EIOPA published the financial stability report, outlining the key financial stability risks of the insurance and occupational pensions sectors in the European economic area. The key trends include the risk of prolonged low-yield environment, concerns over debt sustainability and stretched valuations across financial markets, and emerging cyber and climate-change-related risks. The report includes two thematic articles, with one focusing on a climate risk assessment of the sovereign bond portfolio of European insurers and the other on the impact of variation margins on liquidity of EU insurers.
Overall, the insurance sector remains well-capitalized but the interest rates reached record lows in August 2019 and an increasing number of EU countries now observe negative yields, even at longer maturities. This low-for-long environment has significant consequences for the business models of insurers and pension funds, putting pressure on both the capital position and long-term profitability. The low long-term interest rates directly affect the capital position of insurers and pension funds with nominally guaranteed liabilities and the low-yield environment makes it increasingly challenging for insurers and pension funds to meet the promises and guarantees made in the past. Thus, EIOPA continues to see the clear benefits of Solvency II, as the market-consistent and risk-based regulatory framework has helped price in the risk, build resilience, and enhance the risk management practices of insurers. The report also stresses the importance of continued robustness of the regulatory framework to adequately reflect the risks faced by insurers in a low-for-long environment. Thus, it is crucial that these elements are addressed in the ongoing Solvency II review to ensure that promises can continue to be met in the future.
Additionally, cyber and climate-change risks continue to demand attention from insurers, pension funds, and supervisors alike. 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. However, ensuring the sound provision of cyber insurance in Europe requires good quality data on cyber incidents and appropriate cyber risk management tools. From supervisors, this requires increased attention for potential non-affirmative coverages, accumulation risk and the potential system-wide impact of cyber incidents. Regarding climate-change risks, insurers and pension funds can play a key role in the transition toward a low-carbon economy as major institutional investors, but this transformation carries significant investment risks as well. Therefore, it is crucial that both insurers and pension funds actively incorporate climate change risks in their own risk management frameworks. Climate change can also have a significant impact on the liabilities of non-life insurers and reinsurers, as extreme weather related events become more frequent and severe.
Next year, EIOPA will build further on the work done in this area so far. It will perform a sensitivity analysis on the investments of European insurers to assess transition risks and potential misalignment with the Paris agreement climate goals and will continue to work on methodologies for climate change stress testing to be used in the future stress test exercises. Analyzing the potential impact of climate change is challenging and requires close cooperation between different fields of academia, economics, policymakers, and financial regulators. In this respect, the thematic article on the impact of climate change on the sovereign bonds portfolio of insurers included in this report provides a great example of this cooperation. EIOPA looks forward to enhancing this cooperation even more going forward to ensure that new emerging risks are incorporated into supervisory frameworks.
Keywords: Europe, EU, Insurance, Pensions, Financial Stability Report, Cyber Risks, Solvency II, Stress Testing, EIOPA
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