EIOPA Report Identifies Key Financial Stability Risks for Insurers
EIOPA published the financial stability report that provides detailed quantitative and qualitative assessment of the key risks identified for the insurance and occupational pensions sectors in the European Economic Area. EIOPA also administered a qualitative questionnaire to national competent authorities to assess the materiality of risks stemming from the COVID-19 shock to the financial stability of the insurance sector. Results reveal that profitability of investment portfolio, solvency position, exposure to banks, underwriting profitability, concentration to domestic sovereign, and cyber risk are the top six key risks and challenges in terms of materiality for insurers. The report includes two thematic articles, with one focusing on the EU sustainable finance taxonomy from the perspective of the insurance and reinsurance sector and the other on the impact of the EIOPA statement on dividend distribution by insurers.
The risk assessment reveals that COVID-19 outbreak highlighted the importance of the Solvency II regulatory framework. The market-consistent and risk-based approach helps insurers to better align capital to risk, build resilience, and enhance the risk management practices. Moreover, the adjustments included for long-term guarantees allow to partially mitigate market volatility associated with the COVID-19 outbreak reflected in own funds and/or solvency capital requirements. As of year-end 2019, the insurance sector had a solid and comfortable capital buffer (median SCR ratio of 213%), which helped insurers to withstand the initial severe market shocks experienced with the COVID-19 crisis. However, a high level of uncertainty on the magnitude of economic disruption increases downside risks going forward. The prolonged low-yield environment has already been a fundamental risk for both insurance and pension sectors and the COVID-19 outbreak further increased its potential.
Moreover, the shock has also increased credit risk, challenging the asset-side valuations of insurers and their solvency positions. The forthcoming recession will negatively affect corporate sector profitability, resulting in rating downgrades. In addition, commercial real estate prices are expected to drop due to the extensive adoption of work from home arrangements by firms. A high interconnectedness of insurers and banks could further support spillovers of mentioned risks from the real sector to insurers and pension funds. Strains to demand and insurers’ underwriting profitability might take some time to unfold in parallel with the deterioration of the macroeconomic environment. Finally, confinement measures resulted in working from home arrangement, which increased cyber risk and further highlighted the importance of a reliable cyber risk insurance market. All these factors might lead to the materialization of the risks on insurers’ balance sheet with a substantial lag and high uncertainties. The report also notes that climate risks remain one of the focal points for the insurance industry, with environmental, social, and governance (ESG) factors increasingly shaping the investment decisions of insurers and affecting their underwriting practices.
Amid the challenging environment due to the COVID-19 shock, EIOPA and national supervisory authorities are working in close cooperation and took actions to help insurers to focus on ensuring business continuity to serve their customers. The Solvency II regime has some layers of flexibility. If the crisis deepens and if there will be a significant number of companies in difficulty, EIOPA is prepared to issue a declaration of adverse developments. This measure will allow national authorities to extend the recovery period, providing insurers more time to rebuild capital levels if needed. Recovery plans need to be assessed and granted consistently across countries. There is no doubt that the economy will experience a deep and unprecedented recession. The high uncertainty on the recovery path needs to be captured by an appropriate forward-looking risk assessment. In this respect, different recovery scenarios should be captured in the design of next year’s European Union-wide insurance stress test.
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Keywords: Europe, EU, Insurance, Financial Stability Report, Cyber Risk, Climate Change Risks, Credit Risks, Credit Risk, Solvency II, COVID-19, Stress Testing, ESG, EIOPA
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