European insurers risk a severe double hit from combined widespread asset price corrections and a decline in risk free interest rates, the European Insurance and Occupational Pensions Authority has warned.
Publishing the latest issue of its Financial Stability report, EIOPA also said the industry would be hurt by continuation of the low-yield environment. Overall, downside risks to insurers had increased.
The regulator said: 'The analysis shows that certain asset prices might not correctly reflect underlying risks. A reversal of markets' perception of those risks could substantially decrease the value of assets held by insurers and pension funds.
'Low interest rates are prompting insurers to review and adapt their business models. EIPOA observes such new developments as reducing profit shares; setting-up specific reserve or additional technical provisions.
'The overall profitability of insurance companies is still relatively favourable but results remain pressurised.
'Because of the low-yield environment, there have been some tendencies towards [a yield search] to improve the overall profitability. For example, there has been infrastructure financing and shifts towards higher yield but lower quality bonds.'
The Financial Stability Report December 2014 also summarised the results of EIOPA's stress test for insurers 2014. It evaluated the key risks and vulnerabilities for the European insurance sector in a bid to strengthen supervision practices and risk management.
It noted that a potential risk premium reassessment would have a significant impact on the capitalisation of the insurance sector through a decrease of the assets values.
Additionally, the report found that the global reinsurance sector continued its robust growth with strong underwriting results and capital returns.
It stated that the dynamics of the catastrophe bonds’ issuance had been high, although the absolute volumes remain modest. According to EIOPA's qualitative assessment, in 2015 positive premium growth is anticipated for non-life insurers only.
EIOPA chair Gabriel Bernardino said: 'EIOPA continues to use the analytical tools to better capture systemic risks for insurers and pensions. Our financial stability analysis aims to help supervisors to strengthen their practices in particular with regard to the implementation of the upcoming risk-based Solvency II framework.
'This will allow insurers to keep their promises to policyholders and, thus, to increase confidence in the financial sector.'
He added that EIOPA's pension funds stress test would run next year and would be a good opportunity to gather important insights on the resilience and vulnerabilities of occupational pensions in the European Union.