Financial intermediaries’ asset-liability dependency and low-interest-rate environment: evidence from EU life insurers

The current environment of low, and even negative, interest rates is a significant challenge for financial intermediaries. In particular, the low interest rates could negatively affect the profitability and solvency of insurance companies because of the large amount of fixed-term investment in the asset side of their balance sheet, and due to the impact of the reduction of the discount rates applied to value their liabilities. The negative effect could be exacerbated by the large diffusion of insurance instruments embedding financial guarantees in terms of minimum payouts that have been sold before the unanticipated decline of interest rates. Life insurers take their decisions concerning the assets to buy and the liabilities to sell under a condition of uncertainty and the outcomes involve interactions among the assets, among the liabilities and between the asset and liability sides of their balance sheet. In this respect, the mixture of assets and liabilities chosen by a life insurer can be seen as a basic portfolio theory decision. By using a canonical correlation analysis, we examine the internal structure of these portfolio decisions. The purpose of this research is to shed more light on the relationships between life insurers’ assets and liabilities and to investigate how these relationships evolved during recent years, when ECB’s monetary policy decisions drove market rates to unexperienced low levels. In our empirical analysis we measure the relationships among and between asset and liability accounts at major EU life insurers in 2007, 2011 and 2015. Insurance companies seem to run their business as if they decide their funding policies after identifying good investment opportunities. We find strong and substantial evidence that insurers’ assets and liabilities have indeed become more independent over time. We argue that the declining trend of market interest rates over the examined time horizon has contributed to the generalized reduction in the linkage between the asset side and the liability side of EU life insurers, and has made insurance companies more exposed to ALM-related risks relative to the period before the financial crisis broke out.