What are the key themes to watch in 2022? The Economic and Financial Division of ING Bank has released its projections. Let’s run through their analysis.

1. Re-risking of portfolios amid market volatility and low interest rates
2. Resilience in the face of Covid-19 and post-crisis shocks
3. Sale of closed life books to continue
4. UFR to remain stable
5. Premiums and demand are set to grow
6. Climate change and sustainability are key topics
7. Solvency II framework to be amended

1. Re-risking of portfolios amid market volatility and low interest rates.

The ongoing environment of low rates has been weighing heavily on insurers’ profitability, especially life insurers, with guarantee products suffering the most. In portfolio allocation strategies, Economic and Financial Analysis 2 November 2021 Article insurance companies have to find a balance between higher returns on capital, lower solvency capital requirement (SCR) and longer duration.

In order to boost returns, insurers have been vocal about their ongoing shift towards higher risk and less liquid assets, while at the same time being conscious of the capital charges these investments attract.

The following alternative asses classes could be insurers’ top picks for the purpose of optimizing their investment portfolio :

• Mortgages – without attracting a penalising duration factor, these limited risk investments attract relatively low capital charges, providing insurers with an opportunity to invest in an amortising asset class with a natural interest rate hedge.
• Private placements – tailor-made products that match the exact needs of both issuer and investor are relatively low risk and can provide insurers with a perfect match for their portfolio on relatively attractive terms.
• Infrastructure debt – an asset class that is characterised by a very long duration, the favourable SCR treatment compensates investors for the absence of a secondary market with a hefty illiquidity premium, and it can also offer something of a sustainability factor.

2. Resilience in the face of Covid-19 and post-crisis shocks

The crisis had a minimal impact on the capitalisation of insurers, as the European Insurance and Occupational Pensions Authority (EIOPA) reported an average Solvency II ratio of 235% for the end of 2020, only seven percentage points lower than in 2019.

Going forward, with all the measures taken to combat the pandemic and ongoing vaccinations, ING expects the performance of the Life segment to improve. In Non-Life, we are going to see some catch-up over the coming months as demand will increase for non-Covid-19 related medical care which was postponed, but they believe that insurers have sufficient reserves to absorb that shock.

3. Sale of closed life books to continue

Insurance companies are dealing with numerous market challenges (such as low interest rates, Solvency II capital charges, an ever changing regulatory framework, etc) and are seeking to create value through both new business as well as through the optimisation of already existing books. Closed books can be managed in several different ways, be it through internal optimisation within the insurer, putting it in run down internally or outsourcing some lines of business to an external company, or completely offloading balance sheet exposure. In order to release capital and shift the focus onto new business, a lot of insurance companies have been vocal about their intention to sell closed life books which pose a significant profitability challenge.

While the market for closed books in the US and the UK is booming, the activity in the EU has not yet reached the same levels. However, the number of deals in the market across Europe continues to grow, with the Dutch insurers playing an active role. In spring 2021, Allianz sold 90,000 policies to Monument Assurance Belgium NV. The latest to announce was Athora Belgium seeking to acquire closed life book of NN Insurance Belgium with €3.3bn of assets under management. The deal is expected to close in mid-2022.

4. UFR to remain stable

Changes to the Ultimate Forward Rate continue to have an impact of insurers’ Solvency II ratio. The UFR, being higher than rates observed in the financial markets, has a positive impact on insurers’ solvency position. For 2022, the UFR was fixed at 3.45%, reflecting the expected real rate and expected inflation. Despite the slight increase in rates in 2021, no upward revision to it is expected short term. Should the trend continue over the coming years, we could see a slight increase in the rate in the coming years. The annual change in the UFR is capped at 15bp, and therefore any upward revision would be limited.

5. Premiums and demand are set to grow

Higher claims during Covid-19 could lead to higher premiums. As such, a lot of them are planning to use built-up reserves to curb premium increases. Increased risk-awareness during the pandemic pushed demand for insurance products higher. We can expect to see growth in sales of life insurance policies, in particular. It is expected that this product will be used more widely, for instance as part of employee benefit packages.

6. Climate change and sustainability are key topics

Climate change is at the heart of the insurance sector for many reasons, having a profound impact on both the liability and the asset side of insurers’ balance sheets. The number of natural disasters has been steadily increasing over the last decades. Climate change has exposed vulnerabilities of P&C insurers and reinsurers in the wake of rising catastrophe claims through natural disasters’ impact on businesses (business interruptions) and homes (property damage and destruction).

One of the challenges of climate change is the systemic nature of the risk.

The interconnected nature of the world means that the consequences of natural catastrophes are spreading far and wide, and multiple claims can be submitted relating to one event, so called aggregation risk.

Insurers underwriting policy is always based off past claims experience, therefore it’s important for them to proactively re-evaluate the risks to be mirrored in their premiums. It is possible that new products will have to appear to reflect the complex nature of new risks, and insurers have to remain flexible in providing new underwriting solutions to maintain coverage ability.

Insurers are also taking active climate conscious actions by offering new innovative products to their customers. Be it a discount on motor insurance of electric vehicles or providing protection on wind and solar energy, insurers are participating in actions targeted at combatting climate change. The systemic nature of climate risk makes the need for global collaboration among insurers indispensable. Insurers need to study climate risks together to better understand them and provide customers with the best solutions.

The European Commission also disclosed that a review of the Solvency II framework will comprise a new requirement for a long-term climate change analysis as well as potential changes to the standard formula catastrophe risk module.

Another way in which climate change is increasingly important for insurers is the environmental impact of their investments.

Across Europe, insurers have over €10t invested in assets, and changes in their investment behavior can have a major impact on the market. As discussed above, insurers are looking to re-risk their portfolio, which is a perfect opportunity to take environmental considerations into account.

ESG-related infrastructure debt investment would be our top pick for insurers’ growing risk appetite, offering portfolio diversification, attractive return on capital, much needed duration and, at the same time, a positive environmental impact.

7. Solvency II framework to be amended

On 22 September 2021, the European Commission adopted a comprehensive review of Solvency II. The review is centered around two main areas. First, the revision of the Solvency II Directive (Directive 2009/138/EC) and a proposal to introduce a new Recovery and Resolution Directive, establishing proper resolution procedures. The aim of the review is to strengthen European insurers’ contributions to the financing of the recovery, with many aspects of the framework coming into focus. The Covid-19 crisis highlighted the vulnerabilities of insurers in an environment of prolonged low interest rates and also showed that there is room to further strengthen crisis management tools amid great economic and market shocks, which could potentially lead to instability in the whole financial sector. The revision is set to release as much as €90bn of funds to contribute to the post Covid-19 recovery. The Recovery and Resolution of insurers is set to be strengthened based on the experiences of the Bank Recovery and Resolution Directive (BRRD) and regulation for the recovery and resolution of central counterparties (CCPRRR) but will take into account the specific nature of risks in the insurance sector and the primary need to protect policyholders.

Source : Publication by Marina Le Blanc, Sector Strategist, Financials at ING.