European insurers could be vulnerable to long-lasting low interest rates, regulator warns

In its half-yearly financial stability report (40-page / 1.8MB PDF), the European Insurance and Occupational Pensions Authority (EIOPA) highlighted the "slightly decreasing trend" in capital reserves held by the EU's 20 largest insurance groups, however commented that the majority remained "well capitalised" according to the current regulatory regime.

The report also warned that the funding position of defined benefit pension schemes was becoming "increasingly grave", particularly in countries such as the UK and the Netherlands where these schemes were more common.

Basing its figures on the current Solvency I regulatory regime, EIOPA said that the 20 largest European insurance groups held on average double the minimum amount of capital reserves needed to meet their obligations. A new regulatory regime known as Solvency II, which sets out stronger risk management and capital requirements, is currently scheduled to come into force from 2013.

Life insurers and pension funds are particularly affected by long-term low interest rates as their obligations to policyholders will become more expensive where the underlying premiums or contributions do not earn sufficient interest. This can be an "even more significant" problem for life insurance companies and defined benefit pension schemes, the report said, as both of these products promise a guaranteed minimum rate of return to investors.

"Although there is a move by the sector to reduce or adjust the offering of guaranteed returns, many contracts cannot be renegotiated and the sector remains vulnerable to a prolonged period of low interest rates," the report explained.

Many insurers and pension funds also invest their underlying assets in government bonds as these are among the most stable investments. However high levels of government debt as a result of the economic crisis which began in 2008 has resulted in the yield, or return on investment, falling as a percentage of the price.

The political and economic climate continue to affect growth prospects in Europe, the report said, particularly uncertainty over the amount of government debt in the eurozone and the political situation in some EU countries. While the insurance sector, particularly larger insurers, would be able to cope with continuing low interest rates "for some time", this could change when combined with the "failure of governments to stabilise fiscal situations" or the effect of developments in Greece on the stability of the euro.

The reinsurance sector, where insurance companies buy up policies issued by another insurer as a means of risk management, experienced its "costliest year ever" in 2011 as a result of a large number of "very severe natural catastrophes", EIOPA said. However, reinsurers only experienced a "modest" capital reduction over the course of the year as a result of their high capital letters at the beginning of 2011. The report said that cost of reinsurance policy renewals in regions particularly affected by these losses during the first six months of 2012, but that "rates have gone up only modestly" overall due to the lack of major catastrophes in Europe and North America.

The European Commission recently announced that the date by which the new Solvency II requirements must be integrated into national legal systems would be delayed until June 2013, with the rules due to take effect from January 2014. The European Parliament's Economic and Monetary Affairs Committee (ECON) approved further compromise measures on the draft of the new rules in March, which will require a new version of the text to be produced. A plenary vote on this draft is due to take place at the European Parliament in September.