By Oliver Suess

Europe’s insurers are preparing to boost dividends to the highest of any industry except utilities, making use of expanding surplus capital to offer investors an alternative to record low interest earnings from bonds.

Companies including Allianz SE, Europe’s biggest insurer, may provide a dividend yield averaging 4.4 percent this year versus 4.1 percent for the past year, according to data compiled by Bloomberg. Insurers are poised to overtake telecommunications firms to become the second-biggest payers in the 18-industry Stoxx Europe 600 Index. They ranked third last year.

The industry is boosting payouts after its pool of shareholder funds swelled to 422 billion euros ($478 billion) at the end of the first half, helped by cost cuts and gains from a bond market rally, according to data provided by Bloomberg Intelligence. Deflation and creaking economic growth forced the European Central Bank to cut deposit rates to negative last June.

“As interest rates are at a record low in many markets, insurer’s dividend yields have become even more attractive as investors are searching for yield,” said Tim Friebertshaeuser, who helps oversee about 1 trillion euros at Deutsche Asset & Wealth Management in Frankfurt. “Pressure on investment income has brought further cost-cutting efforts and pricing discipline.”

AXA SA, France’s largest insurer, said on Wednesday it will increase dividends to 95 cents a share from 81 cents in 2013. U.K. insurer St. James’s Place will pay out 14.37 pence a share, 10 percent higher than it indicated six months into 2014. Its shares climbed to a record in London.

Stocks Outperform

Gains for insurance stocks are beating those of the wider market. The Stoxx Europe 600 Insurance index climbed 21 percent over the past year compared with an increase of 14 percent for the broad Stoxx Europe 600 and less than 1 percent for the region’s banks.

Allianz, Italy’s Assicurazioni Generali SpA and Munich Re, the world’s biggest reinsurer, have pledged to keep payouts at least stable and if possible raise them further. Dividend yields are payments per share expressed as a percentage of the current stock price.

Average yields in the telecommunications industry are expected to fall to 4.1 percent from 9.4 percent last year, according to data compiled by Bloomberg. Payouts by utilities such as gas and electricity companies are estimated to decline to 4.7 percent over the same period from 6 percent.

“Strong payouts have become one of investors’ key arguments for the sector,” said Reiner Kloecker, who helps oversee about 232 billion euros at Union Investment in Frankfurt. “Business is in decline for most insurers and as a result they are distributing excess capital.”

Economic Reality

Pressure on insurers’ investment returns is increasing as the European Central Bank embarks on a bond-buying program worth at least 1.14 trillion euros, dubbed quantitative easing, or QE, raising doubts about how much further they can boost dividends. The measures, announced last month, are making it more difficult for insurers to earn the income needed to meet pension and life insurance policies with guaranteed returns.

“The economic reality of ECB QE for significant parts of the sector is actually quite dire, particularly for guarantee businesses,” analysts including Andy Broadfield at Barclays Plc wrote in a note to clients on Feb. 11.

Record Low

Germany auctioned five-year notes with a negative yield for the first time on Wednesday. The rate on Irish 10-year securities touched a record-low 0.991 percent, while that on similar-maturity Italian bonds fell for a seventh day to 1.45 percent.

Allianz said in November that it will raise its dividend payout ratio to 50 percent of net income from 40 percent. The company is due to report fourth-quarter earnings and its dividend proposal for 2014 Thursday. It is expected to raise the dividend to 7 euros per share from a payout of 5.30 euros for 2013 according to the Bloomberg Dividend Forecast.

Munich Re said this month it plans to raise its dividend for 2014 to 7.75 euros a share from the 7.25 euros distributed for 2013. The U.K.’s largest insurers, Prudential plc, Aviva plc and Legal & General Group plc have also focused on generating more cash for payouts.

“Lower-for-longer interest rates will not so much impact dividend paying capacity in the short term, but will eat into earnings and cash flow generation of life insurers primarily in the longer term,” said Esther Dijkman Dulkes, who helps manage about 850 billion euros at Amundi Asset Management. “Insurers’ dividend yields are driven by capital discipline, a shift toward capital light products and efforts to cut costs.”

–With assistance from Sarah Jones in London.

Copyright 2015 Bloomberg.