Summary of main issues and conclusions

Sovereign risk is currently the main source of concern for the financial stability of the European Insurance and Occupational Pension Sectors. The process towards sustainable debt levels for sovereigns, both in Europe and globally, will determine whether, and to what extent, these risks will materialise to impact adversely the financial situation of the sectors. EIOPA considers that the risks described in CEIOPS' second half-yearly report 2010 have not changed significantly, and that risks remain at high levels. The financial positions of the insurance and occupational pension funds have, however, improved slightly during the period under review, and the sectors have therefore built up additional loss absorbing capacity.

Insurance sector

In 2010, the European insurance business largely recovered from the financial market crisis. Premiums have started to increase again, however at a slower pace in life than in non-life business, while profits tended to be higher, albeit at a still modest level. The combined ratio of premiums over claims and operating expenses (all net) came down slightly, and the recovery of asset values helped to improve the solvency positions of insurance undertakings. As such, insurance undertakings' solvency margins have again built up shock absorption capacity for future stress events.

Following up on the last report's risk perception, EIOPA has analysed the sector's resilience to a possible, even if apparently less likely, longer-lasting low interest rate environment, towards which vigilance is warranted as it would affect the sector's ability to finance guaranteed returns. Overall, EIOPA believes that the sector is well suited to cope with these challenges, albeit at varying degrees. EIOPA has assessed the sector's exposure to sovereign risk with general reassuring, if diverging results.

A year of significant natural catastrophes, 2010 left the reinsurance industry with above average loss claims; however, the industry was still able to restore its balance sheets and accumulate capital. Despite a continuing trend of natural catastrophes in the first quarter of 2011, with two devastating earthquakes in New Zealand and Japan, there is still abundant reinsurance capacity which is meeting hesitant demand. The insurance industry as a whole faces several risks and challenges going forward, most of which are seen as still increasing. The prevalent ones are financial risks, in particular the risk of a longer period of low interest rates and the risks related to a downward correction in equity markets. A rapid increase in interest rates from their low levels may also be destabilising for life insurers. A prolonged period of economic recession would be particularly challenging for the underwriting performance. It is also acknowledged that the implementation of Solvency II will be an important medium-term challenge for the industry.

Pension Funds sector

Concentrated in importance in only a few Member States, the Sector of Institutions for Occupational Retirement Provisions (IORPs) is growing at a fast pace. There is a trend towards the area of defined contribution schemes, which leave sponsors less vulnerable to market downturns.

Preliminary data for 2010 provided by supervisors on a best effort basis, show that the recovery in the financial markets in the last two years has had a significant positive effect on the funding positions of IORPs, although they have not yet reached the levels of 2007 in some countries. While funding levels have improved, there still exists a great deal of uncertainty in the financial markets, and the current low interest rate environment also creates differing problems in the Defined Benefit (DB) and Defined Contribution (DC) sector. The impact of the financial turmoil on the European occupational pension system had not been as severe as seen in other financial sectors, as the long-term nature of the liabilities affords some protection in this respect, and IORPs had not experienced the liquidity problems seen elsewhere. However the crisis hit pension funds primarily in their role as institutional investors and had a significant impact on consumer confidence.

The funding ratios of the DB occupational pension fund sector are improving, but remain below the levels observed in 2007. In many countries the funding conditions were strengthened quite substantially thus not requiring the need of substantial increases in contributions or to cut benefits. In others, some pension funds needed to increase the capital/contributions required from sponsors or to extend funding periods taking account of the underlying economic conditions. The financial turmoil directly affected the portfolio of DC members, with the greatest impact being on those close to retirement and/or heavily invested in equities. However, almost all DC systems are relatively young, so the numbers of older workers affected is small in absolute as well as in relative (to DB schemes) terms. For those further from retirement age, there is the potential for markets to recover and the recovery of equity markets in the last year has partially offset the losses experienced previously.

In response to the crisis, supervisory authorities focused on the flexibilities within the current framework facilitated by the IORP Directive and the different security mechanisms available. No major changes in the supervisory approaches have been reported or are expected. However some EU governments have started to consider how to improve the management of IORPs and to reduce risks affecting members. In DC systems, a careful plan design, such as suitable default and life-cycle options, and the promotion of financial education initiatives are increasingly considered to be crucial in order to empower people to minimise effects of financial downturns, as well as being able to make sensible and informed choices regarding their pension provisions in the future.

Full report