European life insurers have become steadily more exposed to systemic risk since before the global financial crisis and remain closely linked to banks through common market shocks, according to new research from the Bank of England.
Solvency risk, the study noted, arises when a life insurer’s assets fall below a threshold proportion of its liabilities. Systemic risk is defined as the amount of extra capital an insurer would need if the wider European life sector were in distress.
Using market‑based stress scenarios, the research estimated how much capital the sample of large life insurers might need to withstand both firm‑specific shocks and sector‑wide turmoil.
Risk built up through low‑for‑long era
The study found that systemic risk across European life insurers has been rising since 2007, peaking around the global financial crisis, the eurozone sovereign debt crisis, and the COVID‑19 market shock in 2020. UK life groups also saw a spike during the 2022 gilt turmoil linked to leveraged liability‑driven investment strategies at pension funds.
From mid‑2023, sector‑wide systemic risk has trended down but remains “non‑trivial”, with significant differences between individual firms.
The authors linked much of the build‑up to the “low‑for‑long” interest rate period and quantitative easing, which compressed yields on traditional bond portfolios and pushed insurers into riskier and less liquid assets in search of return.
Since 2016, asset allocations have diversified away from predominantly fixed‑income holdings into alternatives, complicating asset‑liability management. "These non-core activities have altered the risk profile of the life insurance sector and may be beyond the purview of traditional solvency regulation," the authors said.
Capital and contagion in the life insurance sector
Despite different business models, the report found a strong common pattern in banks' and insurers' systemic risk -- a single factor explains around three-quarter of the variation in risk measures for the two sectors, and volatility "spillovers" between them intensify in periods of market stress. That suggests shocks which hit bank balance sheets are likely to affect large life insurers at the same time and vice versa.
The findings may feed into debates on whether capital frameworks for life insurers should include an explicit systemic buffer, more stringent stress testing or targeted tools for particularly interconnected firms, with possible implications for product design, investment risk appetite and reinsurance demand.
The Bank of England study concludes that life insurance regulation should incorporate a systemic element in capital assessments, and that supervisors need to account for the channels through which large insurers and banks can transmit volatility to each other in future crises.
"[T]here is a case for prudential regulation to consider adding a systemic component to capital adequacy that is linked to the life insurer's contribution to systemic risk," the authors said.
