Climate change risk and transmission channels
During the 2020 review of Solvency II EIOPA identified several divergent practices regarding the valuation of best estimate, as presented in the analysis background document to EIOPA’s Opinion on the 2020 review of Solvency II. Divergent practices require additional guidance to ensure a convergent application of the existing regulation on best estimate valuation.
In accordance with Article 16 of Regulation (EU) No 1094/20102 EIOPA issues these revised Guidelines to provide guidance on how insurance and reinsurance undertakings should apply the requirements of Directive 2009/138/EC3 (“Solvency II Directive”) and in Commission Delegated Regulation (EU) No 2015/354 (“Delegated Regulation”), on best estimate valuation.
This revision introduces new Guidelines and amends current Guidelines on topics that are relevant for the valuation of best estimate, including
- the use of future management actions and expert judgment,
- the modelling of expenses and the valuation of options and guarantees by economic scenarios generators
- and modelling of policyholder behaviour.
EIOPA also identified the need for clarification in the calculation of expected profits in future premiums (EPIFP).
The revised Guidelines apply to both individual undertakings and mutatis mutandis at the level of the group. These revised Guidelines should be read in conjunction with and without prejudice to the Solvency II Directive, the Delegated Regulation and EIOPA’s Guidelines on the valuation of technical provisions. Unless otherwise stated in this document, the current guidelines of EIOPA’s Guidelines on the valuation of technical provisions remain unchanged and continue to be applicable.
If not defined in these revised Guidelines, the terms have the meaning defined in the Solvency II Directive. These revised Guidelines shall apply from 01-01-2023.
NEW: GUIDELINE 0 – PROPORTIONALITY
3.1. Insurance and reinsurance undertakings should apply the Guidelines on valuation of technical provisions in a manner that is proportionate to the nature, scale and complexity of the risks inherent in their business. This should not result in a material deviation of the value of the technical provisions from the current amount that insurance and reinsurance undertakings would have to pay if they were to transfer their insurance and reinsurance obligations immediately to another insurance or reinsurance undertaking.
NEW: GUIDELINE 24A – MATERIALITY IN ASSUMPTIONS SETTING
3.6. Insurance and reinsurance undertakings should set assumptions and use expert judgment, in particular taking into account the materiality of the impact of the use of assumptions with respect to the following Guidelines on assumption setting and expert judgement.
3.7. Insurance and reinsurance undertakings should assess materiality taking into account both quantitative and qualitative indicators and taking into consideration binary events, extreme events, and events that are not present in historical data. Insurance and reinsurance undertakings should overall evaluate the indicators considered.
NEW: GUIDELINE 24B – GOVERNANCE OF ASSUMPTIONS SETTING
3.11. Insurance and reinsurance undertakings should ensure that all assumption setting and the use of expert judgement in particular, follows a validated and documented process.
3.12. Insurance and reinsurance undertakings should ensure that the assumptions are derived and used consistently over time and across the insurance or reinsurance undertaking and that they are fit for their intended use.
3.13. Insurance and reinsurance undertakings should approve the assumptions at levels of sufficient seniority according to their materiality, for most material assumptions up to and including the administrative, management or supervisory body.
NEW: GUIDELINE 24C – COMMUNICATION AND UNCERTAINTY IN ASSUMPTIONS SETTING
3.14. Insurance and reinsurance undertakings should ensure that the processes around assumptions, and in particular around the use of expert judgement in choosing those assumptions, specifically attempt to mitigate the risk of misunderstanding or miscommunication between all different roles related to such assumptions.
3.15. Insurance and reinsurance undertakings should establish a formal and documented feedback process between the providers and the users of material expert judgement and of the resulting assumptions.
3.16. Insurance and reinsurance undertakings should make transparent the uncertainty of the assumptions as well as the associated variation in final results.
NEW: GUIDELINE 24D – DOCUMENTATION OF ASSUMPTIONS SETTING
3.17. Insurance and reinsurance undertakings should document the assumption setting process and, in particular, the use of expert judgement, in such a manner that the process is transparent. 3.18. Insurance and reinsurance undertakings should include in the documentation
- the resulting assumptions and their materiality,
- the experts involved,
- the intended use
- and the period of validity.
3.19. Insurance and reinsurance undertakings should include the rationale for the opinion, including the information basis used, with the level of detail necessary to make transparent both the assumptions and the process and decision-making criteria used for the selection of the assumptions and disregarding other alternatives.
3.20. Insurance and reinsurance undertakings should make sure that users of material assumptions receive clear and comprehensive written information about those assumptions.
NEW: GUIDELINE 24E – VALIDATION OF ASSUMPTIONS SETTING
3.21. Insurance and reinsurance undertakings should ensure that the process for choosing assumptions and using expert judgement is validated.
3.22. Insurance and reinsurance undertakings should ensure that the process and the tools for validating the assumptions and in particular the use of expert judgement are documented.
3.23. Insurance and reinsurance undertakings should track the changes of material assumptions in response to new information, and analyse and explain those changes as well as deviations of realisations from material assumptions.
3.24. Insurance and reinsurance undertakings, where feasible and appropriate, should use validation tools such as stress testing or sensitivity testing.
3.25. Insurance and reinsurance undertakings should review the assumptions chosen, relying on independent internal or external expertise.
3.26. Insurance and reinsurance undertakings should detect the occurrence of circumstances under which the assumptions would be considered false.
AMENDED: GUIDELINE 25 – MODELLING BIOMETRIC RISK FACTORS
3.27. Insurance and reinsurance undertakings should consider whether a deterministic or a stochastic approach is proportionate to model the uncertainty of biometric risk factors.
3.28. Insurance and reinsurance undertakings should take into account the duration of the liabilities when assessing whether a method that neglects expected future changes in biometrical risk factors is proportionate, in particular in assessing the error introduced in the result by the method.
3.29. Insurance and reinsurance undertakings should ensure, when assessing whether a method that assumes that biometric risk factors are independent from any other variable is proportionate, and that the specificities of the risk factors are taken into account. For this purpose, the assessment of the level of correlation should be based on historical data and expert judgment.
NEW: GUIDELINE 28A – INVESTMENT MANAGEMENT EXPENSES
3.30. Insurance and reinsurance undertakings should include in the best estimate administrative and trading expenses associated with the investments needed to service insurance and reinsurance contracts.
3.31. In particular, for products whose terms and conditions of the contract or the regulation requires to identify the investments associated with a product (e.g. most unit linked and index linked products, products managed in ring-fenced funds and products to which matching adjustment is applied), insurance and reinsurance undertakings should consider the investments.
3.32. For other products, insurance and reinsurance undertakings should base the assessment on the characteristics of the contracts.
3.33. As a simplification, insurance and reinsurance undertakings may also consider all investment management expenses.
3.34. Reimbursements of investment management expenses that the fund manager pays to the undertaking should be taken into account as other incoming cash flows. Where these reimbursements are shared with the policyholders or other third parties, the corresponding cash out flows should also be considered.
AMENDED: GUIDELINE 30 – APORTIONMENT OF EXPENSES
3.41. Insurance and reinsurance undertakings should allocate and project expenses in a realistic and objective manner and should base the allocation of these expenses
- on their long-term business strategies,
- on recent analyses of the operations of the business,
- on the identification of appropriate expense drivers
- and on relevant expense apportionment ratios.
3.42. Without prejudice to the proportionality assessment and the first paragraph of this guideline, insurance and reinsurance undertakings should consider using, in order to allocate overhead expenses over time, the simplification outlined in Technical Annex I, when the following conditions are met:
a) the undertaking pursues annually renewable business;
b) the renewals must be reputed to be new business according the boundaries of the insurance contract;
c) the claims occur uniformly during the coverage period.
AMENDED: GUIDELINE 33 – CHANGES IN EXPENSES
3.47. Insurance and reinsurance undertakings should ensure that assumptions with respect to the evolution of expenses over time, including future expenses arising from commitments made on or prior to the valuation date, are appropriate and consider the nature of the expenses involved. Insurance and reinsurance undertakings should make an allowance for inflation that is consistent with the economic assumptions made and with dependency of expenses on other cash flows of the contract.
NEW: GUIDELINE 37A – DYNAMIC POLICYHOLDER BEHAVIOUR
3.53. Insurance and reinsurance undertakings should base their assumptions on the exercise
rate of relevant options on:
- statistical and empirical evidence, where it is representative of future conduct, and
- expert judgment on sound rationale and with clear documentation.
3.54. The lack of data for extreme scenarios should not be considered alone to be a reason to avoid dynamic policyholder behaviour modelling and/or the interaction with future management actions.
NEW: GUIDELINE 37B – BIDIRECTIONAL ASSUMPTIONS
3.59. When setting the assumptions on dynamic policyholder behaviour, insurance and reinsurance undertakings should consider that the dependency on the trigger event and the exercise rate of the option is usually bidirectional, i.e. both an increase and a decrease should be considered depending on the direction of the trigger event.
NEW: GUIDELINE 37C – OPTION TO PAY ADDITIONAL OR DIFFERENT PREMIUMS
3.60. Insurance and reinsurance undertakings should model all relevant contractual options when projecting the cash flows, including the option to pay additional premiums or to vary the amount of premiums to be paid that fall within contract boundaries.
NEW: GUIDELINE 40A – COMPREHENSIVE MANAGEMENT PLAN
3.61. Insurance and reinsurance undertakings should ensure that the comprehensive future management actions plan that is approved by the administrative, management or supervisory body is either:
- a single document listing all assumptions relating to future management actions used in the best estimate calculation; or
- a set of documents, accompanied by an inventory, that clearly provide a complete view of all assumptions relating to future management actions used in best estimate calculation.
NEW: GUIDELINE 40B – CONSIDERATION OF NEW BUSINESS IN SETTING FUTURE MANAGEMENT ACTIONS
3.64. Insurance and reinsurance undertakings should consider the effect of new business in setting future management actions and duly consider the consequences on other related assumptions. In particular, the fact that the set of cash-flows to be projected through the application of Article 18 of the Delegated Regulation on contract boundaries is limited should not lead insurance and reinsurance undertakings to consider that assumptions only rely on this projected set of cash-flows without any influence of new business. This is particularly the case for assumptions on the allocation of risky assets, management of the duration gap or application of profit sharing mechanisms.
NEW: GUIDELINE 53A – USE OF STOCHASTIC VALUATION
3.70. Insurance and reinsurance undertakings should use stochastic modelling for the valuation of technical provisions of contracts whose cash flows depend on future events and developments, in particular those with material options and guarantees.
3.71. When assessing whether stochastic modelling is needed to adequately capture the value of options and guarantees, insurance and reinsurance undertakings should, in particular but not only, consider the following cases:
- any kind of profit-sharing mechanism where the future benefits depend on the
return of the assets;
- financial guarantees (e.g. technical rates, even without profit sharing mechanism), in particular, but not only, where combined with options (e.g. surrender options) whose dynamic modelling would increase the present value of cash flows in some scenarios.
NEW: GUIDELINE 57A – MARKET RISK FACTORS NEEDED TO DELIVER APPROPRIATE RESULTS
3.75. When assessing whether all the relevant risk factors are modelled with respect to the provisions of Articles 22(3) and 34(5) of the Delegated Regulation, insurance and reinsurance undertakings should be able to demonstrate that their modelling adequately reflects the volatility of their assets and that the material sources of volatility are appropriately reflected (e.g. spreads and default risk).
3.76. In particular, insurance and reinsurance undertakings should use models that allow for the modelling of negative interest rates.
AMENDED: GUIDELINE 77 – ASSUMPTIONS USED TO CALCULATE EPIFP
3.78. For the purpose of calculating the technical provisions without risk margin under the assumption that the premiums relating to existing insurance and reinsurance contracts that are expected to be received in the future are not received, insurance and reinsurance undertakings should apply the same actuarial method used to calculate the technical provisions without risk margin in accordance with Article 77 of the Solvency II Directive, with the following changed assumptions:
a) policies should be treated as though they continue to be in force rather than being considered as surrendered;
b) regardless of the legal or contractual terms applicable to the contract, the calculation should not include penalties, reductions or any other type of adjustment to the theoretical actuarial valuation of technical provisions without a risk margin calculated as though the policy continued to be in force.
3.79. All the other assumptions (e.g. mortality, lapses or expenses) should remain unchanged. This means that the insurance and reinsurance undertakings should apply
- the same projection horizon,
- future management actions
- and policyholder option exercise rates used in best estimate calculation
without adjusting them to consider that future premiums will not be received. Even if all assumptions on expenses should remain constant, the level of some expenses (e.g. acquisition expenses or investment management expenses) could be indirectly affected.
NEW: GUIDELINE 77A – ALTERNATIVE APPROACH TO CALCULATE EPIFP
3.88. Insurance and reinsurance undertakings may identify EPIFP as the part of present value of future profits related to future premiums in case the outcome does not materially deviate from the value that would have resulted from the valuation described in Guideline 77. This approach may be implemented using a formula design.
EIOPA’S DIGITAL TRANSFORMATION STRATEGIC PRIORITIES AND OBJECTIVES
EIOPA’s supervisory and regulatory activities are always underpinned by two overarching objectives:
promoting consumer protection and financial stability. The digital transformation strategy aims at
identifying areas where, in view of these overarching objectives, EIOPA can best commit its
resources in view of the challenges posed by digitalisation, while at the same time seeking to
identify and remove undue barriers that limit the benefits.
This strategy sits alongside EIOPA’s other forward thinking prioritisation tools –
- the union-wide strategic supervisory priorities,
- the Strategy on Cyber Underwriting,
- the Suptech Strategy
– but its focus is less on the specific actions needed in different areas, and more on how EIOPA will support NCAs and the pensions and insurance sectors in facing digital transformations following a
- and secure approach
to financial innovation and digitalisation.
Five key long-term priorities have been identified, which will guide EIOPA’s contributions on
- Leveraging on the development of a sound European data ecosystem
- Preparing for an increase of Artificial Intelligence while focusing on financial inclusion
- Ensuring a forward looking approach to financial stability and resilience
- Realising the benefits of the European single market
- Enhancing the supervisory capabilities of EIOPA and NCAs.
These five long-term priorities are described in the following sections. Each relates to areas where
work is already underway or planned, whether at national or European level, by EIOPA or other
The aim is to focus on priority areas where EIOPA can add value so as to enhance synergies and
improve overall convergence and efficiency in our response as a supervisory community to the
LEVERAGING ON THE DEVELOPMENT OF A SOUND EUROPEAN DATA ECO-SYSTEM
ACCOMPANYING THE DEVELOPMENT OF AN OPEN FINANCE AND OPEN INSURANCE FRAMEWORK
Trends in the market show that the exchange of both personal and non-personal data through
Application Programming Interfaces (APIs) is a leading factor leading to transformation and
integration in the financial sector. By enabling several stakeholders to “plug” to an API to have access
to timely and standardised data, insurance undertakings in collaboration with other service providers can timely and adequately assess the needs of consumers and develop innovative and convenient proposals for them. Indeed, there are multiple types of use cases that can be developed as a result of enhanced accessing and sharing of data in insurance.
Examples of potential use cases include pension tracking systems (see further below), public and
private comparison websites, or different forms of embedding insurance (including micro
insurances) in the channels of other actors (retailers, airlines, car sharing applications, etc.).
Another use case could consist in allowing consumers to conveniently access information about their
insurance products from different providers in an integrated platform / application and identify any
protection gaps (or overlaps) in coverage that they may have.
In addition to having access to a greater variety of products and services and enabling consumers
to make more informed decisions, the transfer of insurance-related data seamlessly from one
provider to another in real-time (data portability) could facilitate switching and enhance
competition in the market.
Supervisory authorities could also potentially connect into the relevant APIs to access anonymised market data so as to develop more pre-emptive and evidence-based supervision and regulation.
However, it is also important to take into account relevant risks such those linked to data
- and misuse.
ICT/cyber risks and financial inclusion risks are also relevant, as well as issues related to a level playing field and data reciprocity.
EIOPA considers that, if the risks are handled right, several open insurance use cases can have
significant benefits for consumers, for the sector and its supervision and will use the findings of
its recent public consultation on this topic to collaborate with the European Commission on the
development of the financial data space and/or open finance initiatives respectively foreseen in
the Commission’s Data Strategy and Digital Finance Strategy, possibly focusing on specific use
ADVISING ON THE DEVELOPMENT OF PENSIONS DATA TRACKING SYSTEMS IN THE EU
European public pension systems are facing the dual challenge of remaining financially sustainable
in an aging society and being able to provide Europeans with an adequate income in retirement.
Hence, the relevance of supplementary occupational and personal pension systems is increasing.
The latter are also seeing a major trend influenced by the low interest environment consisting on
the shift from Defined Benefit (DB) plans, which guarantee citizens a certain income after
retirement, to Defined Contribution (DC) plans, where retirement income depends on how the
accumulated contributions have been invested. As a consequence of these developments, more
responsibility and financial risks are placed on individual citizens for planning for their income after
In this context, Pensions Tracking Systems (PTS) can provide simple and understandable information
to the average citizen about his or her pension savings in an aggregated manner, typically
conveniently accessible via digital channels. PTS are linked to the concept of Open Finance, since
different providers of statutory and private pensions share pension data in a standardised manner
so that it can be aggregated so as to provide consumers with relevant information for adopting
informed decisions about their retirement planning.
EIOPA considers that it is increasingly important to provide consumers with adequate information
to make informed decisions about their retirement planning, as it is reflected in EIOPA’s technical
advice to the European Commission on best practices for the development of Pension Tracking
Systems. EIOPA remains ready to further assist on this area, as relevant.
TRANSITIONING TOWARDS A SUSTAINABLE ECONOMY WITH THE HELP OF DATA AND TECHNOLOGY
Technologies such as
- or the Internet of Things
can assist European insurance undertakings and pension schemes in the implementation of more sustainable business models and investments.
For example, greater insights provided by new datasets (e.g. satellite images or images taken by drones) combined with more granular AI systems may allow to better assess climate change-related risks and provide advanced insurance coverage. Indeed, as highlighted by the Commission’s strategy on adaptation to climate change, actions aimed to adapt to climate change should be informed by more and better data on climate-related risks and losses accessible to everyone as well as relevant risks assessment tools.
This would allow insurance undertakings to contribute to a wider inclusion by incentivising
customers to mitigate risks via policies whose pricing and contractual terms are based on effective
measurements, e.g. with the use of telematics-based solutions in home insurance. However, there
are also concerns about the impact on the affordability and availability of insurance for certain
consumers (e.g. consumers living in areas highly exposed to flooding) as well as regarding the
environmental impact of some technologies, notably concerning the energy consumption of certain
data centres and crypto-assets.
Promoting a sustainable economy is a core priority for EIOPA. For this purpose, EIOPA will
specifically develop a Sustainable Finance Action Plan highlighting, among other things, the
importance of improving the accessibility and availability of data and models on climate-related
risks and insured losses and the role that EIOPA can play therein, as highlighted by the
Commission’s strategy on adaptation to climate change and in line with the Green deal data space
foreseen in the Commission’s Data Strategy.
PREPARING FOR AN INCREASE OF ARTIFICIAL INTELLIGENCE WHILE FOCUSING ON FINANCIAL INCLUSION
TOWARDS AN ETHICAL AND TRUSWORTHY ARTIFICIAL INTELLIGENCE IN THE EUROPEAN INSURANCE SECTOR
The take-up of AI in all the areas of the insurance value chain raises specific opportunities and
challenges; the variety of use cases is fast moving, while the technical, ethical and supervisory issues
thrown up in ensuring appropriate governance, oversight, and transparency are wide ranging.
Indeed, while the benefits of AI in terms of prediction accuracy, cost efficiency and automation are
very relevant, the challenges raised by
- the limited explainability of some AI systems
- and the potential impact on some AI use cases on the fair treatment of consumers and the financial inclusion of vulnerable consumers and protected classes
is also significant.
A coordinated and coherent approach across markets, insurance undertakings and intermediaries,
and between supervisors is therefore of particular importance, also given the potential costs of
addressing divergences in the future. EIOPA acknowledges that AI can play a pivotal role in the digital transformation of the insurance and pension markets in the years to come and therefore the importance of establishing adequate governance frameworks to ensure ethical and trustworthy AI systems. EIOPA will seek to leverage the AI governance principles recently developed by its consultative expert group on digital ethics, to develop further sectorial work on specific AI use cases in insurance.
PROMOTING FINANCIAL INCLUSION IN THE DIGITAL AGE
On the one hand, new technologies and business models could be used to improve the financial
inclusion of European citizens. For example, young drivers using telematics devices installed in their
cars or diabetes patients using health wearable devices reportedly have access to more affordable
insurance products. In addition to the incentives arising from advanced risk-based pricing, insurance
undertakings could provide consumers loss prevention / risk mitigation services (e.g. suggestions to
drive safely or to adopt healthier lifestyles) to help them understand and mitigate their risk
From a different perspective, digital communication channels, new identity solutions and
onboarding options could also facilitate access to insurance to certain customer segments.
On the other hand, certain categories of consumers or consumers not willing to share personal data
could encounter difficulties in accessing affordable insurance as a result of more granular risk
assessments. This would be for instance the case of consumers having difficulties to access
affordable flood insurance as a result detailed risk-based pricing enabled by satellite imagery
processed by AI systems. In addition,
- other groups of potentially vulnerable consumers deserve special attention due to their personal characteristics (e.g. elderly people or in poverty),
- life-time events (e.g. car accident),
- health conditions (e.g. undergoing therapy)
- or people with difficulties to access digital services.
Furthermore, the trend towards increasingly data-driven business models can be compromised if adequate governance measures are not put in place to deal with biases in datasets used in order to avoid discriminatory outcomes.
EIOPA will assess the topic of financial inclusion from a broader perspective i.e. not only from a
digitalisation angle, seeking to promote the fair and ethical treatment of consumers, in particular
in front-desk applications and in insurance lines of businesses that are particularly important due
to their social impact.
EIOPA will routinely assess its consumer protection supervisory and policy work in view of
impacts on financial inclusion, and ensuring its work on digitalisation takes into account
accessibility or inclusion impacts.
ENSURING A FORWARD LOOKING APPROACH TO FINANCIAL STABILITY AND RESILIENCE
ENSURING A RESILIENT AND SECURE DIGITALISATION
Similar to other sectors of the economy, incumbent undertakings as well as InsurTech start-ups
increasingly rely on information and communication technology (ICT) systems in the provision of
insurance and pensions services. Among other benefits, the increasing adoption of innovative ICT
allow undertakings to implement more efficient processes and reduce operational costs, enable
data tracking and data backups in case of incidents, as well as greater accessibility and collaboration
within the organisation (e.g. via cloud computing systems).
However, undertakings’ operations are also increasingly vulnerable to ICT security incidents,
including cyberattacks. Furthermore, the complexity of some ICT or a different governance applied
to new technologies (e.g. cloud computing) is increasing as well as the frequency of ICT related
incidents (e.g. cyber incidents), which can have a considerable impact on undertakings’ operational
functioning. Moreover, relevance of larger ICT service providers could also lead to concentration
and contagion risks. Supervisory authorities need to take into account these developments and
adapt their supervisory skills and competences accordingly.
Early on, EIOPA identified cyber security and ICT resilience as a key policy priority and in the years to come will focus on the implementation of those priorities, including the recently adopted cloud computing and ICT guidelines, and on the upcoming implementation of the Digital Operational Resilience Act (DORA).
ASSESSING THE PRUDENTIAL FRAMEWORK IN THE LIGHT OF DIGITALISATION
The Solvency II Directive sets out requirements applicable to insurance and reinsurance undertakings in the EU with the aim to ensure their financial soundness and provide adequate protection to policyholders and beneficiaries. The Solvency II Directive follows a proportional, risk-based and technology-neutral approach and therefore it remains fully relevant in the context of digitalisation. Under this approach, all undertakings, including start-ups that wish to obtain a licence to benefit from Solvency II’s pass-porting rights to access the Internal Market via digital (and non-digital) distribution channels need to meet the requirements foreseen in the Directive, including minimal capital.
A prudential evaluation respective digital transformation processes should consider that insurance undertakings are incurring in high IT-related costs, to be appropriately reflected in their balance sheet. Furthermore, Solvency II requirement on outsourcing and the system of governance requirements are also relevant, in light of the increasing collaboration with third-party service providers (including BigTechs) and the use of new technologies such as AI. Investments on novel assets such as crypto-assets as well as the trend towards the “platformisation” of the economy are also relevant from a prudential perspective and the type of activities developed by insurance undertakings.
EIOPA considers that it is important to assess the prudential framework in light of the digital transformation that is taking place in the sector, seeking to ensure its financial soundness, promote greater supervisory convergence and also assess whether digital activities and related risks are adequately captured and if there are any undue regulatory barriers to digitalisation in this area.
REALISING THE BENEFITS OF THE EUROPEAN SINGLE MARKET
SUPPORTING THE DIGITAL SINGLE MARKET FOR INSURANCE AND PENSION PRODUCTS
Digital distribution can readily cross borders and reduce linguistic and other barriers; economies of scale linked to offering products to a wider market, increased competition, and greater variety of products and services for consumers are some of the benefits arising from the European Internal Market.
However, the scaling up the scope and speed of distribution of products and services across the Internal Market is an area where there is still a major untapped potential. Indeed, while legislative initiatives such as the
- Insurance Distribution Directive (IDD),
- Solvency II Directive,
- Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation,
- or the Directive on the activities and supervision of institutions for occupational retirement provision (IORP II)16
have made considerable progress towards the convergence of national regimes in Europe, considerable supervisory and regulatory divergences still persist amongst EU Member States.
For example, the IDD is a minimum harmonisation Directive. Existing regulation does not always allows for a fully digital approach. For instance, the need to use non-digital signatures or paper-based requirements as established by Article 23 (1) (a) IDD and Article 14 (2) (a) PRIIPs Regulation can limit end-to-end digital workflows. It is critical that the opportunities – and risks, for instance in relation to financial inclusion and accessibility – that come with digital transformations are fully integrated into future policy work. In this context, the so-called 28th regime used in Regulation on a pan-European Personal Pension Product (PEPP)17, which does not replace or harmonise national systems but coexists with them, is an approach that could eventually be explored taking into account the lessons learned.
EIOPA supports the development of the Internal Market in times of transformation, through the recalibration where needed of the IDD, Solvency II, PRIIPS and IORP II from a digital single market
perspective. EIOPA will also explore what a digital single market for insurance might look like from
a regulatory and supervisory perspective. Furthermore, EIOPA will integrate a digital ‘sense check’
into all of its policy work, where relevant.
SUPPORTING INNOVATION FACILITATORS IN EUROPE
In recent years many NCAsin the EU have adopted initiatives to facilitate financial innovation. These
initiatives include the establishment of innovation facilitators such as ‘innovation hubs’ and ‘regulatory sandboxes’ to exchange views and experience concerning Fintech-related regulatory issues and enable the testing and development of innovative solutions in a controlled environment and to learn more as to supervisory expectations. These initiatives also allow supervisory authorities to gather a better understanding of the new technologies and business models taking place in the market.
At European level, the European Forum for Innovation Facilitators (EFIF), created in 2019, has
become an important forum where European supervisors share experiences from their national
innovation facilitators and discuss with stakeholders topics such as Artificial Intelligence,
Platformisation, RegTech or crypto-assets. The EFIF will soon be complemented with the Commission’s Digital Finance platform; a new digital interface where stakeholders of the digital
finance ecosystem will be able to interact.
Innovation facilitators can play a key role in the implementation and adoption of innovative
technologies and business models in Europe and EIOPA will continue to support them through its
work in the EFIF and the upcoming Digital Finance Platform. EIOPA will work to further facilitate
cross-border / cross-sector cooperation and information exchanges on emergent business models.
ADDRESSING THE OPPORTUNITIES AND CHALLENGES OF FRAGMENTED VALUE CHAINS AND THE PLATFORM ECONOMY
New actors including InsurTech start-ups and BigTech companies are entering the insurance market,
both as competitors as well as cooperation partners of incumbent insurance undertakings.
Concerning the latter, incumbent undertakings reportedly increasingly revert to third-party service
providers to gain quick and efficient access to new technologies and business models. For example,
based on in EIOPA’s Big Data Analytics thematic review, while the majority of the participating
insurance undertakings using BDA solutions in the area of claims management developed these
tools in-house, two thirds of the undertakings reverted to outsourcing arrangements in order to
implement AI-powered chatbots.
This trend is reinforced by the platformisation of the economy, which in the insurance sector goes
beyond traditional comparison websites and is reflected in the development of complex ecosystems
integrating different stakeholders. They often share data via Application Programming Interfaces
(APIs) and cooperate in the distribution of insurance products via platforms (including those of BigTechs) embedded (bundled) with other financial and non-financial services. In addition, in a
broader context of Decentralised Finance (DEFI), Peer-to-Peer (P2P) insurance business models
using digital platforms and different levels of decentralisation to interact with members with similar
risks profiles have also emerged in several jurisdiction; although their significance in terms of gross
written premiums is very limited to date, it is a matter that needs to be monitored.
EIOPA notes the opportunities and challenges arising from increasingly fragmented value chains and the platformisation of economy which will be reflected in the ESAs upcoming technical advice on digital finance to the European Commission, and will subsequently support any measures within its remit that may be needed to
- encourage innovation and competition,
- protect consumers,
- safeguard financial stability
- and ensure a level playing field.
ENHANCING THE SUPERVISORY CAPABILITIES OF EIOPA AND NCAS
LEVERAGING ON TECHNOLOGY AND DATA FOR MORE EFFICIENT SUPERVISION AND REGULATORY COMPLIANCE
Digital technologies can also help supervisors to implement more agile and efficient supervisory
processes (commonly known as Suptech). They can support a continuous improvement of internal
processes as well as business intelligence capabilities, including enhancing the analytical framework, the development of risk assessments and the publication of statistics. This can also include new capabilities for identifying and assessing conduct risks.
With its European perspective, EIOPA can play a key role by enhancing NCAs data analysis capabilities based on extensive and rich datasets and appropriate processing tools.
As outlined in its SupTech strategy and Data and IT strategy, EIOPA has the objective to promote its own transformation to become a digital, user-focused and data driven organisation that meets its strategic objectives effectively and efficiently. Several on-going projects are already in place to achieve this objective.
INCREASING THE UNDERSTANDING OF NEW TECHNOLOGIES BY SUPERVISORS IN CLOSE COOPERATION WITH STAKEHOLDERS
Building supervisory capacity and convergence is a critical enabler for other benefits of digitalisation; without strong and convergent supervision, other benefits may be compromised. With the use of different tools available (innovation hubs, regulatory sandboxes, market monitoring, public consultations, desk-based reports etc.), supervisors seek to understand, engage and supervise increasingly technology-driven undertakings.
Closely cooperating with stakeholders with hands-on experience on the use of innovative tools has proofed to be useful tool to improve the knowledge by supervisors, and also for the stakeholders it is important to understand what are the supervisory expectations.
Certainly, the profile of the supervisors needs to evolve and they need to extend their knowledge into new areas and understand how new business models and value chains may impact undertakings and intermediaries both from a conduct and from a prudential perspective. Moreover, in view of the growing importance of new technologies and business models for insurance undertakings and pensions schemes, it is important to ensure that supervisors have access to relevant data about these developments in order to enable an evidence-based supervision.
EIOPA aims to continue incentivising the sharing of knowledge and experience amongst NCAs by organising InsurTech roundtables, workshops and seminars for supervisors as well as pursuing further potential deep-dive analysis on certain financial innovation topics. EIOPA will also further emphasise an evidence-based supervisory approach by developing a regular collection of harmonised data on digitalisation topics. EIOPA will also develop a stakeholder engagement strategy on digitalisation topics to identify those actors and areas where the cooperation should be reinforced.
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.
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.
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.
The Solvency II Directive provides that certain areas of the framework should be reviewed by the European Commission at the latest by 1 January 2021, namely:
- long-term guarantees measures and measures on equity risk,
- methods, assumptions and standard parameters used when calculating the Solvency Capital Requirement standard formula,
- Member States’ rules and supervisory authorities’ practices regarding the calculation of the Minimum Capital Requirement,
- group supervision and capital management within a group of insurance or reinsurance undertakings.
Against that background, the European Commission issued a request to EIOPA for technical advice on the review of the Solvency II Directive in February 2019 (call for advice – CfA). The CfA covers 19 topics. In addition to topics that fall under the four areas mentioned above, the following topics are included:
- transitional measures
- risk margin
- Capital Markets Union aspects
- macroprudential issues
- recovery and resolution
- insurance guarantee schemes
- freedom to provide services and freedom of establishment
- reporting and disclosure
- proportionality and thresholds
- best estimate
- own funds at solo level
EIOPA is requested to provide technical advice by 30 June 2020.
This consultation paper sets out technical advice for the review of Solvency II Directive. The advice is given in response to a call for advice from the European Commission. EIOPA will provide its final advice in June 2020. The call for advice comprises 19 separate topics. Broadly speaking, these can be divided into three parts.
- Firstly, the review of the long term guarantee measures. These measures were always foreseen as being reviewed in 2020, as specified in the Omnibus II Directive. A number of different options are being consulted on, notably on extrapolation and on the volatility adjustment.
- Secondly, the potential introduction of new regulatory tools in the Solvency II Directive, notably on macro-prudential issues, recovery and resolution, and insurance guarantee schemes. These new regulatory tools are considered thoroughly in the consultation.
- Thirdly, revisions to the existing Solvency II framework including in relation to
- freedom of services and establishment;
- reporting and disclosure;
- and the solvency capital requirement.
Given that the view of EIOPA is that overall the Solvency II framework is working well, the approach here has in general been one of evolution rather than revolution. The principal exceptions arise as a result either of supervisory experience, for example in relation to cross-border business; or of the wider economic context, in particular in relation to interest rate risk. The main specific considerations and proposals of this consultation paper are as follows:
- Considerations to choose a later starting point for the extrapolation of risk-free interest rates for the euro or to change the extrapolation method to take into account market information beyond the starting point.
- Considerations to change the calculation of the volatility adjustment to risk-free interest rates, in particular to address overshooting effects and to reflect the illiquidity of insurance liabilities.
- The proposal to increase the calibration of the interest rate risk submodule in line with empirical evidence. The proposal is consistent with the technical advice EIOPA provided on the Solvency Capital Requirement standard formula in 2018.
- The proposal to include macro-prudential tools in the Solvency II Directive.
- The proposal to establish a minimum harmonised and comprehensive recovery and resolution framework for insurance.
A background document to this consultation paper includes a qualitative assessment of the combined impact of all proposed changes. EIOPA will collect data in order to assess the quantitative combined impact and to take it into account in the decision on the proposals to be included in the advice. Beyond the changes on interest rate risk EIOPA aims in general for a balanced impact of the proposals.
The following paragraphs summarise the main content of the consulted advice per chapter.
Long-term guarantees measures and measures on equity risk
EIOPA considers to choose a later starting point for the extrapolation of risk-free interest rates for the euro or to change the extrapolation method to take into account market information beyond the starting point. Changes are considered with the aim to avoid the underestimation of technical provisions and wrong risk management incentives. The impact on the stability of solvency positions and the financial stability is taken into account. The paper sets out two approaches to calculate the volatility adjustment to the risk-free interest rates. Both approaches include application ratios to mitigate overshooting effects of the volatility adjustment and to take into account the illiquidity characteristics of the insurance liabilities the adjustment is applied to.
- One approach also establishes a clearer split between a permanent component of the adjustment and a macroeconomic component that only exists in times of wide spreads.
- The other approach takes into account the undertakings-specific investment allocation to further address overshooting effects.
Regarding the matching adjustment to risk-free interest rates the proposal is made to recognise in the Solvency Capital Requirement standard formula diversification effects with regard to matching adjustment portfolios. The advice includes proposals to strengthen the public disclosure on the long term guarantees measures and the risk management provisions for those measures.
The advice includes a review of the capital requirements for equity risk and proposals on the criteria for strategic equity investments and the calculation of long-term equity investments. Because of the introduction of the capital requirement on long-term equity investments EIOPA intends to advise that the duration-based equity risk sub-module is phased out.
EIOPA identified a larger number of aspects in the calculation of the best estimate of technical provisions where divergent practices among undertakings or supervisors exist. For some of these issues, where EIOPA’s convergence tools cannot ensure consistent practices, the advice sets out proposals to clarify the legal framework, mainly on
- contract boundaries,
- the definition of expected profits in future premiums
- and the expense assumptions for insurance undertakings that have discontinued one product type or even their whole business.
With regard to the risk margin of technical provisions transfer values of insurance liabilities, the sensitivity of the risk margin to interest rate changes and the calculation of the risk margin for undertakings that apply the matching adjustment or the volatility adjustment were analysed. The analysis did not result in a proposal to change the calculation of the risk margin.
EIOPA has reviewed the differences in tiering and limits approaches within the insurance and banking framework, utilising quantitative and qualitative assessment. EIOPA has found that they are justifiable in view of the differences in the business of both sectors.
Solvency Capital Requirement standard formula
EIOPA confirms its advice provided in 2018 to increase the calibration of the interest rate risk sub-module. The current calibration underestimates the risk and does not take into account the possibility of a steep fall of interest rate as experienced during the past years and the existence of negative interest rates. The review
- of the spread risk sub-module,
- of the correlation matrices for market risks,
- the treatment of non-proportional reinsurance,
- and the use of external ratings
did not result in proposals for change.
Minimum Capital Requirement
Regarding the calculation of the Minimum Capital Requirement it is suggested to update the risk factors for non-life insurance risks in line with recent changes made to the risk factors for the Solvency Capital Requirement standard formula. Furthermore, proposals are made to clarify the legal provisions on noncompliance with the Minimum Capital Requirement.
Reporting and disclosure
The advice proposes changes to the frequency of the Regular Supervisory Report to supervisors in order to ensure that the reporting is proportionate and supports risk-based supervision. Suggestions are made to streamline and clarify the expected content of the Regular Supervisory Report with the aim to support insurance undertakings in fulfilling their reporting task avoiding overlaps between different reporting requirements and to ensure a level playing field. Some reporting items are proposed for deletion because the information is also available through other sources. The advice includes a review of the reporting templates for insurance groups that takes into account earlier EIOPA proposals on the templates of solo undertakings and group specificities.
EIOPA proposes an auditing requirement for balance sheet at group level in order to improve the reliability and comparability of the disclosed information. It is also suggested to delete the requirement to translate the summary of that report.
EIOPA has reviewed the rules for exempting insurance undertakings from the Solvency II Directive, in particular the thresholds on the size of insurance business. As a result, EIOPA proposes to maintain the general approach to exemptions but to reinforce proportionality across the three pillars of the Solvency II Directive.
Regarding thresholds EIOPA proposes to double the thresholds related to technical provisions and to allow Member States to increase the current threshold for premium income from the current amount of EUR 5 million to up to EUR 25 million.
EIOPA had reviewed the simplified calculation of the standard formula and proposed improvements in 2018. In addition to that the advice includes proposals to simplify the calculation of the counterparty default risk module and for simplified approaches to immaterial risks. Proposals are made to improve the proportionality of the governance requirements for insurance and reinsurance undertakings, in particular on
- key functions (cumulation with operational functions, cumulation of key functions other than the internal audit, cumulation of key and AMSB function)
- own risk and solvency assessment (ORSA) (biennial report),
- written policies (review at least once every three years)
- and administrative, management and supervisory bodies (AMSB) ( evaluation shall include an assessment on the adequacy of the composition, effectiveness and internal governance of the administrative, management or supervisory body taking into account the nature, scale and complexity of the risks inherent in the undertaking’s business)
Proposals to improve the proportionality in reporting and disclosure of Solvency II framework were made by EIOPA in a separate consultation in July 2019.
EIOPA proposes a number of regulatory changes to address the current legal uncertainties regarding supervision of insurance groups under the Solvency II Directive. This is a welcomed opportunity as the regulatory framework for groups was not very specific in many cases while in others it relies on the mutatis mutandis application of solo rules without much clarifications.
In particular, there are policy proposals to ensure that the
- definitions applicable to groups,
- scope of application of group supervision
- and supervision of intragroup transactions, including issues with third countries
Other proposals focus on the rules governing the calculation of group solvency, including own funds requirements as well as any interaction with the Financial Conglomerates Directive. The last section of the advice focuses on the uncertainties related to the application of governance requirements at group level.
Freedom to provide services and freedom of establishment
EIOPA further provides suggestions in relation to cross border business, in particular to support efficient exchange of information among national supervisory authorities during the process of authorising insurance undertakings and in case of material changes in cross-border activities. It is further recommended to enhance EIOPA’s role in the cooperation platforms that support the supervision of cross-border business.
EIOPA proposes to include the macroprudential perspective in the Solvency II Directive. Based on previous work, the advice develops a conceptual approach to systemic risk in insurance and then analyses the current existing tools in the Solvency II framework against the sources of systemic risk identified, concluding that there is the need for further improvements in the current framework.
Against this background, EIOPA proposes a comprehensive framework, covering the tools initially considered by the European Commission (improvements in Own Risk and Solvency Assessment and the prudent person principle, as well as the drafting of systemic risk and liquidity risk management plans), as well as other tools that EIOPA considers necessary to equip national supervisory authorities with sufficient powers to address the sources of systemic risk in insurance. Among the latter, EIOPA proposes to grant national supervisory authorities with the power
- to require a capital surcharge for systemic risk,
- to define soft concentration thresholds,
- to require pre-emptive recovery and resolution plans
- and to impose a temporarily freeze on redemption rights in exceptional circumstances.
Recovery and resolution
EIOPA calls for a minimum harmonised and comprehensive recovery and resolution framework for (re)insurers to deliver increased policyholder protection and financial stability in the European Union. Harmonisation of the existing frameworks and the definition of a common approach to the fundamental elements of recovery and resolution will avoid the current fragmented landscape and facilitate cross-border cooperation. In the advice, EIOPA focuses on the recovery measures including the request for pre-emptive recovery planning and early intervention measures. Subsequently, the advice covers all relevant aspects around the resolution process, such as
- the designation of a resolution authority,
- the resolution objectives,
- the need for resolution planning
- and for a wide range of resolution powers to be exercised in a proportionate way.
The last part of the advice is devoted to the triggers for
- early intervention,
- entry into recovery and into resolution.
Other topics of the review
The review of the ongoing appropriateness of the transitional provisions included in the Solvency II Directive did not result in a proposal for changes. With regard to the fit and proper requirements of the Solvency II Directive EIOPA proposes to clarify the position of national supervisory authorities on the ongoing supervision of propriety of board members and that they should have effective powers in case qualifying shareholders are not proper. Further advice is provided in order to increase the efficiency and intensity of propriety assessments in complex cross-border cases by providing the possibility of joint assessment and use of EIOPA’s powers to assist where supervisors cannot reach a common view.
The global and European economic outlook has deteriorated in the past months with weakening industrial production and business sentiment and ongoing uncertainties about trade disputes and Brexit. In particular, the “low for long” risk has resurfaced in the EU, as interest rates reached record lows in August 2019 and an increasing number of countries move into negative yield territory for their sovereign bonds even at longer maturities in anticipation of a further round of monetary easing by central banks and a general flight to safety. Bond yields and swap rates have since slightly recovered again, but protracted low interest rates form the key risk for both insurers and pension funds and put pressure on both the capital position and long-term profitability. Large declines in interest rates can also create further incentives for insurers and pension funds to search for yield, which could add to the build-up of vulnerabilities in the financial sector if not properly managed.
Despite the challenging environment, the European insurance sector remains overall well capitalized with a median SCR ratio of 212% as of Q2 2019. However, a slight deterioration could be observed for life insurers in the first half of 2019 and the low interest rate environment is expected to put further pressures on the capital positions of life insurers in the second half of 2019. At the same time, profitability improved in the first half of 2019, mainly due to valuation gains in the equity and bond portfolios of insurers. Nevertheless, the low yield environment is expected to put additional strains on the medium to long term profitability of insurers as higher yielding bonds will have to be replaced by lower yielding bonds, which may make it increasingly difficult for insurers to make investment returns in excess of guaranteed returns issued in the past, which are still prevalent in many countries.
THE EUROPEAN INSURANCE SECTOR
The challenging macroeconomic environment is leading insurance undertakings to further adapt their business models. In order to address the challenges associated with the low yield environment and improve profitability, life insurers are lowering guaranteed rates in traditional products and are increasingly focusing on unit-linked products. On the investment side, insurers are slowly moving towards more alternative investments and illiquid assets, such as unlisted equity, mortgages & loans, infrastructure and property. For non-life insurers, the challenge is mostly focused on managing increasing losses stemming from climate-related risks and cyber events, which may not be adequately reflected in risk models based on historical data, and continued competitive pressures.
Despite the challenging environment, the European insurance sector overall gross written premiums slightly grew by 1.6% on an annual basis in Q2 2019. This growth is particularly driven by the increase in non life GWP (3.7%), in comparison to a slightly decrease in life (-0.5%). This reduction growth rate in life GWP is associated to the slowdown in the economic growth; however this does not seem to have affected the growth of non-life GWP to the same extent. Overall GWP as a percentage of GDP slightly increased from 9% to 11% for the European insurance market, likewise total assets as a share of GDP improved from 70% to 74%. The share of unit-linked business has slightly declined notwithstanding the growth expectations. Even though insurers are increasingly trying to shift towards unit-linked business in the current low yield environment, the total share of unit-linked business in life GWP has slightly decreased from 42% in Q2 2018 to 40% in Q2 2019, likewise the share for the median insurance company declined from 34% in Q2 2018 to 31% in Q2 2019. Considerable differences remain across countries, with some countries still being plagued by low trust due to misselling issues in the past. Overall, the trend towards unit-lead business means that investment risks are increasingly transferred to policyholders with potential reputational risks to the insurance sector in case investment returns turn out lower than anticipated.
The liquid asset ratio slightly deteriorated in the first half of 2019. The median value for liquid asset increased by 1.5% from 63.3% in 2018 Q2 to 64.8% in 2018 Q4, and after slightly decreased to 63.8% in Q2 2019. Furthermore, the distribution moved down (10th percentile reduced in the past year by 6 p.p. to 47.9%). Liquid assets are necessary in order to meet payment obligations when they are due. Furthermore, a potential increase in interest rate yields might directly impact the liquidity needs of insurers due to a significant increase in the lapse rate as policyholders might look for more attractive alternative investments.
Lapse rates in the life business remained stable slightly increased in the first half of 2019. The median value increased from 1.34% in Q2 2018 to 1.38% in Q2 2019. Moreover, a potential sudden reversal of risk premia and abruptly rising yields could trigger an increase in lapse rates and surrender ratios as policyholders might look for more attractive investments. Although several contractual and fiscal implications could limit the impact of lapses and surrenders in some countries, potential lapses by policyholders could add additional strains on insurers’ financial position once yields start increasing.
The return on investment has substantially declined further over 2018. The investment returns have significantly deteriorated for the main investment classes (bonds, equity and collective instruments). The median return on investment decreased to only 0.31% in 2018, compared to 2.83% in 2016 and 1.95% in 2017. In particular the four main investment options (government and corporate bonds, equity instruments and collective investment undertakings) – which approximately account for two-thirds of insurers’ total investment portfolios – have generated considerably lower or even negative returns in 2018. As a consequence, insurers may increasingly look for alternative investments, such as unlisted equities, mortgages and infrastructure to improve investment returns. This potential search for yield behaviour might differ per country and warrants close monitoring by supervisory authorities as insurers may suffer substantial losses on these more illiquid investments when markets turn sour.
Despite the challenging investment climate, overall insurer profitability improved in the first half of 2019. The median return on assets (ROA) increased from 0.24% in Q2 2018 to 0.32% in Q2 2019, whereas the median return on excess of assets over liabilities (used as a proxy of return on equity), increased from 2.8% in Q2 2018 to 4.9 % in Q2 2019. The improvement in overall profitability seems to stem mainly from valuation gains in the investment portolio of insurers driven by a strong rebound in equity prices and declining yields (and hence increasing values of bond holdings) throughout the first half of 2019, while profitability could be further supported by strong underwriting results and insurers’ continued focus on cost optimisation. However, decreased expected profits in future premiums (EPIFP) from 11% in Q1 2019 to 10.3% in Q2 2019 suggest expectations of deteriorating profitability looking ahead. Underwriting profitability remained stable and overall positive in the first half of 2019. The median Gross Combined Ratio for non-life business remained below 100% in the first half of 2019 across all lines of business, indicating that most EEA insurers were able to generate positive underwriting results (excluding profits from investments). However, significant outliers can still be observed across lines of business, in particular for credit and suretyship insurance, indicating that several insurers have experienced substantial underwriting losses in this line of business. Furthermore, concerns of underpricing and underreserving remain in the highly competitive motor insurance markets.
Solvency positions slightly deteriorated in the first half of 2019 and the low interest rate environment is expected to put further pressures on the capital positions in the second half of the year, especially for life insurers. Furthermore, the number of life insurance undertakings with SCR ratios below the 100% threshold increased in comparison with the previous year from 1 in Q2 2018 to 4 in Q2 2019 mainly due to the low interest rate environment, while the number of non-life insurance undertakings with SCR ratios below 100% threshold decreased from 9 in Q2 2018 to 7 in Q2 2019. The median SCR ratio for life insurers is still the highest compared to non-life insurers and composite undertakings. However, the SCR ratio differs substantially among countries.
The impact of the LTG and transitional measures varies considerably across insurers and countries. The long term guarantees (LTG) and transitional measures were introduced in the Solvency II Directive to ensure an appropriate treatment of insurance products that include long-term guarantees and facilitate a smooth transition of the new regime. These measures can have a significant impact on the SCR ratio by allowing insurance undertakings, among others, to apply a premium to the risk free interest rate used for discounting technical provions. The impact of applying these measures is highest in DE and the UK, where the distribution of SCR ratios is signicantly lower without LTG and transitional measures (Figure 2.16). While it is important to take the effect of LTG measures and transitional measures into account when comparing across insurers and countries, the LTG measures do provide a potential financial stability cushion by reducing overall volatility.
On October 15th 2019, EIOPA launched a public consultation on an Opinion that sets out technical advice for the 2020 review of Solvency II. The call for advice comprises 19 separate topics. Broadly speaking, these can be divided into three parts.
- The review of the LTG measures, where a number of different options are being consulted on, notably on extrapolation and on the volatility adjustment.
- The potential introduction of new regulatory tools in the Solvency II framework, notably on macro-prudential issues, recovery and resolution, and insurance guarantee schemes. These new regulatory tools are considered thoroughly in the consultation.
- Revisions to the existing Solvency II framework including in relation to
- freedom of services and establishment;
- reporting and disclosure;
- and the solvency capital requirement.
The main specific considerations and proposals of this consultation are as follows:
- Considerations to choose a later starting point for the extrapolation of risk-free interest rates for the euro or to change the extrapolation method to take into account market information beyond the starting point.
- Considerations to change the calculation of the volatility adjustment to risk-free interest rates, in particular to address overshooting effects and to reflect the illiquidity of insurance liabilities.
- The proposal to increase the calibration of the interest rate risk sub-module in line with empirical evidence, in particular the existence of negative interest rates. The proposal is consistent with the technical advice EIOPA provided on the Solvency Capital Requirement standard formula in 2018.
- The proposal to include macro-prudential tools in the Solvency II Directive.
- The proposal to establish a minimum harmonised and comprehensive recovery and resolution framework for insurance.
The European Supervisory Authorities (ESAs) published on the 4th October 2019 a Joint Opinion on the risks of money laundering and terrorist financing affecting the European Union’s financial sector. In this Joint Opinion, the ESAs identify and analyse current and emerging money laundering and terrorist financing (ML/ TF) risks to which the EU’s financial sector is exposed. In particular, the ESAs have identified that the main cross-cutting risks arise from
- the withdrawal of the United Kingdom (UK) from the EU,
- new technologies,
- virtual currencies,
- legislative divergence and divergent supervisory practices,
- weaknesses in internal controls,
- terrorist financing and de-risking;
in order to mitigate these risks, the ESAs have proposed a number of potential actions for the Competent Authorities.
Following its advice to the European Commission on the integration of sustainability risks in Solvency II and the Insurance Distribution Directive on April 2019, EIOPA has published on 30th September 2019 an Opinion on Sustainability within Solvency II, which addresses the integration of climate-related risks in Solvency II Pillar I requirements. EIOPA found no current evidence to support a change in the calibration of capital requirements for “green” or “brown” assets. In the opinion, EIOPA calls insurance and reinsurance undertakings to implement measures linked with climate change-related risks, especially in view of a substantial impact to their business strategy; in that respect, the importance of scenario analysis in the undertakings’ risk management is highlighted. To increase the European market and citizens’ resilience to climate change, undertakings are called to consider the impact of their underwriting practices on the environment. EIOPA also supports the development of new insurance products, adjustments in the design and pricing of the products and the engagement with public authorities, as part of the industry’s stewardship activity.
On the 15th July 2019 EIOPA submitted to the European Commission draft amendments to the Implementing technical standards (ITS) on reporting and the ITS on public disclosure. The proposed amendments are mainly intended to reflect the changes in the Solvency II Delegated Regulation by the Commission Delegated Regulation (EU) 2019/981 and the Commission Delegated Regulation 2018/1221 as regards the calculation of regulatory capital requirements for securitisations and simple, transparent and standardised securitisations held by insurance and reinsurance undertakings. A more detailed review of the reporting and disclosure requirements will be part of the 2020 review of Solvency II.
On 18th June 2019 the Commission Delegated Regulation (EU) 2019/981 amending the Solvency II Delegated Regulation with respect to the calculation of the SCR for standard formula users was published. The new regulation includes the majority of the changes proposed by EIOPA in its advice to the Commission in February 2018 with the exception of the proposed change regarding interest rate risk. Most of the changes are applicable since July 2019, although changes to the calculation of the loss-absorbing capacity of deferred taxes and non-life and health premium and reserve risk will apply from 1 January 2020.
QUALITATIVE RISK ASSESSMENT
EIOPA conducts twice a year a bottom-up survey among national supervisors to determine the key risks and challenges for the European insurance and pension fund sectors, based on their probability and potential impact.
The EIOPA qualitative Autumn 2019 Survey reveals that low interest rates remain the main risks for both the insurance and pension fund sectors. Equity risks also remain prevalent, ranking as the 3rd and 2nd biggest risk for the insurance and pension funds sectors respectively. The cyber risk category is now rank as the 2nd biggest risk for the insurance sector, as insurers need to adapt their business models to this new type of risk both from an operational risk perspective and an underwriting perspective. Geopolitical risks have become more significant for both markets, along with Macro risks, which continue to be present in the insurance and pension fund sectors, partially due to concerns over protectionism, trade tensions, debt sustainability, sudden increase in risk premia and uncertainty relating to the potential future post-Brexit landscape.
The survey further suggests that all the risks are expected to increase over the coming year. The increased risk of the low for long interest rate environment is in line with the observed market developments, particulary after the ECB’s announcement of renewed monetary easing in September 2019. The significant expected raise of cyber, property, equity, macro and geopolitical risks in the following year is also in line with the observed market developments, indicating increased geopolitical uncertainty, trade tensions, stretched valuations in equity and real estate markets and more frequent and sophisticated cyber attacks which could all potentially affect the financial position of insurers and pension funds. On the other hand, ALM risks and Credit risk for financials are expected to increase in the coming year, while in the last survey in Spring 2019 the expectations were following the opposite direction.
Although cyber risk is ranking as one of the top risks and expected to increase in the following year, many jurisdictions also see cyber-related insurance activities as a growth opportunity. The rapid pace of technological innovation and digitalisation is a challenge for the insurance market and insurers need to be able to adapt their business models to this challenging environment, nonetheless from a profitability perspective, increased digitalisation may offer significant cost-saving and revenue-increasing opportunities for insurance companies. The increase of awareness of cyber-risk and higher vulnerability to cyber threats among undertakings due to the increased adoption of digital technologies could drive a growth in cyber insurance underwriting.
The survey shows the exposure of an sudden correction of the risk premia significantly differs across EU countries. In the event of a sudden correction in the risk premia, insurance undertakings and pension funds with ample exposure to bonds and real estate, could suffer significant asset value variations that could lead to forced asset sales and potentially amplify the original shock to asset prices in less liquid markets. Some juridictions, however, confirm the limited exposure to this risk due to the low holding of fixed income instruments and well diversified portfolios.
The survey further indicates that national authorities expect the increase of investments in alternative asset classes and more illiquid assets. Conversely, holdings of governement bonds are expected to decrease in favour of corporate bonds within the next 12 months. Overall this might indicate potential search for yield behaviour and a shift towards more illiquid assets continues throughout numerous EU jurisdictions. Property investments – through for instance mortgages and infrastructure investment – are also expected to increase in some jurisdictions, for both insurers and pension funds. A potential downturn of real estate markets could therefore also affect the soundness of the insurance and pension fund sectors.
QUANTITATIVE RISK ASSESSMENT EUROPEAN INSURANCE SECTOR
This section further assesses the key risks and vulnerabilities for the European insurance sector identified in this report. A detailed breakdown of the investment portfolio and asset allocation is provided with a focus on specific country exposures and interconnectedness with the banking sector. The chapter also analyses in more detail the implications of the current low yield environment for insurers.
Insurance companies’ investments remain broadly stable, with a slight move towards less liquid investment. Government and corporate bonds continue to make up the majority of the investment portfolio, with only a slight movement towards more non-traditional investment instruments such as unlisted equity and mortgage and loans. Life insurers in particular rely on fixed-income assets, due to the importance of asset-liability matching of their long-term obligations. At the same time, the high shares of fixed-income investments could give rise to significant reinvestment risk in the current low yield environment, in case the maturing fixed-income securities can only be replaced by lower yielding fixed-income securities for the same credit quality.
The overall credit quality of the bond portfolio is broadly satisfactory, although slight changes are observed in 2018. The vast majority of bonds held by European insurers are investment grade, with most rated as CQS1 (AA). However, the share of CQS2 has increased in the first half of 2019, and significant differences can be observed for insurers across countries.
INTERCONNECTEDNESS BETWEEN INSURERS AND BANKS
The overall exposures towards the banking sector remain significant for insurers in certain countries, which could be one potential transmission channel in case of a sudden reassessment of risk premia. The interconnectedness between insurers and banks could intensify contagion across the financial system through common risk exposures. A potential sudden reassessment of risk premia may not only affect insurers directly, but also indirectly through exposures to the banking sector. This is also a potential transmission channel of emerging markets distress, as banks have on average larger exposures to emerging markets when compared to insurers.
Another channel of risk transmission could be through different types of bank instruments bundled together and credited by institutional investors such as insurers and pension funds.
Insurers’ exposures towards banks are heterogeneous across the EU/EEA countries, with different levels of home bias as well. Hence, countries with primary banks exposed to emerging markets or weak banking sectors could be impacted more in case of economic distress. On average, 15.95% of the EU/EEA insurers’ assets are issued by the banking sector through different types of instruments, mostly bank bonds.
Risk exposures for the European insurance sector remain overall stable.
Macro and market risks are now at a high level due to a further decline in swap rates and lower returns on investments in 2018 which put strain on those life insurers offering guaranteed rates. The low interest rate environment remains a key risk for the insurance sector.
Credit risks continue at medium level with broadly stable CDS spreads for government and corporate bonds.
Profitability and solvency risks increased due to lower return on investments for life insurers observed in year-end 2018 data; SCR ratios are above 100% for most undertakings in the sample even when excluding the impact of the transitional measures.
Market perceptions were marked by a performance of insurers’ stocks broadly in line with overall equity markets, while median CDS spreads have slightly increased. No change was observed in insurers’ external ratings and rating outlooks.
Macro risks are now at a high level. Since the April 2019 assessment, swap rates have further declined for all the currencies considered (EUR, GBP, CHF, USD). The indicator on credit-to-GDP gaps has deteriorated due to a more negative gap in the Euro area. Key policy rates remained unchanged and the rate of expansion of major central banks’ (CB) balance sheets is now close to zero. Recent monetary policy decisions suggest that some degree of monetary accomodation is still to be expected for the forseeable future.
Credit risks remained stable at medium level. Since the previous assessment, spreads have remained broadly stable for all corporate bond segments except financials (unsecured). The average credit quality of insurers’ investments remained broadly stable, corresponding to an S&P rating between AA and A, while the share of below investment grade assets remains limited.
Market risks are now at a high level. Volatility of the largest asset class, bonds, remained broadly stable compared to the January’s assessment, whereas equity market volatility spiked in June 2019. Newly available annual information shows a decline in the spread of investment returns over the guaranteed rates to negative values in 2018, mainly due to lower investment returns. The mismatch between the duration of assets and liabilities remained broadly stable in the same period.
Liquidity and funding risks remained stable at medium level. Liquidity indicators have remained broadly unchanged since the previous quarter, while funding indicators such as the average ratio of coupons to maturity and the average multiplier for catastrophe bond issuance increased.
Profitability and solvency risks remain at medium level but show an increasing trend. This is mainly due to newly available data on the return on investments for life solo undertakings, which was considerably lower in 2018 than in the preceding year. SCR ratios are above 100% for the majority of insurers in the sample even when excluding the impact of the transitional measures on technical provisions and interest rates. The proportion of Tier 1 capital in total own funds remains high across the whole distribution and the share of expected profit in future premiums in eligible own funds is below 15% for most undertakings in the sample.
Interlinkages and imbalances risks remained at medium level in Q1-2019. A minor increase is observed for exposures to banks, while the opposite is true for exposures to other financial institutions. An increase has been reported in the share of premiums ceded to reinsurers.
Insurance risks remained constant at a medium level. Median premium growth of life and non-life business remains positive and a reduction has been reported in insurance groups’ loss ratios and cat loss ratios.
Market perceptions remained constant at medium level. Insurance groups stocks’ performance was broadly in line with the overall market. Median insurers’ CDS spreads have increased, while external ratings have remained unchanged.
Regulation is only effective for as long as it remains relevant. While EIOPA is evolving into a supervisory-focused organisation, it pays close attention to how regulation is applied and how effective it remains, with a view to reinforcing cross-sectoral consistency and improving fairness and transparency and with a focus on better and smart regulation.
- SOLVENCY II REVIEW
Since the successful implementation of Solvency II Directive in 2016, EIOPA played an important role in monitoring its consistent implementation and during 2018 was able to provide valuable input into preparations for its review.
EIOPA provided advice to the European Commission on the review of the Solvency Capital Requirement based on an in-depth analysis of 29 different elements of the Standard Formula. The advice focused on increasing proportionality, removing unjustified constraints to financing the economy and removing technical inconsistencies.
EIOPA proposed further simplifications and reduced the burden to insurers by:
- Further simplifying calculations for a number of sub-modules of the Solvency Capital Requirement (SCR) such as natural, man-made and health catastrophes, in particular fire risk and mass accident;
- Simplifying the use of external credit ratings in the calculation of the SCR (an issue especially relevant for small insurers);
- Reducing the burden of the treatment of lookthrough to underlying investments;
- Developing simplifications in the assessment of lapse and counterparty default risks;
- Recommending the use of undertaking specific parameters for reinsurance stop-loss treaties.
Furthermore, one of the major technical inconsistencies found related to the calculation of interest rate risk, which did not capture very low or even negative interest rates. EIOPA recommended to adjust the methodology using a method already adopted by internal model users and, given the material impact on capital requirements, suggested to implement it gradually over three years.
EIOPA also carried out an analysis of the loss-absorbing capacity of deferred taxes practices. In face of the evidence of wide diversity, especially concerning the projection of future profits, EIOPA proposed a set of key principles that will ensure greater convergence and level playing field, while maintaining a certain degree of flexibility.
Finally, EIOPA analysed the treatment and the evidence available on unrated debt and unlisted equity and proposed criteria for a more granular treatment, namely with the use of financial ratios.
In some areas, the analysis of recent developments did not provide for sufficient reasons to change. This is, for example, the case of mortality and longevity risks and the cost of capital in the calculation of the risk margin. The evolution of financial markets does not justify a change in the cost of capital: the decrease in interest rates has not lead to a decrease in the cost of raising equity.
- REPORTING ON THE IMPLEMENTATION OF SOLVENCY II
In 2018, EIOPA published a number of reports related to different aspects of Solvency II.
- Report on group supervision and capital management
In response to a European Commission’s request for information, EIOPA submitted its Report on Group Supervision and Capital Management of (Re)Insurance Undertakings and specific topics related to Freedom to Provide Services (FoS) and Freedom of Establishment (FoE) under the Solvency II Directive. The report concluded that overall the Solvency II Group supervision regime was operating satisfactorily. The tools developed by EIOPA to further strengthen group supervision and supervision of cross-border issues contributed to further convergence of practices of NCAs’ supervisory practices.
The report also highlighted a number of gaps in the regulatory framework, including issues related to the application of Solvency II requirements for determining scope of insurance groups subject to Solvency II group supervision, the application of certain of these provisions governing the calculation of group solvency in particular where several methods are used, the definition and supervision of intra-group transactions, or the application of governance requirements at group level.
Further, EIOPA’s report emphasised that effective supervision of insurance groups will benefit from a harmonised approach on a number of areas, for example, early intervention, recovery and resolution and the assessment of group own funds.
- Second annual report on the use of capital addons under Solvency II
In December 2018, EIOPA published its second annual report on the use of capital add-ons by NCAs according to Article 52 of Solvency II. The objective was to contribute to a higher degree of supervisory convergence in the use of capital add-ons between supervisory authorities and to highlight any concerns regarding the capital add-ons framework. In general, the capital add-on appears to be a good and positive measure to adjust the Solvency Capital Requirement to the risks of the undertaking, when the application of other measures, for example the development of an internal model, is not adequate.
- Third annual report on the use of limitations and exemptions from reporting under Solvency II
This report, published in December 2018, addresses the proportionality principle on the reporting requirements, from which the limitations and exemptions on reporting – as foreseen in Article 35 of the Solvency II Directive – are just one of the existing proportionality tools. Reporting requirements also reflect a natural embedded proportionality and in addition, risk-based thresholds were included in the reporting Implementing Technical Standard (ITS).
- Third annual report on the use and impact of long-term guarantee measures and measures on equity risk
This is a regular report published in accordance with Article 77f(1) of the Solvency II Directive. This year’s report also included an analysis on risk management aspects in view of the specific requirements for LTG measures set out in Article 44 and 45 of the Directive as well as an analysis of detailed features and types of guarantees of products with long-term guarantees.
This report shows that – as in previous years – most of the measures, in particular the volatility adjustment and the transitional measures on technical provisions are widely used. The average Solvency Capital Requirement (SCR) ratio of undertakings using the voluntary measures is 231 % and would drop to 172 % if the measures were not applied. This confirms the importance of the measures for the financial position of (re)insurance undertakings.
- INVESTIGATING ILLIQUID LIABILITIES
The treatment of long-term insurance business remains a hotly debated issue. In particular, it has been discussed whether the risks of long-term insurance business and the associated investments backing those long-term insurance business are adequately reflected. The illiquidity characteristics of liabilities may contribute to the ability of insurers to mitigate short-term volatility by holding assets throughout the duration of the commitments, even in times of market stress.
To explore any new evidence on the features of liabilities, especially concerning their illiquidity characteristics, a dedicated EIOPA Project Group on illiquid liabilities was set up with the following main goals:
- To identify criteria of liquidity characteristics for the liabilities and measures for insurers’ ability to invest over the long term;
- To explore the link between the characteristics of liabilities and the management of insurers’ assets;
- To analyse whether the current treatment in the regulatory regime appropriately addresses the risks associated with the long-term nature of the insurance business.
Following a request for information from the European Commission on asset and liability management, EIOPA launched a request for feedback on illiquid liabilities in autumn and held a roundtable with interested stakeholders in December to discuss the submitted responses on illiquidity measurements and asset liability management practices.
- ANALYSIS OF THE INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) 17 INSURANCE CONTRACTS
Following the publication of International Financial Reporting Standards (IFRS) 17 Insurance Contracts by the International Accounting Standards Board (IASB), EIOPA assessed its potential effects on financial stability and the European public good, on product design, supply and demand of insurance contracts, and the practical implementation in light of the applicable inputs and processes for Solvency II.
EIOPA concluded that the introduction of IFRS 17 can be described as positive paradigm shift compared to its predecessor IFRS 4 Insurance Contracts, bringing increased transparency, comparability and additional insights on insures’ business models. EIOPA, however, noted a few reservations regarding concepts that may affect comparability and relevance of IFRS 17 financial statements.
EIOPA promotes greater transparency in the European pensions sector. In support of this aim, EIOPA is working to enhance the information available to consumers and supporting pension providers by making clear the expectations, justifications and decisions linked with the information they provide, in particular to prospective members, members and beneficiaries as laid out in Articles 38 – 44 of the EU Directive on the activities and supervision of institutions for occupational retirement provision (IORP II).
- REPORT ON THE PENSION BENEFIT STATEMENT: GUIDANCE AND PRINCIPLESBASED PRACTICES IMPLEMENTING IORP II
The report presents the outcomes of NCA exchanges of views and assessments of current practices for the implementation of the IORP II Pensions Benefit Statement (PBS) requirement. Based on this investigation, several principles have been identified that will facilitate clear understanding and comparability of statements.
Two proposals are now in further development: a basic PBS and an advanced PBS (containing more detailed information) to meet the PBS goals. These proposals will, as far as possible, take account of the behavioral approach principle be subject to further consumer testing.
- DECISION ON THE CROSS-BORDER COLLABORATION OF NCAS WITH RESPECT TO IORP II DIRECTIVE
This Decision, published in November 2018, replaces the former Budapest Protocol which had to be revised as a result of the new IORP II Directive. The Decision introduces new rules to improve the way occupational pension funds are governed, to enhance information transparency to pension savers and to clarify the procedures for carrying out cross-border transfers and activities.
The Decision also describes different situations and possibilities for NCAs to exchange information about cross-border activities in relation to the ‘fit and proper’ assessment and the outsourcing of key functions, both new provisions of the IORP II Directive in addition to the cross-border transfer.
PRESERVING FINANCIAL STABILITY
As part of EIOPA’s mandate to safeguard financial stability, EIOPA works to identify trends, potential risks and vulnerabilities that could have a negative effect on the pension and insurance sectors across Europe.
- 2018 INSURANCE STRESS TEST
EIOPA published the results of its stress test of the European insurance sector in December 2018. This exercise assessed the participating insurers’ resilience to the three severe but plausible scenarios: a yield curve up shock combined with lapse and provisions deficiency shocks; a yield curve down shock combined with longevity stress; and a series of natural catastrophes.
In total, 42 European (re)insurance groups participated representing a market coverage of around 75 % based on total consolidate assets. EIOPA published for the first time the post-stress estimation of the capital position (Solvency Capital Requirement ratio) of major EU (re)insurance groups.
Overall, the stress test confirmed the significant sensitivity to market shocks combined with specific shocks relevant for the European insurance sector. On aggregate, the sector is adequately capitalised to absorb the prescribed shocks. Participating groups demonstrated a high resilience to the series of natural catastrophes tested, showing the importance of the risk transfer mechanisms, namely reinsurance, in place.
An additional objective of this exercise, stemming from recommendations from the European Court of Auditors, was to increase transparency in order to reinforce market discipline by requesting the voluntary disclosure of a list of individual stress test indicators by the participating groups. Since EIOPA does not have the power to impose the disclosure of individual results, participating groups were asked for their voluntary consent to the publication of a list of individual stress test indicators. Only four of the 42 participating groups provided such consent.
- RISK DASHBOARD
EIOPA publishes a risk dashboard on a quarterly basis and a financial stability report twice a year. In the December 2018 report, EIOPA concluded:
- the persistent low yield environment remains challenging for insurers and pension funds;
- the risk of a sudden reassessment of risk premia has become more pronounced over recent months amid rising political and policy uncertainty;
- interconnectedness with banks and domestic sovereigns remains high for European insurers, making them susceptible to potential spillovers;
- some European insurers are significantly exposed in their investment portfolios to climate-related risks and real estate.
- FINANCIAL STABILITY REPORT
EIOPA published two reports on the financial stability of the insurance and occupational pensions sector in 2018.
In general the persistent low yield environment remains challenging for both the insurance and pension fund sector, which continues to put pressure on profitability and solvency. However, towards the end of the year, as noted in the December report, the risk of a sudden reassessment of risk premia became more pronounced. This is largely due to rising political uncertainty and trade tensions, concerns over debt sustainability and the gradual normalisation of monetary policy. In the short run a sudden increase in yields driven by rising risk premia could significantly affect the financial and solvency position of insurers and pension funds as the investment portfolios could suffer large losses only partly offset by lower liabilities. In this regard, the high degree of interconnectedness with banks and domestic sovereigns of insurers could lead to potential spillovers in case a sudden reassessment of risk premia materialise.
While overall the insurance sector remains adequately capitalised, profitability is under increased pressure in the current low yield environment. The Solvency Capital Requirement ratio for the median company is 225 % for life and 206 % for non-life insurance sector, although significant disparities remain across undertakings and countries.
In the European occupational pension fund sector, total assets increased for the euro area and cover ratios slightly improved. However, the current macroeconomic environment and ongoing low interest rates continue to pose significant challenges to the sector, with the weighted return on assets considerably down in 2017.
- ENHANCED INFORMATION AND STATISTICS
EIOPA continuously works to improve the availability and quality of available information and statistics on insurance and pensions.
- Solvency II information
For the insurance sector, EIOPA publishes high-quality insurance statistics at both solo and group level. The statistics are based on Solvency II information from regulatory reporting and their regular publication demonstrates EIOPA’s commitment to transparency. Over the past year, through the increased availability of Solvency II data EIOPA has been able to increase the coverage of its statistics. In June 2018, for the first time, the Authority published further insight into the assets of solo (re)insurance undertakings at country level.
- Decision on EIOPA’s regular information requests towards NCAs regarding provision of occupational pensions information
In April 2018, the Authority published its decision regarding the submission of occupational pension information. The decision defined a single framework for the reporting of occupational pension information that facilitates reporting processes. As a result, EIOPA will receive the information required to carry out appropriate monitoring and assessment of market developments, as well as in-depth economic analyses of the occupational pension market. The requirements were developed in close cooperation with the European Central Bank in order to minimise the burden on the industry and will apply as of 2019.
- Pensions information taxonomy
In November 2018, EIOPA published the eXtensible Business Reporting Language (XBRL) Taxonomy applicable for reporting of information on IORPs. It provides NCAs with the technical means for the submission to EIOPA of harmonised information of all pension funds in the European Economic Area. Developed in close collaboration with the European Central Bank (ECB), it allows for integrated technical templates and means to report via a single submission both the information required by EIOPA and the ECB.
In addition to regular financial stability tools, EIOPA undertooka number of additional activities in 2018 related to crisis prevention.
- Development of a macroprudential framework for insurance
With the aim of contributing to the overall debate on systemic risk and macroprudential policy, over the last year, EIOPA has published a series of reports that extend the debate to the insurance sector and, more specifically, the characteristics of that sector. These reports cover the following:
- Systemic risk and macroprudential policy in insurance;
- Solvency II tools with macroprudential impact; and
- Other potential macroprudential tools and measures to enhance the current framework.
As a next step, EIOPA will consult on concrete proposals to include macroprudential elements in the upcoming review of Solvency II.
- Analysis of the causes and early identification of failures and near misses in insurance
In July 2018, EIOPA published ‘Failures and near misses in insurance: Overview of the causes and early identification’ as the first in a series aimed at enhancing supervisory knowledge of the prevention and management of insurance failures. The report’s findings are based on information contained in EIOPA’s database of failures and near misses, covering the period from 1999 to 2016, including sample data of 180 affected insurance undertakings in 31 European countries.
The report focuses on an examination of the causes of failure in insurance, as well as the assessment of the reported early identification signals. It also examines the underlying concepts ‘failure’ and ‘near miss’ as well as providing further information on EIOPA’s database, established in 2014.
Data processing has historically been at the very core of the business of insurance undertakings, which is rooted strongly in data-led statistical analysis. Data has always been collected and processed to
- inform underwriting decisions,
- price policies,
- settle claims
- and prevent fraud.
There has long been a pursuit of more granular data-sets and predictive models, such that the relevance of Big Data Analytics (BDA) for the sector is no surprise.
In view of this, and as a follow-up of the Joint Committee of the European Supervisory Authorities (ESAs) cross-sectorial report on the use of Big Data by financial institutions,1 the European Insurance and Occupational Pensions Authority (EIOPA) decided to launch a thematic review on the use of BDA specifically by insurance firms. The aim is to gather further empirical evidence on the benefits and risks arising from BDA. To keep the exercise proportionate, the focus was limited to motor and health insurance lines of business. The thematic review was officially launched during the summer of 2018.
A total of 222 insurance undertakings and intermediaries from 28 jurisdictions have participated in the thematic review. The input collected from insurance undertakings represents approximately 60% of the total gross written premiums (GWP) of the motor and health insurance lines of business in the respective national markets, and it includes input from both incumbents and start-ups. In addition, EIOPA has collected input from its Members and Observers, i.e. national competent authorities (NCAs) from the European Economic Area, and from two consumers associations.
The thematic review has revealed a strong trend towards increasingly data-driven business models throughout the insurance value chain in motor and health insurance:
- Traditional data sources such as demographic data or exposure data are increasingly combined (not replaced) with new sources like online media data or telematics data, providing greater granularity and frequency of information about consumer’s characteristics, behaviour and lifestyles. This enables the development of increasingly tailored products and services and more accurate risk assessments.
- The use of data outsourced from third-party data vendors and their corresponding algorithms used to calculate credit scores, driving scores, claims scores, etc. is relatively extended and this information can be used in technical models.
- BDA enables the development of new rating factors, leading to smaller risk pools and a larger number of them. Most rating factors have a causal link while others are perceived as being a proxy for other risk factors or wealth / price elasticity of demand.
- BDA tools such as such as artificial intelligence (AI) or machine learning (ML) are already actively used by 31% of firms, and another 24% are at a proof of concept stage. Models based on these tools are often cor-relational and not causative, and they are primarily used on pricing and underwriting and claims management.
- Cloud computing services, which reportedly represent a key enabler of agility and data analytics, are already used by 33% of insurance firms, with a further 32% saying they will be moving to the cloud over the next 3 years. Data security and consumer protection are key concerns of this outsourcing activity.
- Up take of usage-based insurance products will gradually continue in the following years, influenced by developments such as increasingly connected cars, health wearable devices or the introduction of 5G mobile technology. Roboadvisors and specially chatbots are also gaining momentum within consumer product and service journeys.
- There is no evidence as yet that an increasing granularity of risk assessments is causing exclusion issues for high-risk consumers, although firms expect the impact of BDA to increase in the years to come.
In view of the evidence gathered from the different stake-holders, EIOPA considers that there are many opportunities arising from BDA, both for the insurance industry as well as for consumers. However, and although insurance firms generally already have in place or are developing sound data governance arrangements, there are also risks arising from BDA that need to be further addressed in practice. Some of these risks are not new, but their significance is amplified in the context of BDA. This is particularly the case regarding ethical issues with the fairness of the use of BDA, as well as regarding the
- and explainability
of certain BDA tools such as AI and ML.
Going forward, in 2019 EIOPA’s InsurTech Task Force will conduct further work in these two key areas in collaboration with the industry, academia, consumer associations and other relevant stakeholders. The work being developed by the Joint Committee of the ESAs on AI as well as in other international fora will also be taken into account. EIOPA will also explore third-party data vendor issues, including transparency in the use of rating factors in the context of the EU-US insurance dialogue. Furthermore, EIOPA will develop guidelines on the use of cloud computing by insurance firms and will start a new workstream assessing new business models and ecosystems arising from InsurTech. EIOPA will also continue its on-going work in the area of cyber insurance and cyber security risks.
During the course of 2018, EIOPA carried out a European-wide stress test (ST) in accordance with Articles 21(2)(b) and 32 of Regulation (EU) 1094/2010 of 24 November 2010 of the European Parliament and of the Council (hereafter the ‘Regulation’).
The Recommendations contained in this document are issued in accordance with Article 21(2)(b) of the Regulation in order to address issues identified in the stress test.
EIOPA will support National Competent Authorities (NCAs) and undertakings through guidance and other measures if needed.
The 2018 Stress Test results showed that on aggregate the insurance sector is sufficiently capitalised to absorb the combination of shocks prescribed in the three scenarios. However, it also confirms the significant sensitivity to market shocks for the European insurance sector with Groups being vulnerable
- not only to low yields and longevity risk,
- but also to a sudden and abrupt reversal of risk premia, combined with an instantaneous shock to lapse rates and claims inflation.
The exercise further reveals potential transmission channels of the tested shocks to insurers’ balance sheets. For instance, in the YCU scenario the assumed claim inflation shock leads to a net increase in the liabilities of those Groups more exposed to non-life business through claims inflation. Finally, both the YCD and YCU scenario have similar negative impact on post-stress SCR ratios.
As outlined in the Executive Summary of the 2018 Insurance Stress Test Report, further analyses of the results are required by EIOPA and the NCAs to obtain a deeper understanding of the risks and vulnerabilities of the sector.
In order to follow-up on the main vulnerabilities, EIOPA is issuing the present Recommendations related to the 2018 stress test exercise.
NCAs should strengthen the supervision of the Groups identified as facing greater exposure to Yield Curve Up and/or Yield Curve Down scenarios. This affects, in particular, those Groups where transitional measures have a greater impact.
NCAs should carefully review and, where necessary, challenge the capital and risk management strategies of the affected Groups. In particular:
- NCAs should require Groups to clarify the impact of the stress test in terms of capital and risk management.
- For the affected Groups, stress test scenarios similar to YCU and YCD should be properly considered in the risk management framework, including the ORSAs.
- Review the risk appetite framework for the affected Groups.
NCAs should evaluate the potential management actions to be implemented by the affected Groups. In particular:
- NCAs should require Groups to indicate the range of actions based on the results of the stress testing.
- NCAs should assess if the actions identified are realistic in such stress scenarios.
- NCAs should consider any eventual second-round effects.
NCAs should further contribute to enhance the stress test process.
NCAs should enhance cooperation and information exchange with other relevant Authorities, such as the ECB/SSM or other national authorities, concerning the stress test results of the affected insurers which form part of a financial conglomerate.