Insurers' investment portfolios tend to suffer when shocks weaken capital markets. The knock-on effect on their capital adequacy makes it the credit factor most likely to be sensitive to crisis events. Given that geopolitical risk is still our top European risk, S&P Global Ratings developed a stress scenario to test the resiliency of the EMEA insurance sector to the risk that a regional war could spill over. The results highlight potential sources of vulnerability and risks within our credit ratings.

A potential escalation of regional wars in EMEA, especially in Ukraine and the Middle East, could have a prolonged effect on financial markets. Other possible events, such as renewed disruption of supply chains, could cause a resurgence of elevated inflation in Europe and beyond (see "Credit Conditions Europe Q4 2024: Turn In Credit Cycle Won't Be Plain Sailing," published on Sept. 25, 2024). EMEA insurers' balance sheets are exposed to both risks, which would not be without consequences.

Capital Adequacy Displays The Most Sensitivity To Our Scenario

Under our stress scenario, financial market risk, combined with inflation, presents the most significant and immediate risk to our ratings on insurers, primarily because it depresses capital adequacy. Events such as the onset of the pandemic and the 2008 financial crisis offer examples of how capital adequacy can be affected. Even when the event has a limited impact on insurance liabilities, and insurers have maintained prudent investment profiles, their investments suffer when capital markets are weaker. Therefore, we have focused on assessing the sensitivity of insurers' capital adequacy positions to movements in asset values, a potential deterioration in credit quality, and the revaluation of reserves. To analyze EMEA insurers' sensitivity to capital market shocks, we use the assumptions listed in table 1 (please see the appendix for additional details). Chart 1 illustrates how the differing impact of the stresses could shrink the surplus, or even create a deficiency against the level currently expected for the credit ratings.

Table 1

Chart 1

Of these, equity risk is most likely to be significant

Although we do not consider EMEA insurers to be overly exposed to equity markets, stock markets have historically been fairly sensitive to heightened geopolitical uncertainty. We cannot rule out the possibility of a rapid and severe drop in market value. Historically, stocks generally recover over time, but our scenario specifically assumes a prolonged erosion of values, and this proved to be the biggest risk for about 60% of the EMEA insurers we rate (see chart 2).

Chart 2

Balance sheets would also be affected by rising interest rates and widening spreads through the revaluation of fixed-income instruments and insurance liabilities. In our view, exposure among insurers is likely to vary; some insurers may be less sensitive to a rise in interest rates than others because of their approach to asset-liability management. Given that EMEA insurers typically invest in bonds that are high in credit quality, these investments may see a pull-to-par effect that benefits insurers. Life insurers, which tend to hold longer-dated instruments, would feel the benefit more slowly than non-life insurers.

Speculative-grade default and inflation are likely to be fairly manageable risks

EMEA insurers tend to hold fixed-income portfolios in which the average rating is in the 'A' or 'AA' categories. As a result, most rated insurers in the region are likely to have modest exposure to the risk of speculative-grade default.

We see excess inflation as largely a manageable risk. For non-life insurers, it could depress liability valuations that embed the expected inflation level in their reserving assumptions. Claims inflation often exceeds the consumer price index (CPI), but EMEA insurers have historically been able to adjust reserves accordingly. The impact would depend on how persistent the excess inflation proves to be, and the extent to which an insurer's core insurance products are exposed to inflation. We expect typical liability-related products, such as general liability or motor third-party liability, to be sensitive. This is based on nature of the cover and the time it takes to settle claims.

Surplus Capital Bolsters The Resilience Of EMEA Insurers

In aggregate, EMEA insurers' capital significantly exceeded that expected at the current rating level as of Dec. 31, 2023. We expect this to cushion the potential rating impact of a prolonged downturn. However, under our stress scenario, this aggregate capital surplus is likely to be almost fully consumed (see chart 3).

Chart 3

Our analysis shows that capital adequacy at 35% of companies could drop by one or more category, based on our model, in the first year of the stress (see chart 4). In our credit ratings, we take a forward-looking approach to our view of capital adequacy and would consider the current financial year, plus the next two financial years. Our assessment takes into account potential future earnings, top-line growth, investment risk appetite, and dividends, among other factors. We estimate that, in aggregate, our rated EMEA insurers may record net income of about €95 billion in a single year, which could help capital at insurers to recover.

Chart 4

About 10% Of Our Insurance Ratings In EMEA May Come Under Immediate Pressure

Nevertheless, we still see the sector as solid. The sensitivity to shocks of an insurer's capital adequacy is an important consideration in our ratings analysis--it is not the sole factor. Our methodology for rating insurers is a framework that is influenced by other qualitative factors beyond the result of our capital model. It also offers scope for analytical judgement, for instance, in the choice of the anchor (see "Insurers Rating Methodology," published on July 1, 2019). As events unfold, we may incorporate additional factors into our credit rating analysis that may mitigate the impact of observed stresses.

Risk mitigating factors include the effectiveness of any hedging programs and the insurer's ability to share losses with policyholders (more common in life insurance products). Our scenario analysis may not have fully captured these factors.

Management at some insurers may also be able to derisk their balance sheets and so release risk capital. For example, management could take out additional reinsurance, alter their asset allocations, or make strategic capital decisions that strengthen their balance sheets. In 2020, some insurers chose to reduce dividends or raise capital to mitigate the negative impact of COVID-19.

Insurance Remains Very Well Capitalized And Resilient

Although the scenario demonstrated potential vulnerabilities, which would erode the sector's aggregate capital and put our ratings on some insurers under pressure, we still view aggregate capital as robust. The sector's ratio of capital available against our capital requirements at the 99.5% confidence level is 191%; under the stresses we applied in our scenario, it would remain elevated at 166% (see chart 5). Our view of insurance ratings in EMEA remains stable because of the sector's conservative approach to asset allocation and advanced risk management, as well as its capital strength.

Chart 5

Appendix

In our scenario, we stress equity prices by an amount commensurate with the maximum drop in equity prices on European stock indexes during the COVID-19 crisis in 2020. Stock markets dropped by 20% in the year Russia invaded Ukraine (September 2021-September 2022). The stress applied is below the 40%-56% stress applied to listed equities at the 99.5% level in our capital model (see capital model criteria).

The drop in real estate prices in our scenario is smaller than the 16%-18% drop seen in 2008, in both the U.K. and U.S. It is at the low end of the 9%-24% shock applied to real estate investments at the 99.5% level in our capital model.

The stresses applied in our scenario to represent defaults and transitions on loans and bonds was informed by the defaults and transitions observed globally during the 2001 credit crisis and are broadly aligned with those assumed for category 2 bonds and loans (lasting one to five years) at the 99.5% level in our capital model. We do not explicitly capture transition risk in our capital model.

Interest rate and spread movements affect both the asset and liability valuations of an insurer. The stress in our scenario is lower than that applied for most of the relevant countries in EMEA at the 99.5% level in our capital model.

We assume excess inflation would affect the valuation of liability-related reserves and is applied over one year. We based the scale of the shock applied on the level reached in the eurozone for several months at the end of 2022. We do not apply an explicit inflation shock in our capital model.

Related Criteria

• Insurers Rating Methodology, July 1,2019
• Insurer Risk-Based Capital Adequacy—Methodology And Assumptions, Nov 15, 2023

Related Research

• European Insurance Outlook 2025: Holding Up Well, Nov. 21, 2024
• Credit Conditions Europe Q4 2024: Turn In Credit Cycle Won't Be Plain Sailing, Sept. 25, 2024