The European Insurance and Occupational Pensions Authority (EIOPA) has warned that the current ultra-low interest rate environment—which it said is being fueled by the COVID-19 pandemic and the resulting economic relief packages—represents a key source of systemic risk for insurers for the future.
EIOPA said in a recent report that the COVID-19 pandemic and central banks’ response measures to alleviate the impact on the economic activity will contribute to the continuation of the low interest rate environment. It also said that, in addition to the ultra-low interest rate environment, the COVID-19 outbreak has severely affected macroeconomic and market conditions worldwide, 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 adaptation,” EIOPA said in a recent report.
The report said the declining yields affect the income of insurers, particularly in the case of life portfolios with high guarantees stemming from products sold in the past.
“The combination of negative duration gap, reinvestment in lower yields, and the long-term duration of liabilities is expected to put additional strains on the medium to long-term profitability of insurers,” the report said. “The analysis of the bonds’ cash-flows based on coupon projections reveals that at least half of their value would be lost in 10-year time assuming reinvestments at the current level of interest rates.”
The report said that low yields challenge insurers both in their balance sheet positions and in terms of their profitability, and that adapting their investment behavior might help mitigate the overall negative effects of the low-yield environment.
“However, financial markets’ volatility in relation to the poor macroeconomic prospects due to the economic shutdowns during the virus outbreak, might substantially complicate insurers’ response and how it will feed back to their risk profile,” the report said.
EIOPA said the report confirms its position published in April when it urged reinsurers to temporarily suspend all discretionary dividend distributions and share buybacks aimed at remunerating shareholders. It also said it will keep monitoring market developments and the level of uncertainty regarding the pace of economic recovery, market performance, and credit outlook, as well as a possible increase in claims.