The latest ECB’s financial stability report has a short but insightful section on the position of the EU insurance sector. While financial positions according to current (Solvency I) standards seem satisfactory, the ECB fears that “a persistent low-yield environment could become a major solvency risk in the medium term”. The planned introduction of the EU’s Solvency II directive in 2014 and the related prospective marking to market of liabilities in a majority of countries could make this issue more obvious.

“The most important risks to the overall solvency of the sector currently emanate from investment activity. Large euro area insurers continue to be highly exposed to government and corporate bond markets. This contrasts with a low aggregate exposure to equity, structured credit and commercial property.
The persistent low-yield environment is the most pressing problem for solvency in those jurisdictions where it coincides with a market-consistent approach to the treatment of insurance liabilities. Besides the impact through a reduced profitability that is independent of the accounting regime, the value of liabilities is higher in a low-yield environment, thus squeezing solvency through an additional channel. Although this is currently limited to a few euro area countries [where liabilities are marked to market], and thus not considered to be a major solvency risk for large euro area insurers on aggregate over the next six to 12 months, the liability effect will gain in importance on the eve of the introduction of the Solvency II regime. Therefore, a persistent low-yield environment could become a major solvency risk in the medium term…. In order to contain this medium-term risk, the EIOPA stress test 2011 was already conducted on the basis of Solvency II requirements. In this exercise, 10% of the participating institutions would have failed to fulfil Solvency II minimum capital requirements under the adverse scenario.”
N.B.: The introduction of Solvency II in Europe for insurance companies requires that: (1) assets should be marked to market, and liabilities be discounted at risk-free rates, possibly augmented by a liquidity premium, or a countercyclical premium in case of stressed financial market situations, and (2) insurers must hold loss-absorbing capital against the full range of risks on both their asset and liability side to withstand unexpected losses with a probability of 99.5% over a one-year horizon. Solvency II is scheduled to come into effect on 1 January 2014. (See also https://eiopa.europa.eu/activities/insurance/solvency-ii/index.html)
According to the ECB, “the aggregate financial situation of large euro area insurers is expected to remain stable over the next 6 to 12 months. The outlook, however, bears a high degree of heterogeneity across individual institutions and euro area countries, in line with the geographical fragmentation of markets.
The divergent developments in government bond yields and prevailing differences in accounting treatment across jurisdictions imply that the types of solvency risk the insurers are facing differ along the national borders…Most euro area jurisdictions do not currently treat insurance liabilities in a market-consistent way. Consequently, low yields on highly rated government bonds inflate assets, but do not impact [i.e. increase] the valuation of liabilities in these countries. A rise in yields on highly rated government bonds would therefore imply a significant decrease in the valuation of the assets, without any impact on the liabilities, thus decreasing solvency.”