Analysis on solvency

• Author: European Insurance and Occupational Pensions Authority (EU body or agency)
• Pages: 31-45

4. ANALYSIS ON SOLVENCY

The low yield environment aects directly the solvency

position of insurers typically through the balance sheet

channel, but also indirectly in alonger time horizon, i.e.

once the expectation of low for long is consolidated,

through the income channel. As the valuation of assets

and liabilities held by the European insurers are market

consistent as prescribed by The Solvency II Directive, the

decrease in yields leads to an increase in f‌ixed income as-

sets and in technical provisions evaluations. In addition,

the duration of the technical provisions is typically longer

than that of the f‌ixed income assets leading to anegative

duration gap, which makes the liabilities more sensitive to

interest rates changes. In other words, for insurers with

negative duration gap, in case of adrop in interest rates,

the increase in f‌ixed income assets does not compensate

for the increase in technical provisions when considering

interest rate sensitive assets alone. Life insurers are par-

ticularly more sensitive to the changes in interest rates

due to their longer liabilities. On the long time horizon,

if the generated income is no longer sucient to cover

guaranteed benef‌it s and policyhold ers’ prof‌it participa-

tion, insurers’ solvency might be at risk.

The Covid-19 shock added additional pressure on insur-

ers’ solvency ratios as the market consistent valuation of

assets and liabilities are sensitive to f‌inancial market vol-

atility, movements in bond yields and credit spreads and

might be negatively aected by bonds downgrades. Key

risk factors putting additional challenges due to the pan-

demic crisis are the negative and ultra-low interest rates

that seem to remain “low for long”11, potential downgrade

of bonds which could determine the need of portfolios

rebalancing, credit and spread risk as well as high market

volatility. The changes in interest rates lead to increases in

the valuations of the liabilities and an increase of their du-

rations that might impact the solvency position of insur-

ers. The extent to which the increases in liabilities exceeds

the changes in asset values drives areduction in solvency

ratios. The positive side is that previously to the pandemic

outbreak, insurance companie s were well capitalised and

some of them hedged and/or using derivatives to oset

the eects of further decline in interest rates.

11 See Chapter 1

4.1. IMPACT OF INTEREST RATES

ON EXCESS OF ASSETS OVER

LIABILITIES AND ASSETS OVER

LIABILITIES RATIOS

Analysing the evolution of the excess of assets over lia-

bilities (eAoL) (Figure 4.1) stemming from the balance

sheets of insurers gives agood indication of the changes

occurred since the end of 2018 when interest rates started

adownward trend. Since Q3 2018 when insurers held the

highest amount of eAoL, it has slightly decreased reach-

ing the end of 2017 level. However, in Q4 2019 the level

of eAoL increased reaching the maximum level since the

entry into force of the Solvency II regime. This increase in

Q4 2019 was driven by aslight increase in interest rates

and by the signif‌icant increase in eligible own funds in

France, due to the implementation of adecree issued

on December 2019, that allows integrating part of the

reserves for prof‌it sharing in the eligible own funds, as

surplus funds. The assets over liabilities ratio (AoL) has

deteriorated in the last quarters of 2019 in line with the

decrease in yields and reached approximately the level of

Q3 2016. This shows that even if the value of assets has

increased, it did not compensate for the increase on the

liabilities side. The increase in the risk free curve and the

high equity prices at the end of 2019 assisted insurers to

improve their excess of assets over liabilities in Q4 2019

when compared to previous quarters, notwithstanding

the prolonged low interest rate environment. After the

historical low interest rates registered in August 2019, the

AoL ratio reached in Q4 2019 the level of Q1 2017.

As mentioned above, life insurers are more prone to be af-

fected by the low yield environment. In Q3 2019, the AoL

ratio of life insurers dropped below the level of Q3 2016

(Figure 4.2), but signif‌icantly increased in Q4 2019 due to

the good macroeconomic conditions and to the legisla-

tive developments explained above. One could infer that

the overall decrease in AoL shown above for Q3 2017–Q3

2019 is thus driven by the life business of insurers.

IMPACT OF ULTRA LOW YIEL DS ON THE INSURANCE SEC TOR, INCLUDING FIRST EFF ECTS OF COVID CRISIS

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