Risk of a prolonged low yield environment is key challenge for European insurers

The risk of a prolonged low yield environment has intensified over the last six months and remains the key challenge for European insurers and pension funds, putting pressure on both solvency positions and long-term profitability. This is according to the December 2019 Financial Stability Report on the re/insurance and occupational pensions sectors in the European Economic Area published by the European Insurance and Occupational Pensions Authority (EIOPA).

It said 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 percent, 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.

The report also said that cyber risk and climate change risks continue to demand attention from insurers, pension funds and supervisors. Interconnectedness with banks and home-bias in investments remain high for European insurers and could lead to potential spillovers of risks from other sectors.

Gabriel Bernardino, chairman of EIOPA said: “Over the past six months, we have seen the risks for a prolonged low yield environment intensify. A combination of a weakening economic outlook, increased downside risks and ongoing uncertainties about trade disputes and Brexit have ushered in a new round of monetary easing by central banks, which has been accompanied by a sharp decline in longer-term yields. In this regard, we continue to see the clear benefits of Solvency II, as the market-consistent and risk-based regulatory framework has helped price in the risk of low interest rates, build resilience and enhance the risk management practices of insurers.

“At the same time, it is important that the regulatory framework continues to remain robust in the future and adequately reflects the risks faced by insurers in a low for long environment. As such, it is crucial that these elements are addressed in the currently ongoing Solvency II review to ensure that promises can continue to be met in the future."

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