For a new life insurance contract which finances entrepreneurial risk

Christian Gollier

Toulouse School of Economics and European Savings Institute

The crisis has massively reduced the value of certain assets: value of Greek sovereign bonds have been divided by 4, European stock indices have fallen by 50% in the last 5 years, real estate prices in the United States have lost a third of their value. This current impoverishment of savers illustrates the counterpart to the comfortable profitability of saving that had been observed for more than a century. The important losses on financial assets observed since the beginning of the crisis remind us of one of the founding rules of our capitalist economies. In a world where individual human capital is difficultly diversifiable, it is desirable to shift the majority of entrepreneurial risk on the capital factor. This would imply that savers agree to bear the macroeconomic risk. This agreement is vital for what remains of our economic dynamism. This question is at the heart of the report from Berger and Lefebvre that was recently given to the government.

For decades, the global tendency, and particularly in France, has been to offer saving products with guaranteed capital or fixed return rates. The consequences of this financial intermediation of popular saving are well known: an abundance of saving, unprecedented growth of capital accumulation through productive investment, but also a terrible hidden vulnerability of the system to important recessionary shocks. This explains how many pension funds with fixed return rates all over the world would today go bankrupt if we valued their liabilities with the appropriate discount rate. In France, life insurance has resisted, but the crisis has forced to re-think the model. What was possible in the past will not be in the future because the system will need to be much more resilient to major macroeconomic catastrophes.

Confronted with the current refusal of savers to incur a loss in capital under these scenarios, it is necessary to progressively reinforce financial intermediaries' shareholder equity. Without another reform, insurers, although reputed to be long-term investors, will reduce their participation in the financing of long term and therefore risky investments, as they have already started to do for 3 years by selling an important part of their stock and property portfolio. As life insurance represents an outstanding amount of €1 500 billion, this evolution is catastrophic for our country as it excludes from risk sharing, savers who are best disposed to support all its consequences. And because profitability of fixed income placements is very weak, this strategy will lead to a decline of life insurance contracts.

The Berger-Lefebvre report follows the right direction by abandoning all assumptions about previous performance, the famous Ratchet effect. But it maintains the capital guarantee at the end of the life insurance contract in euro. However, globally, it is impossible to finance companies all the while guaranteeing investors that they will not have to digest a part of their losses in times of crisis.
The combination of the reinforcement of stability norms, the very weak profitability of bonds and the digestion of the lessons of the current crisis will ineluctably make the capital guarantee of traditional life insurance extremely expensive. The market will then be forced to innovate, by offering saving products with reduced guarantee, but with higher expected profitability. Indeed, voluntary migration towards this type of contract will alleviate the shareholder equity expectations of insurers, and will restore the sector's appetite for long-term financing which our economy urgently needs. Life insurance must be used to service the long term financing of entrepreneurial risk, with a fiscal advantage that enables to smoothen out these risks over generations of savers. Those who refuse to carry this risk in a solidary fashion need from now on to pay the real price of this insurance supported by others. Unfortunate for them, and for our companies.