2022 Midyear Europe Insurance Investment Outlook: Navigating Rough Waters


  • The insurance industry is well-positioned overall, with rising rates generally accretive to capital generation and inflation risk broadly contained.
  • We see a hard landing as a growing risk for insurers. Monetary policy errors or external shocks could triple-hit capital adequacy and dividend-paying capacity with a combination of policyholder lapses, mark-to-market losses on bond portfolios, and corporate downgrades.
  • In this environment, insurers have both the incentives and the flexibility to review their asset allocations. Judicious rotation from traded (and volatile) fixed income into private credit could help reduce rates sensitivity and profit and loss (P&L) volatility. Liability- and capital-aware global diversification of bond portfolios would shorten the tail of downgrade risk. Further allocations to real estate, infrastructure, and other real assets could offer a degree of protection from inflation while helping insurers to progress towards their environmental and sustainability goals.
  • Elevated tail risks and persistent volatility strengthen the case for active, conviction-driven portfolio management. The complexity of insurers’ balance sheets calls for tailored, deeply customized solutions, and ever-changing regulatory and ESG requirements set a high bar for asset managers seeking to be competent partners to European insurers.
2022 Midyear Europe Insurance Investment Outlook: Navigating Rough Waters

The past six months saw a war erupting in the heart of Europe, displacement of millions of refugees, stubbornly high Covid infection rates, and soaring inflation. Monetary authorities have been hitting the brakes, sending equity markets into bear territory. Viewed as somewhat of a tail-risk event at the start of the year, a downturn in the next two years now seems highly likely.

While clouds keep gathering on the horizon, we believe European insurers are well-prepared to weather the storm. Despite the lingering impact of Covid, supply-chain disruptions, and accelerating inflation, the industry remains well-capitalized, with additional Solvency II capital being created by rising rates. However, this is no time to be complacent. The new environment puts up for examination the received wisdoms of asset-liability duration-matching, portfolio stress-testing, and investment risk appetite. Evolving regulations, the ongoing climate emergency, and longer-term implications of the war in Ukraine call for revisions to insurers’ strategic asset allocations.

Navigating the rough waters of higher, more volatile rates and elevated uncertainty calls for an active, conviction-driven approach to investment management. Efficient harvesting of illiquidity, complexity, and geographic risk premia requires specialist skills and dedicated resources, which may justify further outsourcing of investment management. The complexity of insurance balance sheets sets a high bar for asset managers seeking to address their clients’ liquidity, capital, accounting, and environmental, social, and governance (ESG) requirements – and calls for deeply customized, bespoke solutions.

Inflation and rates scenarios

Central scenario: manageable risk. Life insurers generally see higher rates as a net positive in the longer term and consider inflation as a broadly well-contained threat.1 Life insurers typically run a negative asset-liability duration gap, with asset duration one to two years below that of liabilities, which positively impacts Solvency II capital in a rising rate environment.2 Most insurers feel confident about their asset-liability management (ALM), with under 5% of insurers identifying duration gap as their main market risk.3 From the accounting perspective, higher rates will gradually translate into higher earnings as new investments start to lock in more attractive yields.

Inflation is not necessarily a major threat for life insurers, either. A significant proportion of European life insurers’ liabilities come with nominal guarantees that will be more easily met in a high-rate environment. Liabilities with an explicit link to inflation – such as individual annuity and bulk annuity contracts in the UK and the Netherlands – are typically hedged with inflation-linked bonds or derivatives; indexation is often contractually capped at around 3%-5%. The impact of inflation shocks over 2021 was largely offset by rising nominal rates and investment returns.4 In their first-quarter 2022 market updates, major life insurers reported modest5 solvency impacts from year-to-date inflation and low sensitivities to future inflation shocks.

For non-life insurers and reinsurers, inflation could be a bigger concern.6 Claims inflation on long-tail liabilities is a risk that is hard to quantify and to hedge, especially for insurers who have historically seen their investment objectives as liquidity and capital preservation. Cost inflation is another source of concern: This risk is typically not hedged and cannot always be offset by pricing.

Reinsurers will have more flexibility in passing the rising costs on to their customers in a hard market;7 some general insurers – such as UK motor insurers8 – will be pressed to absorb the rising costs to maintain their market share.

Spotlight on Germany: higher rates and ZZR9

The accounting impact of higher rates is further exacerbated by local generally accepted accounting principles (GAAP) requirements. Many German insurers have been gradually realizing gains on their fixed income investments to cover their additional reserving requirements (Zinszusatzreserve, or ZZR). Rising rates would reduce the stock of unrealized gains;10 however, higher rates will also mean lower need for further ZZR funding.11

While the short-term accounting impact of rising rates will depend on the composition of a particular insurer’s balance sheet, in the longer term, we believe most insurers to benefit from higher investment yields. Lower unrealized gains also give insurers more flexibility in rebalancing their portfolios without creating significant P&L volatility.

Downside scenario: hard landing. The reassuring picture painted by insurers’ capital adequacy ratios and risk factor sensitivities may turn out to be misleading. The real threat for insurers is not the high-inflation environment per se, but a hard landing driven by mistakes in policymakers’ response. Aggressive rate hikes and sharp credit tightening, falling equity markets, and declining real incomes could drive up policy surrenders and squeeze new business pricing. This, in turn, would put pressure on insurers’ liquidity and turn them into forced sellers of higher-quality government and corporate bonds12 – just as yields are peaking and market liquidity is drying up. Average credit quality of insurers’ bond portfolios has been drifting downward since the first quarter of 2019.13 A recessionary wave of downgrades14 on insurers’ sizable holdings of BBB-rated debt could drive a sharp increase in capital requirements, compounded by a concurrent decrease in capital resources as spreads widen.15

Climate change and sustainability

Against the backdrop of growing regulatory concerns about greenwashing,16 the insurance industry continues to distil the best practices of climate risk and sustainability stress-testing, governance, measurement, and reporting into actionable standards.17 Industry regulators continue their attempts at quantifying the industry’s sensitivity to climate and energy risk, with the Bank of England releasing the results of its biennial climate scenario analysis exercise. Russia’s assault on Ukraine created a new sense of urgency for transiting away from fossil fuels in Europe.

Climate risk stress testing: the Bank of England’s climate stress test results. On 24 May 2022, the Bank of England published the results of the Climate Biennial Exploratory Scenario (CBES), exploring the financial risks posed by climate change for major UK insurers.18 The exercise quantifies the long-term impact of three climate transition scenarios (early action, late action, and no additional action) on life and general insurers’ assets and general insurers’ liabilities over a 30-year time horizon.

Investment losses19 are projected to range from 15% (under the no additional action scenario) to 8% (early action scenario), with losses mostly arising from exposures to mining, petrochemicals, and power generation.

Life insurers continue to think of climate transition as a threat, rather than an opportunity, for their investments. Participating insurers identified few concrete new investment opportunities arising from climate transition. Insurers’ plans for changes to industry exposures in their investments were modest (especially in comparison with participating banks), with a roughly 10% projected reduction in exposure to petroleum manufacturing and up to 5% reduction in exposures to other highly impacted sectors.

Acceleration of Europe’s energy transition. Russia’s assault on Ukraine has caused tremendous suffering, displaced millions, and spurred lasting changes in the global balance of powers. It has also thrown a sharp spotlight onto Europe’s reliance on Russian energy and strengthened the case for a more immediate – if painful – energy transition. This transition is likely to create investment opportunities for insurers.

On 8 March 2022, the European Commission published its plan to drastically reduce Russian gas imports by the end of 2022 and to reach complete independence from Russian fossil fuels before 2030. This will be achieved by diversifying gas suppliers, ramping up the production of wind and solar power, and improving energy efficiency.20 Acting on these plans would require new financing for pipelines, liquefied natural gas (LNG) storage facilities, and renewables infrastructure – with European insurers uniquely positioned to help meet these financing requirements.

Evolving regulations

In the first half of 2022, EIOPA continued with its ongoing review of the Solvency II Directive, including a call for firm-level stress-test result disclosures21 and final revision of guidelines on contract boundaries and valuation of technical provisions.22 On the national level, significant regulatory changes are underway in Italy and the UK.

Italy: New regulations for index-linked and unit-linked funds. On 11 March 2022, IVASS started a public consultation on regulations for index-linked and unit-linked (ILUL) products,23 potentially affecting over €200 billion of Italian insurers’ ILUL assets24 as well as assets managed for Italian policyholders outside Italy. Results are expected in summer 2022.

The new regime will introduce additional requirements for internal governance and compliance, valuation, and reporting on ILUL products, with a particular focus on demographic risk. In addition, it will overhaul ILUL asset investment restrictions, including counterparty and concentration limits for internally managed unit-linked funds.

The proposal risks inhibiting insurers’ ability to allocate ILUL assets to illiquid investments and to develop complex investment products for sophisticated retail investors. Existing internal unit-linked funds will need to be adapted to the new regulation within six months from its commencement, putting further pressure on insurers. Controversially, IVASS also aims for the regulation to apply to non-Italian insurers operating in Italy under the EU freedom of establishment and freedom to provide services.

The UK

Matching adjustment and risk margin review. On 28 April 2022, the UK Treasury unveiled a consultation paper detailing proposed changes to matching adjustment (MA) rules,25 a mechanism affecting over £300 billion of UK life insurers’ assets and generating over £80 billion in capital benefits as of year-end 2021.26

The proposal aims to increase the flexibility of matching adjustment portfolios by:

  • Broadening the scope of MA-eligible assets to include assets with uncertain redemption dates, such as callable bonds, commercial real estate lending, or middle-market loans
  • Extending the range of MA-eligible liabilities to include income protection products, with-profit annuities, and deferred annuities in with-profit funds
  • Lifting the cap on sub-investment-grade assets in MA-eligible portfolios to help insurers manage the impact of rating downgrades
  • Facilitating matching adjustment approvals, treatment of innovative assets, and matching adjustment breaches

Concurrently, the Prudential Regulation Authority (PRA) published a discussion paper on calculation of risk margin and fundamental spread, open until 21 July 2022.27 The reform aims to reduce capital requirements for the life insurance industry and ensure more stable balance sheets for matching-adjustment firms.

A broader range of MA-eligible investments will help insurers diversify their portfolios and deliver better risk-adjusted returns for policyholders and shareholders. The complexity of matching adjustment regulations means that insurers looking to complement their in-house matching adjustment investment capabilities with external expertise may do well to partner with asset managers that combine deep insurance expertise with structuring flexibility.

House of Lords Industry and Regulators Committee recommendations. On 6 April 2022, the UK House of Lords Industry and Regulators Committee published its recommendations to the UK Treasury on reforms to insurance and reinsurance regulations.28 The recommendations aim to boost the competitiveness of the UK insurance industry by leveraging the regulatory best practices of other jurisdictions, such as Bermuda and Singapore.

The Committee recommended:

  • Regular reviews of Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) rulebooks aimed at ensuring the competitiveness of the UK financial industry
  • Establishing competitiveness criteria for the PRA and the FCA, as well as appropriate performance measures
  • Promoting open and transparent communication with industry participants

The UK Treasury is due to introduce the Financial Services Bill, reflecting these recommendations, in the second half of 2022.

Investment implications: go private, get active?

How might insurers brace their portfolios against market turbulence and a potential hard landing?

Further diversification of core fixed income portfolios, including allocations to emerging market (EM) credit, could help insurers contain the potential impact of downgrades. Despite the challenging macro backdrop, EM corporate fundamentals are strong and can likely withstand a downcycle: net margins are stable, while leverage is the lowest it has been in 10 years.

Judicious replacement of traded fixed income with floating-rate illiquid credit, such as middle-market loans, commercial real estate debt, and infrastructure debt, could help insulate insurance balance sheets from excessive mark-to-market volatility, position for potential future rate hikes, and secure higher recoveries in the event of default. Real estate and infrastructure equity could offer a degree of protection from inflation over the longer term.

More than ever, high volatility and elevated uncertainty strengthen the case for active portfolio management.

For more investment insights, visit our 2022 Midyear Investment Outlook.


1 JPMorgan Europe Equity Research, 17 June 2022: Love Actuary #6: Feedback from our 9th European Insurance Conference - and thoughts on market volatility; Insurance Asset Risk, 15 June 2022: Inflation - simply transitory or a permanent headache on the horizon.
2 As evidenced by interest rate sensitivities reported in their 2021 Solvency and Financial Condition Reports (SFCRs).
3 See Figure 5.3 in EIOPA (22 June 2022) Financial Stability Report – June 2022
4 For instance, according to National Bank of Belgium (7 June 2022) Financial Stability Report 2022, over 2021 H1 inflation had an aggregate -10 percentage points negative impact on the average SCR ratio of Belgian insurers. Over the same period, median SCR ratio of Belgian insurers increased from 201% to 207% according to EIOPA Solo Quarterly Insurance Statistics.
5 Up to -5 percentage points from a base of 175%-225%.
6 Moody’s Investor Service, 25 April 2022. Risks of prolonged high inflation outweigh rate hike benefits.
7 Chubb Ltd., 27 April 2022. Q1 2022 Earnings Call – Edited Transcript.
8 The Press Association, 19 June 2022. Motor Insurers ‘Facing Challenges’ From Rising Costs and Supply Chain Issues.
9 Zinszusatzreserve (ZZR) is an additional premium reserve established for German insurers in 2011 to ensure that they can meet their long-term policyholder guarantees in the persistently low-rate environment.
10 S&P Global Ratings, 6 May 2022. German Insurers Brace For More Resiliency Tests In 2022-2023.
11 Münchener Rückversicherungs-Gesellschaft Aktiengesellschaft in München, 14 May 2022. Q1 2022 Results - Earnings Call Transcript.
12 See Table 36 in EIOPA’s 16 December 2019 Report on insurers’ asset and liability management in relation to the illiquidity of their liabilities for a comprehensive – if a bit dated – summary of European insurers’ asset divestment plans in the event of a liquidity stress.
13 See Figure A.2.6 in EIOPA’s Financial Stability Report December 2021, published 13 December 2021.
14 Moody’s forecasts a downgrade rate of around 6.0% for Baa rated debt over May 2022 to April 2023, compared with the long-term average global one-year downgrade of 4.2% for Baa rated corporates over 1970-2021.
15 See Exhibit 23 in Moody’s Investor Service’s April 2022 Monthly Default Report (published 16 May 2022) and Exhibit 33 in Moody’s Investor Service’s Annual Default Study: After a sharp decline in 2021, defaults will rise modestly this year (published 8 February 2022).
16 City AM, 9 June 2022: UK’s financial watchdog vows to crack down on greenwashing; and IPE, 10 June 2022: BaFin to tackle greenwashing but guidelines on hold.
17 Banque de France, 18 February 2022: Climate change risk governance; and UNEPFI, April 2022: Insuring the net-zero transition: Evolving thinking and practices.
18 Bank of England, 24 May 2022. Results of the 2021 Climate Biennial Exploratory Scenario (CBES).
19 Defined as cumulative over the 30-year projection horizon in aggregate market value for both life and general insurers' invested assets, relative to a hypothetical counterfactual scenario in which there are no additional headwinds from climate risks.
21 EIOPA, 12 April 2022. Opinion to institutions of the European Union on individual disclosures in the context of EU-wide stress test exercises.
22 EIOPA, 21 April 2022. Final Reports on the revision of EIOPA Guidelines on Contract Boundaries and Guidelines on the Valuation of Technical Provisions.
23 IVASS, 11 March 2022. Consultation Paper No. 3/2022 -- Draft IVASS Regulation laying down provisions relating to the linked contracts (according to the art. 41, paragraphs 1 and 2, CAP).
24 EIOPA, Q4 2021. Insurance Statistics -- Solo Quarterly Balance Sheet.
25 HM Treasury, 28 April 2022. Solvency II Review: Consultation.
26 This can be compared to £116 billion overall capital requirement of the UK life insurance industry reported by the Bank of England, 20 October 2021. Summary slides from Solvency II meetings with firms Q4 2021.
27 Bank of England, 28 April 2022. DP2/22 – Potential Reforms to Risk Margin and Matching Adjustment within Solvency II.
28 UK House of Lords, 6 April 2022. Letter from Lord Hollick to Economic Secretary John Glen MP on commercial insurance and reinsurance regulation.


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