Forty-four per cent of EEA IORPs were using derivatives at the end of 2022, the European Insurance and Occupational Pensions Authority (EIOPA) has said.

The figures were published in the authority’s December 2023 Financial Stability Report, which explores the challenges the shifting macroeconomic landscape poses for insurers and pension funds.

In addition to covering key developments in the sectors, the report includes four topical focuses on specific areas of interest. These delve into topics ranging from the liquidity position of insurers and changes in their investment behaviours in the new macro environment to the impact of derivate margin calls on the liquidity position of occupational pension funds, due to the rapid rise of interest rates.

“Insurers and pension funds are affected by rising and more volatile interest rates as they use interest rate derivatives. Rising rates trigger calls for additional cash variation margin,” EIOPA explained.

“The events in the UK in 2022 illustrated the detrimental effect of sudden large collateral calls on pensions funds when rates suddenly spiked. The topical focus on variation margin and their funding shows that EEA IORPS received substantial margin calls when rates rose in the first three-quarters of 2022 and analyses which investments they sold in response.”

The analysis shows that IORPs had to pay substantial amounts of variation margin in the first three quarters. Derivative users liquidated substantial amounts of equity as well as investments in equity, bond and money market funds, resulting in net sales of approximately €151bn.

IORPs do not provide detailed reporting on derivatives to EIOPA, but anecdotical evidence suggests that the most frequently used instruments are interest rate derivatives to manage their duration mismatch and currency derivatives (FX) as they invest in foreign currencies while liabilities are denominated in their local one.

Overall, EIOPA said that 2022 brought seismic shifts in both the geopolitical and economic sphere, which have persisted in 2023. However, pension funds have tackled these well so far.

“A bright spot in all the uncertainty has been the robust solvency position of insurers and IORPS which allows them to absorb shocks…. The funding ratio of EEA Defined Benefit IORPs dropped slightly from 119 per cent to 118 per cent in 2022 followed by an upward move in the first two quarters of 2023,” EIOPA noted.

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