On 8 June 2020 the European Systemic Risk Board (ESRB) wrote to Mr Gabriel Bernardino, Chairman of the European Insurance and Occupational Pensions Authority (EIOPA) regarding liquidity risk in the insurance sector in light of the COVID-19 pandemic.
The letter states that market (il)liquidity, with a particular focus on the implications for asset managers and insurers, is one of five priority areas for European authorities (including EIOPA) for safeguarding financial stability in the EU. While it is acknowledged that (re)insurers are less exposed to liquidity risks than banks, some (re)insurers could nevertheless be prone to liquidity risk due to the unprecedented shock of the pandemic, as parts of the sector may now be facing a number of concurrent cash flow issues. There is also the additional risk that some insurance products, such as unit-linked plans, allow investors to redeem funds at short notice, while the underlying assets can be relatively illiquid.
ESRB warns that crystallisation of liquidity risks in the insurance sector could affect financial stability in two main circumstances. First, insurers may be unable to meet their own liquidity needs due to, for example, margin calls on derivative positions. This may have knock-on effects on other parts of the financial system which are exposed to these insurers. Second, if insurers seek to meet liquidity needs by rapidly selling less liquid assets, this could result in ‘fire-sale dynamics’ and pose challenges to affected markets.
EIOPA published a statement on its website on 9 June 2020, indicating its support to the views expressed by ESRB in its letter. In the context of COVID-19, EIOPA has put in place a proportionate framework to enhance the information collected on liquidity risks. As at the date of EIOPA’s statement, there is no evidence of the materialisation of liquidity risks in the insurance sector. EIOPA also notes that as part of the Solvency II review, it has consulted on concrete proposals to reinforce the macro-prudential dimension of the Solvency II regime, including strengthening the tools available to supervisors to monitor liquidity risks. ESRB repeated its view, in the letter, that the Pillar II requirements in Solvency II need to be enhanced to enable supervisors to require (re)insurers with vulnerable liquidity profiles to hold a liquidity buffer. These proposals will be assessed in the coming months as the COVID-19 situation continues to evolve.
ESRB’s letter to EIOPA is available to view here.
If you would like to know more about the services which we are offering or have any queries in relation to the above, please contact our partners listed here or your usual contact at William Fry.
Contributed by Claire O’Connor
