insurance Rating Methodology (Sept 2011)

French Life Insurance October 2011

2010

1317

Life technical reserves at 31 December (LHS)

Life premium income (RHS)

(EURbn) 160 140 120 100 80 60 40 20 0

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Current Trends
Returns Still Attractive But Decreasing
Returns offered to policyholders onlife insurance products have gradually shrunk since 1990, adversely affected by the structural decline in interest rates. In 2010, policyholders' returns paid on euro-denominated policies averaged 3.4% (2009: 3.7%; 2008: 4%). Nevertheless, the competitive position of life insurance products did not deteriorate in 20092010, mainly due to the less attractive yields offered by short-term bank deposit-type investment products in that period. In particular, yields offered by Livret A passbook and other short-term banking deposits significantly declined from their 4% peak reached in August 2008 to a low of 1.25% in August 2009 and 1.75% at end-2010.

Profitability Remains Under Pressure

Margins on euro-denominated products remained weak in 2010 as, on the one hand, insurers paid relatively high, although decreasing, returns to their policyholders and, on the other hand, their investment income remained somewhat low. That said, most life insurers decided to reduce the returns offered on their products for 2010 (reduction of 30bps on average), while guaranteed interest rates have continually declined since 1998 (to around 1% on average at end-2010). Fitch notes that measures taken by insurers to reduce the rates paid to their policyholders have not been sufficient to significantly restore their profitability, which structurally suffers from the low interest rate environment and the volatile performance of equity investments.
Figure 2

Yield Offered by Euro-Denominated life Insurance Policies and Livret A

Average rate of return on traditional policies Investment income/actuarial reserves (%) 10 8 6 4 2 0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011e

Return for livret A

Sources FFSA-GEMA, Fitch

Based on a sample of six of the top 10 life insurers, representing 58% of premiums collected in the market, Fitch estimates that life insurers increased their Provision pour participation aux excedents (PPE) profit-sharing reserves in 2010 (stable in 2009). The majority of life insurers had released part of their buffer reserves in 2008 in order to maintain attractive yields in a challenging financial environment. Short-term interest rates have started to recover in 2011. Yields offered by Livret A passbook deposits increased to 2.25% in August 2011. This has contributed to the poor performance of life insurance premiums (euro-denominated premiums decreased by 13% during the first six months of 2011 compared with the same period in 2010) and more than ever puts life insurers' decisions on returns offered to their policyholders for 2011 under the spotlight.

Flight to Security
The bulk (around 86%) of life insurance premiums were concentrated on guaranteed products in 2010 as policyholders maintained their preference for capital guaranteed products in a still uncertain financial environment. Asset risks taken by insurers on these products are becoming smaller, explaining the weak margins earned by the industry and the decline in yields offered to

French Life Insurance October 2011

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policyholders. More aggressive asset allocation tends to be made by insurers only on UL products, where policyholders bear the investment risk. Premiums collected on UL policies are strongly correlated with developments in equity markets, albeit with a lag. In 2010, premiums collected on these products increased by 11% compared with 2009, after declining by an average 26% per year during 2007-2009. UL policies accounted for 13% of total premiums collected by French life insurers in 2010, significantly below the proportion reached in 2007 (27%) before the financial crisis. In the first six months of 2011, the lower volatility of equity markets did not convince policyholders to reinvest in UL products, with no growth reported in these products. In addition, given the substantial fall in the CAC40 index since end-June 2011, it will take some time for investors to return to these products, as investment decisions by policyholders are typically largely based on recent stock market performance.

Competition: Little Change

The life insurance market did not experience major changes in the number of companies in 2010. Concentration remained very high, with the 10 largest groups representing 85% of premiums collected. Bancassurers continued to dominate the market with a 61% share of gross premiums written, stable over the recent past. Fitch notes that bancassurers have recently tended to diversify their distribution channels and target some niche segments, in particular high-net-worth clients. This has been illustrated by the acquisitions of Dexia Epargne Pension by BNP Paribas Assurance and of Axeria Vie (now Spirica) by Crdit Agricole Assurances. Both acquired companies target a high-end clientele and distribute their products mostly through independent financial advisors. This should have a positive impact on the two bancassurers' business positions and profitability as wealth management activity is generally more oriented towards UL products. In addition, Basel III rules may require banks to deduct shares in insurance companies from their regulatory capital. This possible requirement could lead major French banks to start thinking about the importance of keeping their 100% ownership in their insurance subsidiaries and might imply some changes in the insurance competitive landscape if it were to be applied. Nevertheless, Fitch does not expect French banks to consider the disposal or loss of control of their insurance activities as has occurred in other European countries as these activities have clearly been identified by the banks as core businesses. Alternatively, they could think of selling minority shareholdings or replacing core capital with subordinated debt. Fitch expects the bancassurance channel to continue to play a significant role in the market, although its share could diminish in the coming years due to the growing focus of banks on gathering on-balance-sheet assets in order to satisfy more stringent regulatory constraints on their liquidity profile.
Figure 3

Premiums and Market Share of France's 10 Largest Life Insurance Groups

2010 CNP Crdit Agricole Assurances AXA France BNP Paribas Assurance Socit Gnrale Insurance Generali France Groupe des Assurances du Crdit Mutuel Aviva France Allianz France AG2R La Mondiale Total
Source: FFSA/Fitch estimates

Premiums (EURbn) 24.4 22.4 15.3 12.2 11.5 11.4 6.7 5.9 5.8 5.7 121.3

Market share (%) 17.0 15.6 10.7 8.5 8.0 8.0 4.7 4.1 4.1 4.0 84.7

French Life Insurance October 2011

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Distribution via the internet continues to expand, as promoted by large groups (for example, Generali France, Nord Europe Assurance and Crdit Agricole Assurances). Due to its efficient cost structure, this channel offers attractive terms and conditions, such as the absence of entry fees. However, a number of policyholders continue to demand the expertise and advice provided by face-to-face distribution. Although fast growing, internet sales still accounted for only about 3% of total premiums collected in 2010.

Market Outlook
Negative Trend in Net New Business
Fitch notes that the savings-type life insurance market is highly dependent on the financial and economic environment. In this context, the lower gap between policyholders' returns and returns on short- to medium-term savings products offered by banks is expected to put significant pressure on new collections in 2011 onwards. In addition, the guaranteed interest rates that insurers can offer on their life insurance contracts have been further restricted by new regulations since August 2010, limiting their ability to implement promotional rates. Although generally few multi-year guarantees have been provided on life insurance contracts since the late 1990s, this now permanently prevents insurers from gaining new clients by offering higher-than-regulated guarantees over short periods. Lastly, there is a risk of dissatisfaction among life insurance policyholders in case of a sharp increase in interest rates. This is because they would not benefit from the upside, being mainly holders of euro-denominated products with average expected returns in the 3%-3.5% range. Also, due to recent high volatility on equity markets, unit-linked business is likely to suffer in the foreseeable future despite commercial efforts being made by life insurance sales networks to boost this business.

Nevertheless, Demographic Challenges are Unchanged

French citizens mostly purchase life insurance to fund future pension gaps and to build up capital for their heirs. This means that life insurance business in France has to be viewed as a substitute for pension funds, which are not widely developed in the country. This structural factor supporting demand for life insurance products is unchanged. Since the early 1990s, growth in the life insurance market has been fuelled by an increase in life expectancy and a reduction in the size of France's working population. Both issues raise major uncertainties about the future of existing pay-as-you-go retirement systems. These demographic trends will continue: according to forecasts produced by the French Statistical Institute (INSEE), the proportion of the French population aged 60 and over is set to increase significantly, from 23% in 2010 to 26% in 2020 and 32% in 2050. Moreover, the decline in the size of the working population will result in a reduction in the number of people actively financing the pensions system, giving rise to concerns over the continued equilibrium of the existing system.

Growth Potential Remains in The Retirement Segment

Heightened demand for ancillary retirement and benefit products in the French market has made an increasing contribution to the growth of insurance premiums, although, as discussed in the preceding paragraphs, the proportion of directly related premiums collected remains small. Premiums collected in the retirement savings segment accounted for about EUR12bn in 2010 (slightly up on 2009), or less than 10% of life insurance premiums. As a comparison, benefits paid to currently retired people by the public pay-as-you-go scheme amounted to EUR265bn in 2010. Fitch expects the pure retirement business to grow in the coming years while remaining dependent on economic growth and further potential tax system changes.

French Life Insurance October 2011

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Benefit Payments Likely to Increase Further
Benefits paid to policyholders include early redemptions of policies and sums paid out on the maturity of the policies (death-related claims, lump sums and annuities). Benefits held steady at around 40% of premiums for most of the 1990s, but have gradually increased in relative terms since 1998, reaching 64% in 2010. Regulations governing early redemptions are not particularly restrictive for policyholders. At least 95% of actuarial provisions are returned to the policyholder in the case of early redemption, which acts as only a minor deterrent on the cancellation option. However, the tax regime applicable to early redemptions, whether partial or total, may penalise policyholders more and hence is more of a deterrent. This is particularly true for policies that have less than eight years' history. In the medium and long term, Fitch does not expect net collections to remain as strong as in the past, as the life insurance market is gradually maturing after two decades of strong growth, leading to further increases in benefit payments. Net collections decreased by 50% over the first six months of 2011 to EUR17bn, compared with the same period in 2010, as benefit payments accounted for a substantial 75% of premiums during the period. Some insurers mention partial lapses made by just retired policyholders as one of the reasons for this unfavourable trend. In addition, more than 50% of life technical reserves consist of old contracts (more than eight years old, which is the threshold for the most favourable tax treatment in France). For this reason, Fitch considers that the industry traditional insurers in particular will have difficulty retaining the amounts paid back, and will risk losing these funds to competition from banks if it is unable to offer attractive offers such as retail banking solutions.

Profitability and Solvency: Still Challenging Recovery

Pressure on life insurers' profitability has become considerable in the current environment of low interest rates (French long-term government bonds rates were below 3% in September 2011). In addition, Fitch notes that the majority of life insurers have decided, since 2008, to reduce the risk profile of their investment portfolios, increasing investments in AAA rated government bonds and reducing investments in shares, both leading to lower expected financial returns. This trend has accelerated in 2011 as a consequence of rising concerns over the credit quality of Southern European government debt. Fitch believes that this trend is going to persist due to the business mix shift towards eurodenominated products and the expected application of Solvency II rules from 2013, which are likely to materially increase capital requirements for investments in equity and corporate bonds. Lack of interest in UL products will also continue to adversely affect insurers' profitability. With the material exposure of French life insurers to southern European government bonds, Fitch expects downward pressure on profitability as a consequence of impairments taken on the sovereign debt of Greece, and possibly other countries, in 2011 onwards. However, this exposure is greater at some insurers than others. Fitch estimates that the recovery of life insurers' profitability and, as a consequence, capital adequacy requires a substantial and sustained improvement in the financial markets, which seems unlikely in the near term. It also depends on the ability of insurers to reduce the returns offered to their policyholders for 2011 onwards. Nevertheless, the relatively small interest gap between yields offered on life insurance products (3.4% on average for 2010) and French longterm government bonds yields (around 3%) could discourage insurers from significantly reducing returns offered to their policyholders for 2011. Also, competitive pressure is likely to prevent insurers, especially those using non-proprietary distribution channels, announcing cuts which are drastic.

French Life Insurance October 2011

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In terms of solvency, French life insurance companies' capital adequacy has been cyclical since 2000. This volatility has not been the result of changes in companies' capital or surpluses; rather, it has been due to fluctuations in the level of unrealised gains, which are integrated into the calculations of the statutory Solvency I ratio. In 2010, the mediocre performance of equity and sovereign debt markets had a negative impact on life insurers' regulatory solvency ratios as unrealised capital gains reported in 2009 by life insurers (EUR70bn) diminished to EUR57bn at end-2010. French life insurers reported more-thanadequate regulatory solvency margins at end-2010 (160% of the minimum required). Nevertheless, the level of life insurers' solvency in 2010 remained below that reached before the economic crisis in 2007 (see Figure 4).
Figure 4

Changes in Solvency Margins

Shareholders' equity and unrealised capital gains or losses/actuarial reserves (%) 20 16 12 8 4 0 Shareholders' equity/actuarial reserves

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source FFSA-GEMA

Fitch believes the poor performance of equity markets since mid-2011 (CAC40 index down by around 20%) will have a negative impact on life insurers' solvency. In addition, the business mix shift towards euro-denominated products will continue to affect solvency margins as eurodenominated policies require a much higher solvency margin than UL policies. Lastly, the application of Solvency II rules expected in 2013 will mean higher capital requirements for insurers who, in order to increase their capital adequacy, will be compelled to substantially improve their retained earnings. Fitch notes that this will be the major challenge for French life insurers in the coming years and a difficult one considering the continuing compression of their margins. The exercise will be all the more difficult as insurers will be penalised from a solvency perspective if they take risks on the asset side.

Tax Regime Changes Expected

Tax incentives are key to life insurance products' continued appeal. However, in the current environment of large national public deficits, it is worth considering that taxes on life insurance products are likely to increase in the coming years. This has been illustrated by the decision taken by the French government in 2009 to submit the benefit of UL investments transmitted to beneficiaries in case of death of the policyholder to social taxes; this benefit had previously been free of tax. In addition, the French government recently announced its plan to request policyholders to pay social taxes every year on the euro portion of their UL investments. This plan further reduces the already currently-low appeal of UL products. Fitch believes that uncertainty over the effects of tax regime changes on life insurance policies will continue to penalise life insurers, especially in the context of still high public deficit expected in the coming years.

French Life Insurance October 2011

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French Life Insurance October 2011