(Bloomberg) -- Europe’s insurers are preparing to boostdividends to the highest of any industry except utilities, makinguse of expanding surplus capital to offer investors an alternativeto record low interest earnings from bonds.

Companies including Allianz SE, Europe’s biggest insurer, mayprovide a dividend yield averaging 4.4% this year versus 4.1% forthe past year, according to data compiled by Bloomberg. Insurersare poised to overtake telecommunications firms to become thesecond-biggest payers in the 18-industry Stoxx Europe 600 Index.They ranked third last year.

The industry is boosting payouts after its pool of shareholderfunds swelled to 422 billion euros ($478 billion) at the end of thefirst half, helped by cost cuts and gains from a bond market rally,according to data provided by Bloomberg Intelligence. Deflation andcreaking economic growth forced the European Central Bank to cutdeposit 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 asinvestors are searching for yield,” said Tim Friebertshaeuser, whohelps oversee about 1 trillion euros at Deutsche Asset & WealthManagement in Frankfurt. “Pressure on investment income has broughtfurther cost-cutting efforts and pricing discipline.”

Axa SA, France’s largest insurer, said on Wednesday it willincrease 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%higher than it indicated six months into 2014. Its shares climbedto a record in London.

Stocks Outperform

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

Allianz, Italy’s Assicurazioni Generali SpA and Munich Re, theworld’s biggest reinsurer, have pledged to keep payouts at leaststable and if possible raise them further. Dividend yields arepayments per share expressed as a percentage of the current stockprice.

Average yields in the telecommunications industry are expectedto fall to 4.1% from 9.4% last year, according to data compiled byBloomberg. Payouts by utilities such as gas and electricitycompanies are estimated to decline to 4.7% over the same periodfrom 6%.

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

Economic Reality

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

“The economic reality of ECB QE for significant parts of thesector is actually quite dire, particularly for guaranteebusinesses,” analysts including Andy Broadfield at Barclays Plcwrote in a note to clients on Feb. 11.

Record Low

Germany auctioned five-year notes with a negative yield for thefirst time on Wednesday. The rate on Irish 10-year securitiestouched a record-low 0.991%, while that on similar-maturity Italianbonds fell for a seventh day to 1.45%.

Allianz said in November that it will raise its dividend payoutratio to 50% of net income from 40%. The company is due to reportfourth-quarter earnings and its dividend proposal for 2014Thursday. It is expected to raise the dividend to 7 euros per sharefrom a payout of 5.30 euros for 2013 according to the BloombergDividend Forecast.

Munich Re said this month it plans to raise its dividend for2014 to 7.75 euros a share from the 7.25 euros distributed for2013. The U.K.’s largest insurers, Prudential Plc, Aviva Plc andLegal & General Group Plc have also focused on generating morecash for payouts.

“Lower-for-longer interest rates will not so much impactdividend paying capacity in the short term, but will eat intoearnings and cash flow generation of life insurers primarily in thelonger term,” said Esther Dijkman Dulkes, who helps manage about850 billion euros at Amundi Asset Management. “Insurers’ dividendyields are driven by capital discipline, a shift toward capitallight products and efforts to cut costs.”

--With assistance from Sarah Jones in London.

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