The European Insurance and Occupational Pensions Authority (EIOPA) issued on 17 March 2020 a statement addressed to the EU insurance sector acknowledging the significant consequences for financial services that the Coronavirus/COVID 19 situation may cause and informing about the actions that should be taken by insurers and that will be taken by EIOPA to help insurers to curb the impact of CoronaVirus/COVID-19 on the insurance business and to guarantee the policyholders protection. These actions are focused on two main business aspects: Business continuity and solvency and capital position.
Insurance businesses in a low interest rate environment
The Supervisory Statement released by the European Insurance and Occupational Pensions Authority (EIOPA) on Wednesday, 18 March is a timely reminder of the potential negative side effects of low or negative interest rates on both life and non-life insurers.
EIOPA considers the current ultra-low interest rate environment to be one of the most important sources of systemic risk for insurers in the coming years. Low interest rates put pressure on the profitability of insurance companies, in particular life insurers with expensive policy guarantees to cover (for example, guaranteed annuity rates and guaranteed investment returns) and non-life insurers which rely heavily on investment returns to cover claims.
EIOPA concludes that the current low interest rate environment is significantly impacting the EU insurance sector in terms of asset allocation, reinvestment risk, profitability and solvency. Weak economic conditions suggest that interest rates are likely to remain low in the euro zone for some time.
As a result of the low interest rate environment, life insurers are changing their product strategy to focus more on products with no guarantees such as unit-linked products. This has been linked to a shift in strategy towards “integrated wealth management”, with life insurers offering a complete suite of pensions and other savings products, often with significant investment in the digitalisation of the customer interface. The other significant trend in recent years has been the sale of legacy businesses with expensive guarantees to consolidators.
What effect do low interest rates have on insurance companies?
Low interest rates have an impact on both the asset and liability side of an insurer’s balance sheet:
- Increase in the present value of the insurer’s liabilities
On the liability side, low interest rates lead to an increase in the present value of the insurer’s obligations, given that insurance liabilities are discounted using risk free rates. EIOPA considers that this increase in liabilities has not been offset by increases in the value of investments.
- Decrease in investment income
Declining interest rates will normally have positive effects on the value of existing fixed-income investments, but will also generally lead to a decrease in investment income, making it harder for an insurer to match outgo on claims and the cost of guarantees under pensions and other savings’ products.
- Acceptance of greater investment risk: the search for yield
The decrease in investment income has led some insurers to change their asset allocations towards higher-yielding but riskier and less liquid assets, for example infrastructure, loan portfolios, property and private equity as well as equities. Since the start of the last financial crisis, banks have tended to retreat from these investments, creating opportunities for insurers but competition and pricing has increased in recent years. In Q2 2019, insurers were buying more equities than government or corporate bonds. But perhaps the most surprising statistic is that in Q2 2019, insurers, in particular life insurers, bought approximately EUR 32 billion of government bonds with a negative yield.
- Increase in reinvestment risk of assets
An analysis of maturing bonds shows that the yields of the replacing bonds were on average significantly lower when compared to yields on the bonds they replaced. EIOPA estimates that the drop in the weighted average yield from a government bond portfolio would be 50% over the next 10 years. The drop is similar for corporate bonds.
- Impact of an economic downturn
If credit spreads rise due to a loss of confidence in the ability of borrowers to service their debt obligations, then the value of fixed-income portfolios held by insurers could fall. This may be offset through lower liability values if the risk free rate also increases. The fall in value of the fixed-income investments would however mean that yields would increase. A sharp increase in yields on fixed-income investments may also trigger an upsurge in lapses and surrenders by policyholders whose policies are not linked to fixed-income investments and who want to take advantage of higher yields available on fixed-income investments, leading to liquidity problems for insurers.
EIPOA’s recommendations to National Supervisory Authorities
EIOPA makes a number of recommendations to National Supervisory Authorities (NSAs) as follows:
- NSAs should intensify the monitoring and supervision of insurers with greater exposure to the low interest rate environment.
- NSAs should discuss with undertakings actions they could take to improve their financial resilience.
- NSAs and undertakings should pay special attention to pre-emptive recovery and resolution planning to reduce the likelihood and impact of insurance failures.
- NSAs should broaden the analysis of the low interest rate environment and also consider the potential build-up of systemic risk.
Medium to long-term actions
- NSAs should identify whether there are any tools or powers are missing from their current toolkit and request them from the relevant (national) authorities.
Authorities have a wide range of powers but they tend to be soft in nature (for example, the ability to require insurers to undertake scenario testing, intensifying monitoring, increasing reporting requirements and issuing recommendations and public statements). In fact, most tools are for identifying and monitoring risks – authorities are more limited when it comes to actual powers to manage risk.
On Saturday 14 March, Spain’s Official State Gazette published Royal Decree 463/2020 declaring the state of alarm for the management of the health crisis situation caused by COVID-19 (RDEA). Under this Royal Decree, Spain has adopted a series of extraordinary measures of great relevance and impact with a threefold objective: i) to protect the health and safety of citizens, ii) to control the spread of the disease, and iii) to strengthen the public health system.
Our Insurance and Reinsurance team in Madrid has analyzed the RDEA, paying special attention to those measures that directly or indirectly impact the Spanish insurance sector: (i) the possibility of keeping “insurance entities” open to the public, (ii) files with the Directorate-General for Insurance and Pension Funds, (iii) ongoing legal proceedings, and (iv) pending legal proceedings.
Our Insurance and Reinsurance team (like all teams in our Madrid office) is 100% operational and available to all our clients to continue providing advice that is necessary in these difficult times. The entire team is teleworking, as a sign of our commitment to the #YomeQuedoenCasa citizen movement. The document with our analysis is available here.
Our Asia insurance regulatory tracker for the third and fourth quarter of 2019 is attached.
The tracker covers a range of developments across the region, including China’s measures to further open up China’s insurance sector, the guidelines issued by the Hong Kong Insurance Authority in light of the regulatory regime for insurance intermediaries from September 2019, and updated cyber hygiene requirements for insurance brokers in Singapore.
After a dearth of decisions in the early months of the Disclosure Pilot, judges have begun lining up to add to the growing body of commentary on best practice for litigants.
Our overview of PD 51U’s (no-longer-new) rules can be found here.
While various judgments have covered a whole host of disclosure issues (e.g. the importance of the new Disclosure Guidance Hearing regime, the reiteration that Model E disclosure (the-artist-formerly-known-as Peruvian Guano) is truly exceptional), the focus of this article is on three recent High Court decisions which have provided helpful clarification in the following areas:
- Cooperation (McParland v Whitehead  EWHC 298 (Ch) (“McParland“)): parties who adopt an uncooperative approach and/or abuse the Disclosure Pilot process for tactical gain have been warned that they may face immediate adverse costs consequences.
- Confidentiality (SL Claimants v Tesco plc  EWHC 3315 (Ch) (“Tesco“)): given that the foundation of the Disclosure Pilot is the need to adopt a cooperative approach, the courts will – now more than ever – strive to find a delicate balance between ensuring proper disclosure while preserving the confidentiality of commercially sensitive information.
- Control, adverse inferences, and Model C issues; Pipia v BGEO Group  EWHC 402 (Comm) (“Pipia“)): a) re-affirmation of the principle that “control” for the purposes of CPR 31.8/PD 51U includes an “arrangement or understanding” (less than a legally enforceable right) which grants access to the relevant documents, b) an overview of circumstances in which adverse inferences will be drawn from failures to comply with disclosure obligations, and c) helpful commentary on the format and scope of Model C searches.
FCA’s Call for Input on Open Finance
Open Finance refers to the extension of open-banking-like data sharing and third-party access to a wider range of financial sectors and products, including in the insurance market.
The FCA highlighted in its recent market study on general insurance pricing practices (October 2019), that Open Finance and the increasing use of consumer data have the potential to transform how consumers use financial products.
With this in mind and following the development of Open Banking, the FCA has recently published a Call for Input to explore the opportunities and risks arising from Open Finance. See our recent blog for more details.
COVID-19 has already had a significant economic impact, which is likely to increase as Wuhan- and Italy-style lockdowns of large regions are implemented in other areas across the globe. While much has been said about large-scale flexible working, this will clearly not be possible for all businesses, and economic losses caused by disruptions including closure of premises, denial of access, supply-chain failures and utility supply issues are inevitable.
Businesses are likely to have varying levels of insurance in place – which ones are potentially responsive to losses caused by COVID-19 and related containment measures?
2020 looks set to be the “Year of the Insurance Customer” with regulators throughout Europe focusing on the customer experience.
Please join us at our forthcoming webinar as we consider the ways in which regulators across Europe have put the spotlight on customers including fair pricing and the so-called “loyalty penalty”, the treatment of vulnerable customers and those with pre-existing medical conditions, as well as open finance.
The Hogan Lovells’ Corporate Insurance Newsletter for February 2020 has been published. This provides a round-up of UK, EU and international regulatory developments relevant to UK based insurance market participants. In this issue, amongst other items, we cover:
- FCA’s paper on its Sector Views 2020 and the Lloyd’s Market Association’s 2020 priorities
- On Brexit – papers from the UK and EU on negotiation mandates and future relationship
- EIOPA has been busy – it has published papers on the insurance capital standard, the low interest rate environment, final guidelines on cloud service provider outsourcing, cyber underwriting, IBOR transitions and more…
Several high profile systems failures resulting in customers being unable to access their finances and an ever-increasing reliance on outsourcing key activities to group entities or third parties have unsurprisingly caught the regulators’ attention.
The PRA and FCA are consulting on proposed new rules on operational resilience. “Operational resilience” is defined as the ability of firms and the financial sector as a whole to prevent, adapt, respond to, recover and learn from operational disruptions.