Europe’s insurance and pension fund sectors stay resilient amid tense risk landscape

The European Insurance and Occupational Pensions Authority (EIOPA) published today its June 2024 Financial Stability Report, which offers a stocktake of key developments and risks in Europe’s insurance and occupational pensions sectors.

Challenging macroeconomic background

Insurers and occupational pension funds are navigating a macroeconomic environment marked by high geopolitical tensions, a string of elections in large economies, uncertainties about the economic outlook and waning support for globalization and international cooperation.

In the final months of 2023, economic activity stalled due to tight financial conditions and cautious consumer spending. Economic growth is expected to remain subdued in 2024. Interest rates in the euro area retreated as inflation has fallen close to the European Central Bank’s 2% medium-term target, but volatility in that respect dominates the debate.

Financial positions stay strong

Europe’s insurance and occupational pensions sectors have remained robust on aggregate, despite widespread challenges. The insurance sector is solidly capitalized. Median SCR ratios for life insurers and composite undertakings have improved throughout the shift from low to higher interest rates, as have profitability levels. Gross written premiums in the non-life sector continued to grow while the life business saw a more moderate increase.

Insurers’ liquid assets ratio has remained stable over the past years although there is considerable variation across countries. Lapse rates in the life business are fairly stable, though there are some signs of vulnerability.

On the guard for emerging risks

In response to the zero-interest rate environment of the past decade, institutional investors including insurers and pension funds looked for yields in so-called ‘alternative assets’. These assets tend to be more illiquid and often more complex in their structure and approach to valuation than conventional asset categories.

EIOPA’s Financial Stability Report shows that European insurers invest a large part of their portfolio in European assets. 87% of their sovereign bond investments, 80% of their equity holdings and 75% of their corporate bond investments go towards European states and companies. The overall portfolio is heavily skewed towards fixed-income assets like government and corporate bonds, however, a significant part (16%) of their investments is in alternative assets, with real estate investments and private debt-related investments as the largest exposures. Insurers allocate 5.7% of their investments to real estate through investment funds, mortgages and property. Private debt makes up 2.6% of their total investments while 1.9% is allocated to private equity.

Sizeable allocations to alternative assets that are often illiquid, difficult to valuate and whose valuation is highly sensitive to interest rates have raised supervisory and financial stability concerns. As a result, supervisors are closely monitoring the risks associated with such investments.

Beyond macro and market risks, insurers and pension funds are also grappling with climate-change related risks as well as those linked to digitalization and cybersecurity.

2023 marked yet another year of high natural disaster losses. Climate change-induced extreme weather events caused approximately €240 billion in economic losses worldwide, with insurers covering an estimated €86-98 billion. Insured losses from severe rainfall and hail over the past two years set new records in Italy and France even as insurance covered only around 10% of the damages. This underscores the urgent need for more action to close protection gaps and to continuously revisit insurers’ risk assessments, models and data.

Supervisors across Europe are also increasingly concerned about risk related to digitalization. While this risk category is currently at a medium level, forward-looking assessments point to an increase, with cybersecurity weaknesses and hybrid geopolitical conflicts being the primary concerns. Legislative initiatives such as the Digital Operational Resilience (DORA), the Artificial Intelligence Act, and the European Single Access Point (ESAP) all aim to enhance the financial sectors’ resilience to digital threats. Risk transfer mechanisms are also expected to play a key role in the growth of the cyber insurance market. In 2022, primary insurers rechanneled more than half of their cyber insurance premiums to reinsurers, and 2023 saw the issuance of the first-ever cyber catastrophe bonds.