19 December 2019

EIOPA outlines key financial stability risks of the European insurance and pensions sector

The European Insurance and Occupational Pensions Authority published its December 2019 Financial Stability Report of the (re)insurance and occupational pensions sectors in the European Economic Area.

The risk of a prolonged low yield environment has intensified over the last 6 months, as a combination of weakening economic outlook, growing trade tensions and increased downside risks have ushered in a new round of monetary policy easening by central banks, which has been accompanied by sharp decline in longer-term yields.

The low yield environment remains the key risk for both the insurance and pension fund sector and continues to put pressure on solvency positions. While the European insurance sector remains overall well capitalized with a median Solvency ratio of 212%, significant disparities remain across undertakings and countries. Overall solvency positions have also deteriorated in the first half of 2019 and the low interest rate environment is expected to put further pressures on the capital positions going forward, in particular for life business.

The low yield environment also has implications for long-term profitability, as it becomes increasingly difficult to meet promises and guarantees issued in the past. This could trigger further search for yield behaviour by insurers and pension funds, which could add to the build-up of vulnerabilities in the financial sector if not managed properly.

Moreover, a combination of weakening economic outlook, concerns over debt sustainability and stretched valuations across financial markets could give rise to a sudden reassessment of risk, in particular for riskier assets, which could trigger losses in the investment porfolios of insurers and pension funds. EIOPA will therefore continue to monitor closely this risk to identify at an early stage any potential vulnerabilities.

Furthermore, cyber risk and climate change risks continue to demand attention from insurers, pension funds and supervisors, as insurers and pension funds are increasingly susceptible to cyber risks as the digital transformation continues, while also bringing new opportunities for insurers in the form of cyber underwriting.

Regarding climate risk, insurers and pension funds can play a key role in the transition towards a low carbon economy as major institutional investors, but this transformation carries significant investment risks as well.

Finally, the challenging economic environment has also taken its toll on the financial situation of the European occupational pension fund sector. The persistently low interest environment affects the current values of DB pension obligations and in almost all Member States, cover ratios (ratio of assets covering the pension obligations) decreased with the outlook continuing to look challenging in light of the slowdown in the global economy and the pressure on the interest rates. Asset values also impaired significantly towards the end of 2018, wiping off substantial values in equity investments which also affected the accumulated savings of members and beneficiaries in DC funds.

Going forward, the improved reporting framework for the IORP sector will allow for an enhancement monitoring and assessment of potential vulnerabilities and financial stability implicatinos of European pension funds.

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