On 4 July 2011, the European Insurance and Occupational Pensions Authority (EIOPA) announced the results of the second Europe-wide stress test for the insurance sector which took place between March and the end of May this year. This test followed the completion of the first Europe-wide stress test in the insurance sector, the results of which were published in March 2010. EIOPA notes that the stress test is an important supervisory and risk management tool which is used as a test of “what if” scenarios to explore insurance companies vulnerabilities.
The purpose of the second stress test was aimed at obtaining information on the current vulnerability of the European insurance industry to adverse capital market developments, using the requirements of Solvency II as a gauge. In other words, the stress test assessed whether the European insurance industry can meet minimum capital requirements (the ultimate regulatory threshold under Solvency II) under a number of well defined stress scenarios. The stress scenarios comprised market, credit and insurance related risks.
The impact of three different stress scenarios or shocks were tested based on 2010 financial results:
- baseline scenario, defined as severe stress;
- adverse scenario, defined as a more severe market deterioration; and
- inflation stress which assumes an increase in inflation, forcing national supervisory authorities to rapidly increase interest rates.
The exercise was completed by 221 (re)insurance groups and companies in the European Union, EEA and Switzerland. 58 groups and 71 companies reported their results due to aggregation of the results within groups. This figure represents approximately 60% of the overall European insurance sector and surpasses EIOPA’s aim to include a minimum of 50% of insurance companies from each country as measured by gross premium income.
EIOPA commented that the results of the second stress test indicate that overall the European insurance sector is well prepared for potential future shocks as tested in the exercise. However, data showed that approximately 10% (13) of the participating groups and companies do not meet the minimum capital requirement under the adverse scenario, while 8% (10) fail to meet the minimum capital requirement in the inflation scenario. The results show that those insurance groups and companies who did not meet the minimum capital requirement threshold show a solvency deficit of €4.4 billion if the adverse scenario were to occur and €2.5 billion if the inflation scenario were to occur.
At an aggregate level, EIOPA identified the main drivers of the results as being adverse developments in equity prices, interest rates and sovereign debt markets. On the liability side, non-life risks are more critical, triggered by increased claims inflation and natural disasters.
EIOPA commented that it is important to consider that the stress test is based on a future regulatory system (Solvency II) and is not necessarily indicative of any current solvency problems. The results of the test should be seen as highlighting an exposure to the hypothetical risks and should be understood in light of the current status of Solvency II during the development of the fifth Quantitative Impact Study (QIS5).
In summary, EIOPA’s conclusion is that overall the European insurance industry remains robust in the occurrence of major shocks. Ninety per cent of those groups/companies tested continue to comply with the minimum capital requirements even in the most adverse scenario. The main vulnerabilities identified are adverse developments in yield curves and sovereign bond markets and a higher than expected rate of severe natural catastrophes combined with limited recourse to reinsurance facilities.
EIOPA intends continue to monitor the evolution of markets and the main vulnerabilities identified, while national supervisors will discuss the main findings of the stress test with the insurance groups and companies.