Towards a European system for natural catastrophe risk management

Publié le par hanswillertbleuazurconsultingeu

EIOPA / ECB December 2024

Executive Summary

Increased economic exposure and the growing frequency and severity of natural catastrophes linked to climate change have been driving up the cost of natural catastrophes in Europe. Between 1981 and 2023, natural catastrophes caused around €900 billion in direct economic losses within the EU, with one-fifth of these losses having occurred in the last three years alone. However, over the same period, only about a quarter of the losses incurred from extreme weather and climate-related events in the EU were insured – and this share is declining.

This “insurance protection gap” is expected to widen further due to the increasing risk posed by climate change. Europe is the fastest-warming continent in the world and increasing climate risk is likely to have implications for both the supply of and demand for insurance if no relevant measures are in place. As the frequency and severity of climate-related events grow, (re)insurance premiums are expected to rise. This will make insurance less affordable, particularly for low-income households. Climate change also increases the unpredictability of these events, which may prompt insurers to stop offering catastrophe insurance in high-risk areas. At the same time, low risk awareness and reliance on government disaster aid further dampen insurance uptake by households and firms.

Recent events, such as the 2024 flooding in central and eastern Europe and in Spain, have further illustrated the challenges that extreme weather events can pose for the EU and its Member States. These events highlight the importance of emergency preparedness, risk mitigation, and adaptation efforts to prevent and/or minimise the losses from natural disasters, as well as the relevance of national insurance schemes in reducing the economic impact of natural catastrophes. They also bring to the fore the importance of addressing the insurance protection gap and the associated burden on public finances.

National schemes aim to broaden insurance coverage and encourage risk prevention. Typically, they do so by setting up risk-based (re)insurance structures involving public-private sector coordination for multiple perils (e.g. floods, drought, fires and windstorms). Some of the schemes further support the availability of insurance through mandatory insurance coverage and improve the affordability of insurance through national solidarity mechanisms. At the same time, there are fewer risk diversification opportunities at national than at EU level and reliance on both national and EU public sector outlays has been growing. Therefore, it is beneficial to discuss at EU level how adaptation measures can help in proactively reducing disaster losses and how the sharing of losses between the public and private sectors can help in raising risk awareness and improving risk management before disasters occur.

Building on existing national and EU structures, the EIOPA and BCE spell out a possible EU-level solution composed of two pillars, firmly anchored in a multi-layered approach:

  • An EU public private reinsurance scheme: this first pillar would aim to increase the insurance coverage for natural catastrophe risk where insurance coverage is low . The scheme would pool private risks across the EU and across perils, with the aim of further increasing diversification benefits at EU level, while incentivising and safeguarding solutions at national level. It could bef unded by risk based premiums from (re)insurers or national schemes , while taking into account potential implications of risk based pricing for market segmentation . Access to the scheme would be voluntary. The scheme would act as a stabilising mechanism over time to achieve economies of scale and diversification for the coverage of high risks at the EU level, similar to an EU public private partnership.
  • An EU fund for public disaster financing: this second pillar would aim at improving public disaster risk management among Member States . Payouts from the fund would target reconstruction efforts following high loss natural disasters, subject to prudent risk mitigation policies, including risk adaptation and climate change mitigation measures. The EU fund would be financed by Member State contributions adjusted to reflect their respective risk profiles. Fund payouts would be condition al on the implementation of concrete risk mitigation measures preagreed under national adaptation and resilience plans. This would incentivise more ambitious risk mitigation at Member State level before and after disasters. Membership would be mandatory for all EU Member States.

Rising economic losses and climate change

Economic losses from extreme weather and climate events are increasing and are expected to rise further due to the growing frequency and severity of catastrophes caused by global warming. Between 1981 and 2023, natural catastrophe-related extreme events caused around €900 billion in direct economic losses in the EU, with more than a fifth of the losses occurring in the last three years (2021: €65 billion; 2022: €57 billion; 2023: €45 billion).

Europe is the fastest-warming continent in the world and the number of climate-related catastrophe events in the EU has been rising, hitting a new record in 2023. Moreover, climate change is already now affecting many weather and climate extremes in every region across the globe and its adverse impacts will continue to intensify. In the EU, all Member States face a certain degree of natural catastrophe risk and the welfare losses are estimated to increase in the absence of relevant measures to improve risk awareness, insurance coverage and adaptation to the rising risks.

Over the last ten years, the reinsurance premiums for property losses stemming from catastrophes have increased across all major insurance markets. In Europe, property catastrophe reinsurance rates have risen by around 75% since 2017. While there may be various factors affecting reinsurance prices, the increasing frequency and severity of events is likely to trigger further repricing of reinsurance contracts, which can in turn increase prices offered by primary insurers. The rising risks may even prompt insurers to retreat from certain areas or types of risk coverage. Moreover, since insurance policies are typically written for one year only, such repricing or insurance retreat may be abrupt. Reduced insurance offer is justified where risks become excessively high or unpredictable. In particular, insurance cannot palliate for inadequate climate adaptation, spatial planning and (re)building conventions.

At the same time, take-up of natural catastrophe insurance in the EU is declining among low-income households, thus increasing the pressure on governments to provide support in the event of a natural catastrophe. For instance, the share of low-income consumers with insurance for property damage caused by natural catastrophes has declined from around 14% to 8% since 2022. Affordability and budgetary constraints are the main reason why 19% of European consumers do not buy or renew insurance. Low-income households may also be disproportionately vulnerable to financial stress and are more likely to live in areas with increased exposure to environmental stress or natural catastrophes, due to the affordability of land and housing or limited resources to relocate to safer areas or invest in disaster-resistant housing. Insurance affordability stress might eventually also contribute to housing affordability issues, because if a larger portion of income is spent on insurance, a smaller portion is available for other expenses (e.g. rent). Therefore, solutions should consider vulnerability and consumer protection aspects.

Lessons from national insurance schemes

National schemes to supplement private insurance cover for natural catastrophes, such as PPPs, help improve insurance coverage and reduce the insurance protection gap. Looking at the European Economic Area (EEA), the share of insured losses tends to be higher in countries with such national schemes: the average share across countries with a national scheme is around 47%, while it is below 18% for those without a national scheme. Currently, eight EEA Member States have established a national scheme:

The schemes share the same objective: they all aim to enhance societal resilience against disasters. They typically do so by improving risk awareness and prevention, while increasing insurance capacity through more affordable (re)insurance.

While the design features vary by scheme, some of them are recurring:

  1. Scope: most national insurance schemes have a broad scope of coverage, which allows them to pool risks across multiple perils and assets. The majority also incorporate a mandatory element, requiring either mandatory offer or mandatory take up of insurance by law .
  2. Structure: the prevalent structure of national schemes is that of a public (re)insurance scheme. Most schemes offer complementary direct (re)insurance and are of a permanent nature.
  3. Payouts and premiums: national schemes are typically indemnity based (i.e. payouts are based on actual losses rather than quantitative/parametric catastrophe thresholds). Premiums are mostly risk based.
  4. Risk transfer and financing: the use of reinsurance by the schemes depends on the availabil ity and the cost of reinsurance, with national schemes increasingly facing issues over affordability. Public financing of the scheme is not an essential design feature.
  5. Risk mitigation and adaptation measures: initiatives to ensure proper coordination between the public and private sectors on risk identification and prevention are now emerging in response to climate change. Private and public sector responsibilities are typically divided, with the private market contributing its insurance expertise and modelling capacity, while the public sector provides the legal basis and operating conditions.

Lesson 1: an EU solution could cover a wider range of perils and assets across several Member States, thus allowing for greater risk pooling and risk diversification benefits than at a national level. This can be particularly relevant for small countries where a single catastrophe can affect the whole country and for countries without a national insurance scheme. By pooling catastrophe risk across different exposures, regions and uncorrelated perils within a single EU scheme, it may be possible to reap larger risk diversification benefits than could be achieved at national level. This would, in turn, reduce the required capital needed to back the risks and lower the cost of reinsuring them. Mandatory elements to boost the demand for or offer of insurance could further increase the risk diversification benefits and limit adverse selection. However, this would also require a certain degree of harmonisation of existing national practices.

Lesson 2: an EU-wide solution could include a permanent public-private reinsurance scheme to complement private sector or national initiatives. Setting up a public-private reinsurance scheme, as opposed to a private structure, would have the advantage that it could be accessed by a large range of entities: primary insurers, reinsurers and various national schemes. Therefore, such a scheme would require no harmonisation of existing national practices. Participation in such a scheme would be voluntary, so that the scheme supplements, rather than crowds out, private sector or national initiatives. Making the scheme permanent would allow for pooling risk over time, thus reaping even greater diversification benefits than if risks were pooled only across perils, asset types and Member States.

Lesson 3: an EU-wide solution could further support affordable risk-based premium setting, owing to the potentially sizeable risk diversification benefits that could be achieved across Member States. Given the significant heterogeneity in the risks faced by policyholders across Member States, flat premiums or premiums capped by law could imply a relatively high level of cross-subsidisation and solidarity, which might be difficult to agree upon at EU level. A risk-based approach at EU level could support additional risk diversification benefits achieved from risk pooling across Member States, time horizons, perils and asset types.

Lesson 4: since public funding mechanisms for disaster recovery are stretched and reinsurance prices have been rising, an EU solution could aim to finance itself through risk-based premiums and could explore tapping capital markets. In addition to collecting risk-based premiums (see Lesson 3), the scheme could explore tapping the capital markets by issuing catastrophe bonds or other insurance-linked securities. The catastrophe bonds could be indemnity-based or parametric (or both), depending on the further design features of the solution (e.g. whether it would provide indemnity-based or index-based payouts). The extensive risk pooling enabled by the EU solution could also allow for the issuance of catastrophe bonds that could be less risky and more transparent than many other catastrophe bonds, thus attracting a relatively wide set of investors. Ultimately, the EU solution could in principle be set up with no public financing or backstop.

Lesson 5: an EU solution could support both insurance and public sector initiatives geared towards risk mitigation and adaptation as part of a public-private concerted action. For instance, an EU solution could improve the availability, quality and comparability of data on insured losses across EU countries. It could also support the modelling of risk prevention and the integration of climate scenario analysis into estimates of future losses (both insured and uninsured) from natural disasters. The analysis of EU solutions might further promote the use and development of open-source tools, models and data to enhance the assessment of risks. In this context, care should be taken to prevent further market segmentation or demutualisation based on granular risk analysis, which could widen the insurance protection gap in the medium term.

A possible EU approach

An EU-level system could rest on two pillars, building on existing national and EU structures:

  1. Pillar 1: EU public private reinsurance scheme. Establishing an EU public private reinsurance scheme would serve to increase the insurance coverage for natural catastrophe risk. The scheme would pool private risks across the EU, perils and over time to achieve economies of scale and diversification at the EU level.
  2. Pillar 2: EU public disaster financing. The second pillar would look to improve public disaster risk management in Member States through EU contributions to public reconstruction efforts following natural disasters, subject to prudent risk mitigation policies, including adaptation and climate change mitigation measures

The EU public-private reinsurance scheme could help to provide households and businesses with affordable insurance protection against natural catastrophe risks, while also providing incentives for risk prevention. Embedded in the ladder of intervention, the design features of the scheme build on the five lessons learned from the analysis of the national schemes. The scheme seeks to (i) ensure coverage of a broad range of natural catastrophe risks, (ii) fulfil a complementary role to national and private market solutions, (iii) rely on risk-based pricing, (iv) reduce dependence on public financing in the long term, and (v) support concerted action on risk mitigation and adaptation.

The EU reinsurance scheme could seek to transfer part of the risks to capital markets via instruments such as catastrophe bonds. The market for these products is less developed in the EU than in North America. Part of the reason is the smaller scale of the issuances. The EU scheme could explore the feasibility of a pan-European catastrophe bond covering more perils than the bonds currently issued. This would serve the dual purpose of expanding the catastrophe bond market and bringing more niche risks directly to capital markets investors. The investors, in return, could benefit from the additional diversification offered by exposure to these risks relative to the risks currently covered.

Risk pooling is a fundamental concept in insurance, grounded in the law of large numbers. As independent risks are added to an insurer’s portfolio, the results become less volatile. For example, in a pool of insured vehicles, the actual number of accidents each year converges with the expected number as the size of the pool increases. In terms of capital, reduced volatility means lower capital needs and costs for the same level of protection. More diversified insurers can therefore offer cover at a lower price and given the level of capital, provide a higher level of protection.

The underlying risk (annual expected loss) remains unchanged when pooling risks together. However, the cost of covering or transferring the risk (cost of capital), along with the cost of information and operating costs, decreases with diversification and risk pooling. Operational costs are lower due to economies of scale, as they are shared among all participants in the pool. The cost of information is also lower , as the time and money required to obtain information can be shared among participants.

Solvency II requires insurers to hold sufficient capital to withstand a loss occurring with a
probability of 1 in 200 years. In an example, using the Moody’s RMS Europe NatCat Climate HD
model, and based on the current insured landscape, the pooled portfolio shows a reduction of
around 40% in the 1 in 200 year return period losses (RPL) compared to the sum of individual
values for countries. This reduction might be even larger if penetration of flood insurance increases. A similar analysis conducted by the World Bank, provid ing a framework for estimating the impact of pooling risks on policyholder premiums , supports these conclusions.

The EU disaster financing component would provide a complementary mechanism that governments could tap when managing natural catastrophe losses. Natural catastrophes can lead to significant costs for governments, including damage to key public infrastructure. The EU disaster financing component would help governments to manage a share of these expenses following a major disaster, thus supplementing their national budgetary expenditure. The component would cover damages caused to key public infrastructure that is inefficient or too costly to insure privately, with a view to supporting resilient reconstruction efforts and public space adaptation. Clear rules on contributions and conditions on the disbursement of the funds should encourage ex ante risk prevention by governments, to minimise the emergency relief and residual private risks that the government may need to cover following a major event.

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Anchoring Climate Change Risk Assessment in Core Business Decisions in Insurance

Publié le par hanswillertbleuazurconsultingeu

Key messages:

  1. The development of decision-relevant climate change risk assessment with a holistic approach requires an exploratory, iterative and adaptive process that will take time. A holistic approach
    considers physical, transition and litigation risks and their interactions at different time horizons in the short and long term. It considers both sides of the balance sheet, as well as interactions across business functions and decision feedback loops to assess the materiality of risks and develop potential actions to address them. Importantly, some re/insurers that have advanced further in this iterative process have found it beneficial to anchor the assessment in overarching decision areas that link both sides of the balance sheet. While re/insurers in all business lines have started exploring the materiality of physical and transition climate change risks on each side of the balance sheet, for life & health re/insurers in particular, more research is required to assess the attributions and materiality of climate change to their underwriting exposures – including longevity, mortality and morbidity –over various time horizons. As research in this field progresses, the ability both to assess life & health re/insurer liability exposures and perform more holistic assessments will improve.
  2. An analysis of regulatory developments since June 2021 and a survey conducted by The Geneva Association reveal that the regulatory and supervisory priorities and approaches are increasingly aligned with earlier GA task force recommendations related to climate change risk assessment and scenario analysis.
  3. Responses from 11 regulatory bodies to a Geneva Association Survey shed light on the regulatory objectives and priorities that can help guide climate change risk assessment exercises within and across jurisdictions. Our analysis has revealed the top four regulatory priorities:
    • policyholder protection,
    • the insurer’s financial health,
    • corporate governance and strategy,
    • the insurability/affordability of insurance solutions,
    • financial stability,
    • raising risk awareness,
    • addressing data/risk assessment services and environmental stewardship.
  4. Company boards and executive management need to consider the following four key issues to drive the process towards a more holistic approach that would produce decision-useful information:
    • Board oversight and executive management buy-in for company-wide engagement, along with appropriate resource allocation to build these capabilities, are important;
    • The coordination and execution of climate change risk assessment require an internally established, company-specific mandate with clear accountability;
    • Central to this process is the development of overarching decision-relevant questions for the board and the C-suite (a list based on the GA survey of regulatory and standard-setting bodies is included);
    • Company-relevant business use cases should be designed and utilised to guide the iterations of climate change risk assessment.
  5. A 10-step template provided in this report can help companies design business use cases to frame the analysis, engage experts from relevant business functions across the balance sheet, and mine and utilise the same data and tools across the company. It is important to start simple by exploring the impacts of each climate change risk type, on each side of the balance sheet, considering short- and long-term time horizons. With each iteration, companies can build up the level of complexity by assessing the interactions of physical, transition and litigation risks and exploring how these risks are manifested within and across business functions. Of note:
    • This process should consider internal business functions and their interactions as well as external drivers that impact issues relevant to the business use case, by risk type and time horizon;
    • Materiality analysis is at the heart of climate change risk assessment, allowing focus on the
      areas most impacted by climate change risks and identifying priorities for a deeper dive and
      resource allocation;
    • As part of the design and implementation of business use cases, the company should seek to
      identify metrics to measure and monitor the risks and track the impacts of the measures taken to manage them;
    • This resource-intensive process will take time and present challenges that will need to be addressed, ranging from overtime and the availability of data for the given region to internal experience and expertise, and the availability of best practices. In this report, we offer three examples of business use cases to demonstrate these points.
  6. The use of forward-looking scenario analysis needs to be further explored, depending on the issue being considered. Scenario analysis is a tool for conducting a forward-looking assessment of risks and opportunities, where the company can systematically explore individual or combined factors and make strategic decisions in the face of significant uncertainties. Scenario analysis may be used for a range of applications, for example:
    • Testing the resilience of a company’s business model to climate change-related risks;
    • Assessing the implications of possible actions a company can take;
    • Stress-testing the company’s business model under extremely adverse conditions.
  7. Through strong industry collaboration, re/insurers should conduct an analysis of existing data challenges, gaps and needs, and define priority areas and requirements for the future development of tools. More work is required by re/insurers and regulatory bodies to identify gaps in data, to converge on best practices and build a robust toolbox for forward-looking climate change risk analyses. Since 2021, several organisations have offered an assessment of the gaps in climate change risk data and tools in the current landscape, with a focus on certain applications or segments in the financial sector. The journey towards a holistic approach could lead re/insurers to address such gaps over time, not least in emissions data, asset locations and supply chain data. Note that life & health re/insurers still face challenges when it comes to identifying the types of data that would allow the extraction of climate change attribution and liability exposures.
  8. Importantly, company leadership should seek to harmonise and align their net-zero target-setting
    activities using ‘inside-out’ analysis with efforts to assess the resilience of their business model to
    climate change risks using ’outside-in’ approaches for developing viable targets, transition strategy and plans    . In fact, a growing number of critics are calling out the misalignment of net-zero pledges with what the companies can actually deliver and the possibility of greenwashing, which could lead to potential reputational and climate litigation risks or even regulatory action.
  9. Robust intra- and inter-sectoral collaboration is the only way to expedite the development and convergence of good practices, meaningful baseline requirements for decision-useful climate change risk assessments and disclosures that would allow for cross-company comparisons. To this end, we acknowledge and deeply appreciate the growing proactive collaboration and engagement
    across the insurance industry and with key regulatory and standard-setting bodies in the financial sector.

Context

In 2020, The Geneva Association (GA) launched its task force on climate change risk assessment with the aim of advancing and accelerating the development of holistic methodologies and tools for conducting forward-looking climate change risk assessment. These efforts have intended not only to support primary insurance and reinsurance companies and regulatory bodies with innovation in this area, but also to demonstrate the benefits of industry-level collaboration to help expedite the development and convergence of best practices.

In its first two reports, the GA task force highlighted the complexities associated with the development of forward-looking climate change risk assessment methodologies and tools. It stressed the need to develop methodologies for holistic climate change risk modelling and scenario analysis for both sides of the balance sheet, using a combination of qualitative and quantitative approaches. The GA task force also highlighted the implications of physical and transition risks for the insurance industry, with a focus on the challenges of quantitative scenario analysis approaches. The conclusion was that the prescriptive quantitative regulatory exercises to date, which were conducted to raise awareness, have outlived their
purpose. More specifically, these resource-intensive exercises do not provide decision-useful information given the significant uncertainties associated with the transition to a carbon-neutral economy (e.g. uncertainties associated with public policy, market and technology risks). Finally, the GA task force called on regulatory bodies to clarify their regulatory objectives and explain how their exercises would deliver decision-useful information. It also stressed the need for convergence on baseline regulatory requirements for analysis and reporting across jurisdictions. To this end, it encouraged stronger collaboration between regulatory bodies within and across jurisdictions, as well as with the insurance industry, to enable the sharing of lessons learned and access to broader expertise, in the aim of expediting the convergence of best practices.

Since June 2021, there have been several developments on the policy, technology, regulatory and scientific fronts, with implications for companies’ climate change risk assessment.

The evolving regulatory landscape for climate change risk assessment

Between June 2021 and May 2022, certain regulators launched new initiatives and published guidelines. A synthesis of these developments reveals the need for regulatory bodies to:

  • Acknowledge the limitations of current tools, models and data for long-term quantitative scenario analysis (as evidence, the 2021 Bank of England Climate Biennial Exploratory Scenarios experiment concluded that projections of climate change losses are uncertain; the view that scenario analysis is still in its infancy, with notable data gaps; and the increasing recognition among some regulatory bodies that quantitative approaches can and should be complemented with qualitative assessments, especially over a longer time horizon);
  • Stress the need to consider multiple scenarios representing different plausible pathways of transition or physical risks, and expand benchmark scenarios (typically NGFS) with sectoral and geographical granularity considerations;
  • Recognise the principle of proportionality, with expectations linked to the size and organisational complexity of the company;
  • Stress the importance of materiality in supervisory expectations for quantitative assessments as well as robust governance of climate change risks, with a need for transparency, particularly in relation to re/insurer investments in carbon-intensive sectors.

As of July 2022, there are still variations in the approaches used by regulators. Regulators agree, however, that this could impede comparisons across companies and jurisdictions as well as the ability to assess broader systemic economic and social impacts. Importantly, the International Association of Insurance Supervisors (IAIS) is working on promoting a globally consistent supervisory response to climate change, with a focus on three areas:

  • standards,
  • data
  • and scenario analysis,

by providing guidance to regulatory bodies. The Financial Stability Board (FSB) is also issuing guidance on supervisory and regulatory approaches across borders and sectors to address market fragmentation and potential sources of systemic risk. Finally, the development of a global baseline for sustainability reporting standards with a focus on climate change, by the ISSB, aims to translate them further into harmonised inter-jurisdictional standards.

Strategic importance of aligning inside-out and outside-in climate risk assessment approaches

Companies are conducting two types of climate risk assessment:

  • Inside-out analysis: This includes assessing the impact of the company’s actions on the climate by setting their climate targets (e.g. net zero targets) based on a variety of science-based approaches, such as those introduced by the UN Net-Zero Asset Owner Alliance (UN NZAOA) and the Science-Based Targets initiative (SBTi). For example, the UN-convened Net-Zero Alliances uses 1.5°C-compatible pathways, which may be far more ambitious than what companies and the real economy can deliver. In fact, the UN NZAOA has warned that the global economy does not move as is required by science, leading to a widening gap between companies’ climate targets and the real economy. Net-zero targets need to take this widening gap into account as this misalignment could lead to other financial and non-financial risks for the company, including reputation risk. This is further exacerbated by the fact that climate science is still evolving.
  • Outside-in analysis: This involves assessing the resilience of the company’s business model to climate change risks, which is the focus of this report. It is important to emphasise that the development of the company’s strategy, transition plan and related actions cannot be done solely using inside-out analysis. Conducting outside-in analysis is critical, enabling the company to assess not only the impacts of climate change risks and their interactions, but also the implications of the possible range of activities under different scenarios on the firm’s business model. Of note, the inside-out view puts greater emphasis on ‘impact’ – which has a clear political component and should be grounded in materiality assumptions, which is the central objective of the outside-in analysis.

In summary, companies should seek to harmonise and align inside-out with outside-in climate change risk assessment efforts (Figure 1). In fact, a growing number of critics are calling out the misalignment of net-zero pledges by the financial sector, in light of their already committed investments in carbon-intensive sectors for the years to come. Critics are also raising the possibility of greenwashing, which could lead to potential climate litigation risk. Regarding the latter, some regulators are developing KPIs to assess and monitor the existence and level of greenwashing as part of their efforts to incorporate climate change factors into their regulatory mandate.

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EIOPA Financial Stability Report July 2020

Publié le par hanswillertbleuazurconsultingeu

The unexpected COVID-19 virus outbreak led European countries to shut down major part of their economies aiming at containing the outbreak. Financial markets experienced huge losses and flight-to-quality investment behaviour. Governments and central banks committed to the provision of significant emergency packages to support the economy, as the economic shock, caused by demand and supply disruptions accompanied by its reflection to the financial markets, is expected to challenge economic growth, labour market and the consumer sentiment across Europe for an uncertain period of time.

Amid an unprecedented downward shift of interest rate curves during March, reflecting the flight-to-quality behaviour, credit spreads of corporates and sovereigns increased for riskier assets, leading effectively to a double-hit scenario. Equity markets dramatically dropped showing extreme levels of volatility responding to the uncertainties on virus effects and on the status of government and central banks support programs and their effectiveness. Despite the stressed market environment, there were signs of improvement following the announcements of the support packages and during the course of the initiatives of gradually reopening the economies. The virus outbreak also led to extraordinary working conditions, with part of the services sector working from home, which rises the potential of those conditions being preserved after the virus outbreak, which could decrease demand and market value for commercial real estate investments.

Within this challenging environment, insurers are exposed in terms of solvency risk, profitability risk and reinvestment risk. The sudden reassessment of risk premia and the increase of default risk could trigger large-scale rating downgrades and result in decreased investments’ value for insurers and IORPs, especially for exposures to highly indebted corporates and sovereigns. On the other hand, the risk of ultra-low interest rates for long has further increased. Factoring in the knock on effects of the weakening macro economy, future own funds position of the insurers could be further challenged, due to potential lower levels of profitable new business written accompanied by increased volume of profitable in-force policies being surrendered or lapsed.

Finally, liquidity risk has resurfaced, due to the potential of mass lapse type of events and higher than expected virus and litigation related claims accompanied by the decreased inflows of premiums.

EIOPA1

For the European occupational pension sector, the negative impact of COVID-19 on the asset side is mainly driven by deteriorating equity market prices, as, in a number of Member States, IORPs allocate significant proportions of the asset portfolio (up to nearly 60%) in equity investments. However, the investment allocation is highly divergent amongst Member States, so that IORPs in other Member States hold up to 70% of their investments in bonds, mostly sovereign bonds, where the widening of credit spreads impair their market value. The liability side is already pressured due to low interest rates and, where market-consistent valuation is applied, due to low discount rates. The funding and solvency ratios of IORPs are determined by national law and, as could be seen in the 2019 IORP stress test results, have been under pressure and are certainly negatively impacted by this crisis. The current situation may lead to benefit cuts for members and may require sponsoring undertakings to finance funding gaps, which may lead to additional pressure on the real economy and on entities sponsoring an IORP.

EIOPA2

Climate risks remain one of the focal points for the insurance and pension industry, with Environmental, Social and Governance (ESG) factors increasingly shaping investment decisions of insurers and pension funds but also affecting their underwriting. In response to climate related risks, the EU presented in mid-December the European Green Deal, a roadmap for making the EU climate neutral by 2050, providing actions meant to boost the efficient use of resources by

  • moving to a clean, circular economy and stop climate change,
  • revert biodiversity loss
  • and cut pollution.

At the same time, natural catastrophe related losses were milder than previous year, but asymmetrically shifted towards poorer countries lacking relevant insurance coverages.

Cyber risks have become increasingly relevant across the financial system in particular during the virus outbreak due to the new working conditions that the confinement measures imposed. Amid the extraordinary en masse remote working arrangements an increased number of cyber-attacks has been reported on both individuals and healthcare systems. With increasing attention for cyber risks both at national and European level, EIOPA contributed to building a strong, reliable, cyber insurance market by publishing its strategy for cyber underwriting and has also been actively involved in promoting cyber resilience in the insurance and pensions sectors.

Click here to access EIOPA’s detailed Financial Stability Report July 2020