Europe’s insurance companies entered 2025 recovering from the spike in inflation and higher rates of the preceding years. They now face elevated volatility from geopolitical and US trade-policy uncertainties.
In portfolios, we see an emphasis on quality and diversification.
In regulation, insurers can begin to look forward to more flexibility.
From Gyrating Rates to Geopolitics
After more than a decade of suppressed interest rates, followed by a rapid move higher in response to the inflationary impact of the pandemic and the Russian invasion of Ukraine, European insurance companies entered 2025 anticipating a return to relative normality in the rates environment. Focus had returned to the familiar tasks of buying government bonds and interest rate swaps to reduce duration gaps and maintain improved solvency levels, while allocating to extended and alternative credit asset classes to sustain returns.
Normality did not last long, however. Economists have revised their US and global growth estimates lower as the new US administration first embarked on aggressive cuts to government spending and then unveiled an extraordinary set of tariffs on all its trading partners. Subsequent rollbacks, carveouts, negotiations and deadlines have softened the blow while maintaining the uncertainty.
At the same time, questions about the US security commitment in Europe have raised the prospect of significant fiscal stimulus in Europe, particularly in Germany, where the political consensus on spending has shifted dramatically. This could create structural investment opportunities in European markets, a convergence of European and US growth rates and, consequently, further convergence of US and European bond yields.
Diversifying Portfolios
While short-term volatility may offer selective opportunities, it is also likely to promote a cautious investment approach. We see insurers increasingly prioritizing higher credit quality and diversification within their portfolios, and our recent discussions indicate that this diversification is concentrated in two key areas:
- New issuers in traditional asset classes. Until recently, central bank support was taking a lot of the volatility out of investment grade corporate credit. As that policy support was removed, we saw insurers seeking value in other areas of the investment grade corporate market. One such area is the Private Placement market, which has seen significant allocations from US life insurance companies. With a market size exceeding $1tn and annual new issuance of approximately $100bn, Private Placements provide exposure not only to corporate issuers, but also to infrastructure and project finance, real estate credit tenant leases, and esoteric asset-backed structures—providing diversification alongside the Financials, Healthcare and Energy concentrations of the major corporate bond indices. The illiquidity and complexity of these transactions also offers some yield enhancement relative to publicly traded bonds.
- Risks traditionally held on bank balance sheets. Real estate debt is a key area of focus here. Insurers have primarily invested in commercial real estate debt in the past, but low default rates, above-average spreads and favourable capital charges under Solvency II are increasingly attracting them to residential real estate. Infrastructure debt, while long popular, has become relatively expensive, prompting greater interest in alternatives such as project finance deals and credit tenant leases, which offer meaningful yield pickup and longer durations. Meanwhile, banks’ dominance in short-duration consumer and corporate lending is being challenged by fintech companies offering solutions such as Buy-Now-Pay-Later and Point-of-Sale financing. We see insurers seeking out asset-backed structures delivering exposure to these loans, attracted by their contractual cash flows, ring-fenced collateral, short maturities, self-liquidating amortization, moderate Solvency Capital charges, and lack of correlation with traditional corporate bonds or direct lending.
More Regulatory Flexibility
The first quarter saw significant developments in the Solvency UK reforms and the comprehensive review of the European Union’s (EU) Solvency II framework.
In the UK, the spotlight is on the Matching Adjustment reform, which introduces greater flexibility by expanding the definition of “Highly Predictable” assets to encompass private debt, residential mortgage-backed securities (RMBS), collateralized loan obligations (CLOs), “Simple, Transparent & Standardised” asset-backed securities (STS-eligible ABS), while also allowing up to 10% of investments in sub-investment-grade assets.
The EU’s revised Solvency II framework is expected to be implemented locally by 2026, offering Member States a degree of flexibility. Key updates include relaxed eligibility criteria for Long-Term Equity Investments, potentially enabling substantial growth in private equity and infrastructure equity allocations; and a new Volatility Adjustment framework that takes duration-matching into account and seeks to better reflect the unique characteristics of government bonds issued by an insurer’s home country.
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