EIOPA published a report on the impact of ultra-low yields in the insurance sector, including first effects of the COVID-19 crisis. The report assesses the risks and implications of the ultra-low or negative yields on the investment behavior of insurers, considers how challenged are the profitability and solvency positions of insurers, and describes the impact on the insurance business models and consumers. For a better understanding of the additional challenges and uncertainty coming from the COVID-19 pandemic, the report also used a qualitative questionnaire to capture the views of national competent authorities regarding the events in the first quarter of 2020 and their expert judgment on potential future risks.
In the current macro-financial environment, one of the major concerns for the insurance market is the exceptionally ultra-low or negative level of interest rates. In addition, the COVID-19 outbreak has severely affected the macroeconomic and market conditions worldwide, with the launch of support packages and monetary easing of some central banks and governments taking place to mitigate the negative effects. In Europe, this was accompanied by a flight to quality, increasing the likelihood of a “low for long” scenario with adverse implications for the insurance sector. As a result, insurers are significantly challenged in terms of asset allocations, profitability, solvency, and business model adaption. The low interest rate environment was and still is, also after COVID-19, one of the main issues for the insurance market.
The report analyzes the impact of interest rates on assets and liabilities, the solvency capital requirement (SCR) and SCR ratios, risk margins, and changes in risk-free rate curves on the technical provisions and asset sensitivity to market movements due to COVID-19. The report highlights that low-yield environment directly affects the solvency position of insurers typically through the balance sheet channel, but also indirectly on a longer time horizon via the income channel. The excess of assets over liabilities has slightly depreciated since interest rates decreased further in 2019, but had a comeback at the end of 2019 reaching the maximum level since the entry into force of the Solvency II regime. The estimates show that some insurers could suffer losses in the excess of assets over liabilities, with the overall market potentially losing more than a third of their excess of assets over liabilities based on this methodological approach. Exact losses are, however, hard to estimate given that Solvency II measures such as the volatility adjustment and the symmetric adjustment of the equity capital charge compensate some of the losses and that several insurers also hedge these risks.
The COVID-19 shock added additional pressure on insurers’ solvency ratios through increased market volatility, adverse movements in equity prices, bond yields and credit spreads, and potential bond downgrades. The report presents a methodological approach that estimates the sensitivity of the balance sheets of insurers to market developments in one of the worst days in the financial markets (March 18) since the pandemic outbreak. During the COVID-19 shock, the flight to quality observed decreased the market value for lower rated assets. Measures such as volatility adjustment and symmetric adjustment could decrease the overall balance sheet effect due to market volatility during COVID-19 shock. The COVID-19 shock of March 2020 has amplified the risks by pushing risk-free rates and high credit quality yields lower while increasing the uncertainty and risk premia of riskier assets. The report also points out that direct impact both on the business model of insurance companies and on the policyholders can also be observed. Regarding the insurers’ business model, there is an evidence of a gradual shift from with profit participation products with guaranteed returns toward pure unit-linked products and hybrid products since at least 2016.
Keywords: Europe, EU, Insurance, COVID-19, Solvency II, SCR, ALM, EIOPA
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