London: Expectations of rising dividends and share buy-backs from Europe’s insurance companies are fading as ultra-low interest rates make it harder for them to meet new capital regulations.

Rock-bottom interest rates reduce insurers’ investment returns, raising the risk of them having to eat into capital reserves to pay policyholders.

With yields on some government bonds — staple investments for insurers — turning negative recently, the International Monetary Fund (IMF) warned last month of a “high and rising” danger to weaker mid-sized European life insurers.

Calling for urgent action to tackle the issue, it cited 2014 data from the European insurance regulator showing 24 per cent of the region’s insurers may not be able to meet new minimum capital requirements if interest rates remain low for a protracted period of time.

Insurance stocks have until recently found favour with investors, hitting 14-year highs this year, partly because of their high dividends. But that has started to change.

“Expectations for dividends and buy-backs have become more restrained in the last few months,” said Andrea Williams, European equities fund manager at Royal London Asset Management.

Insurance watchdog chief Gabriel Bernardino told the Reuters Regulation Summit that insurers should exercise caution over dividends as they strive to meet new capital rules akin to those imposed on banks after the financial crisis.

The hit to solvency levels could mean some mutual insurers reliant on a single area of insurance need capital injections, according to Paul Traynor, international head of insurance at BNY Mellon.

The Stoxx Europe 600 Insurance index currently offers a dividend yield of 4.3 per cent, against 3.4 per cent for the broader FTSE Eurofirst index.

While no large listed insurers are expected to ask shareholders for more cash, any stress among smaller peers could damage confidence in the sector as a whole, the IMF said.

Reversing course

Some analysts are speculating that as the year goes on, listed insurers’ capital reserves over and above those required by impending so-called Solvency II rules will shrink. The rules are due to go live in 2016.

As a result, many investors that had piled into insurance stocks as a safer, income-offering way of playing the financial sector — given the regulatory and litigation uncertainties facing banks — are now reversing course.

The European insurance index has dropped 9 per cent from its 14-year high since the IMF’s report, while the banking sector has fallen only 3 per cent.

Although the big insurers are expected to deliver on promises of cash made so far, hopes for greater returns in the future appear to have run their course, analysts said.

“The more difficult environment and falling interest rates in particular have caused solvency ratios to decline, bringing them closer to the point where companies might be wary of paying out additional money,” said Berenberg analyst Peter Eliot.

Barclays last week cut its rating on the European insurance sector to “negative” from “neutral,” citing “significant and growing capital and earnings headwinds”.

“Earnings and solvency headwinds should combine to stall or even shrink dividends,” it said.