Rising government bond yields, driven in part by increased defence spending, are expected to have a broadly positive impact on most European insurers, according to Fitch Ratings.
Higher yields improve profitability by allowing insurers to invest premiums at better rates, while a steeper yield curve may enhance the appeal of certain life insurance products, potentially increasing new business volumes.
Life insurers offering annuities or long-term savings products with investment guarantees are likely to see the greatest benefit. The yield at which premiums can be invested directly influences the profitability and attractiveness of these products. Other insurance lines, such as unit-linked savings and short-tail non-life policies, are less sensitive to bond yields.
One downside of rising bond yields for insurers is the potential increase in refinancing costs. However, Fitch does not expect this to significantly weaken the profitability of rated insurers.
Refinancing needs remain limited due to insurers’ well-distributed debt maturity schedules, regulatory constraints on leverage, and other factors such as credit rating considerations.
In recent years, Europe has experienced a significant increase in defence spending, driven by evolving geopolitical dynamics and strategic considerations.
Many experts are calling the United States’ recent actions a critical turning point for the segment in Europe. Under President Donald Trump's administration, a reduction in US military aid to Europe has led EU countries to take greater responsibility for their own defence.
The ongoing conflict in Ukraine and perceived threats from Russia have prompted European nations to reassess and bolster their defence capabilities. This is also spurred by the US softening its ties to Ukraine, with President Trump’s spat with Ukraine’s President Volodymyr Zelenskyy presenting a wakeup call for leaders in the continent.
The European Union has since launched strategic initiatives, such as the proposed €800 billion "ReArm Europe" plan, aimed at enhancing military capabilities and reducing reliance on external allies.
In 2023, EU member states collectively spent €279 billion on defence, marking a 10% increase from the previous year and representing 1.6% of the EU's GDP.
2024 estimates indicate that defence equipment procurement spending exceeded €90 billion, accounting for 88.2% of total defence investments and reflecting a year-on-year increase of over 50%.
Higher bond yields and increased yield volatility will also have implications for insurers’ Solvency II positions. Fitch anticipates the impact will be minimal, as European insurers typically match the duration of their assets and liabilities or use hedging strategies to reduce capital sensitivity to bond yields.
Similarly, accounting impacts are expected to be limited under IFRS 17, which took effect on 1 January 2023. The standard largely offsets changes in asset and liability values, reducing accounting mismatches that were common under IFRS 4.
Another potential risk for life insurers is an increase in policy lapses, as customers may choose to cash in older contracts to reinvest in newer ones offering higher returns. While historical data suggests the link between bond yields and early redemptions has been weak due to customer inertia, higher yields could still lead some insurers to increase capital reserves under Solvency II to cover mass lapse risk.
In some cases, weaker insurers could come under pressure. The 2023 capital shortfall and subsequent regulatory intervention at Italian life insurer Eurovita – which is unrated by Fitch – highlighted such risks.
However, Fitch notes that rated insurers typically maintain strong capital positions and diversified business models, reducing their exposure to these challenges.
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