Macroeconomic environment negative for reinsurers, positive for ILS: EIOPA

The European Insurance and Occupational Pensions Authority (EIOPA) has published its second half-year report for 2012 on the financial stability of the insurance, reinsurance and occupational pension sectors in the European Economic Area. The report says that the financial soundness of the insurance and reinsurance sector in Europe could face a ‘significantly negative outlook’ over the medium term due to macroeconomic and financial market fragility.

EIOPA said in the report that despite positive developments where the European Central Bank are trying to alleviate financial market issues in Europe, the risks to financial stability remain high. They remain concerned about the state of the global financial climate and the Eurozone crisis in particular and say that this is putting pressure on insurers and reinsurers.

For the insurance sector, while premium growth has been observed across the market, some insurers have done much better than others. Profitability remains relatively stable and Solvency I capital levels remain adequate and at comfortable levels. EIOPA said that this should not give rise to complacency though as under Solvency I regulators do not have a full picture of underlying market and credit risks to which insurers undertakings are exposed.

For the reinsurance sector, EIOPA said that profitability will likely remain under pressure due to excess capacity in the market as well as reduced demand for reinsurance services because of the weak global macroeconomic environment. Despite 2012 having a much lower catastrophe loss burden than 2011, EIOPA suggests reinsurers will not fare much better this year.

The low-interest rate and challenging investment environment means that reinsurers are under pressure to achieve rate increases and to improve underwriting results to compensate for loss of investment income. 2013 reinsurance renewals are expected to be stable or to have slight increases and EIOPA see’s it as crucial that reinsurers get risk-adequate prices at the January renewals.

Conversely, in the same report EIOPA highlights the insurance-linked security and catastrophe bond space as one which has benefitted from the global macroeconomic environment. The persistent low-interest rate environment and uncertainty in the capital markets has heightened investor demand for catastrophe bonds. This strong demand helps to keep pressure on cat bond premium rates meaning that issuance can become more cost-effective and thus more attractive for both new and repeat sponsors.

Of course the same macroeconomic factors are also helping to attract capital into the reinsurance space as well, both through traditional players and convergence or collateralised operations. That additional capital is a contributing factor to the hard-to-profit environment reinsurers are facing. So macroeconomic factors and global capital market uncertainty can be seen as negative for reinsurance and positive for cat bonds at the same time.

Of course the picture is much more complex than this simplistic view, but it is interesting how capital and markets affect different sides of the same reinsurance and risk transfer coin in contrasting ways.

Gabriel Bernardino, Chairman of EIOPA, said; “Despite all the positive developments in financial markets and concerted policy actions, risks to financial stability remain quite high. Maintaining a clear perspective on these risks is difficult in a Solvency I environment. In this context a clear and realistic timetable for the implementation of Solvency II would be a very serious contribution to the financial stability work in Europe”.

You can access the full report from EIOPA here.