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EIOPA marks CIOs’ cards for 2018

Posted January 17, 2018

David Worsfold

Just as chief investment officers were tidying up their desks and clearing their inboxes before heading off for Christmas, the European Insurance and Occupational Pensions Authority (EIOPA) quietly slipped out its latest Financial Stability Report for the (re)insurance and occupational pensions sectors.

It flags up a few issues that will just not go away as far as the regulator is concerned.

According to the report, while the global economic outlook continues to improve, the prolonged low yield environment and low market volatility coupled with high levels of economic and political uncertainty continue to represent major challenges for European insurers and pensions funds. EIOPA’s big – and persistent – worry is the impact of a sudden yield spike. It wants insurers to assess the impact of this on their investments.

This is by far from its only concern.

In November, it published a survey of the investment behavior of insurers over the last five years and found plenty to worry about in insurers’ responses to the persistent low yield environment, highlighting:

  • Increased exposures towards lower credit rating quality fixed income securities
  • More illiquid investments such as non-listed equities and gradual increase in exposure to non-traditional asset classes such as infrastructure, mortgages, loans and real estate
  • Increase of the average maturity of the bond portfolios

It is unlikely that any of this will come as much surprise to CIOs, but it was sufficient to prompt EIOPA chairman Gabriel Bernardino to warn at the end of November that the regulator was monitoring how these trends were impacting insurers: “The survey points to a search-for-yield investment behaviour of insurers, which is a natural reaction to the low interest rate environment. The increased exposure to more illiquid investments and to non-traditional asset classes, such as infrastructure, improves asset diversification but also demands new risk management capabilities from insurers and closer supervisory attention. At the same time, in line with our expectations, the first observations from the impact of Solvency II point to an increase in long-term investment and a stable allocation to equity. EIOPA will continue to closely monitor the investment behaviour of insurers to ensure that it continues to remain in line with their risk bearing capacity.”

Now, EIOPA has expanded the list of issues it is monitoring to take in a broad range of topics, such as climate change, new technologies and digitalisation that might not always be high on CIOs’ agendas. It also raises concerns over lapse ratios which in some policy lines are increasing and putting strain on insurers’ capital.

There is a growing awareness across the sector that more attention needs to be paid to retaining business and reducing policy lapses, says Swiss Re in its latest sigma report:

“In addition to providing more benefit to consumers, the increased focus on managing their in-force business can help insurers sustain long-term profitability. Retaining customers is an important component in this regard, not least because keeping existing policyholders is less expensive than winning new business.

“Traditionally, life insurers have focused on growing new business, but many are currently paying increased attention to enhancing the value of existing portfolios. To do so, they are applying different levers for a more effective management of in-force books (i.e. existing business) with the aim of increasing customer satisfaction”.

The consequences of ignoring this trend will be stain on solvency ratios with precious capital used to support the expensive acquisition of new business, says Swiss Re.

It is not all gloom and pessimism at EIOPA headquarters over what 2018 might hold, however.

The insurance sector remains well capitalised with a Solvency Capital Requirement ratio for the median company above 200%, says the Financial Stability Report. There is further optimism about SCR ratios and the diverse use of long-term guarantees and transitional measures around Europe. “In many cases, in particular for life insurers, these measures represent a substantial cumulative effect on the SCR ratios, providing a financial stability cushion and potentially acting in a countercyclical manner”, says the report.

In the reinsurance sector, EIOPA warns that the 2017 hurricane season may have added to rising claims towards the end of the year, which will impact profitability and solvency levels.

Commenting on the publication of the Financial Stability Report, Bernardino made it clear that EIOPA will not be passively sitting back, quietly monitoring these trends. It plans to launch another EU-wide stress test this year with a wide-ranging remit.

“In order to address current challenges and newly emerging risks stemming from climate change, new technologies and digitalisation, EIOPA will broaden the range of its future risk analysis and include a wider range of business and scenarios. In addition, as part of its regular vulnerability analyses, EIOPA plans to launch an EU-wide Insurance Stress Test exercise in 2018, focusing on the most relevant and current risks for the sector.”

It seems clear that this stress test will probe deeply into investment strategies, priorities and trends and measure the responses against what it perceives as the wider issues facing CIOs.

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