EIOPA: European Insurance and Occupational Pensions Authority Results of its Second European insurance Stress Test

Frankfurt, 4 July, 2011 – The European Insurance and Occupational Pensions Authority (EIOPA) announced today the results of its second European insurance stress test. The exercise confirms that the insurance market in Europe covered by the stress test is robust.

Between March and May, EIOPA tested insurers’ ability to meet the future Solvency II Minimum Capital Requirements (MCR), the ultimate regulatory threshold, under a number of stress scenarios. The stress scenarios comprised market, credit and insurance-related risks. Simultaneously, EIOPA performed a supplementary test to evaluate sovereign bond exposures. EIOPA emphasises that the stress test is based on hypothetical and severe stress scenarios and is not a forecast of what is likely to happen.

The results of this stress test indicate that overall the European insurance market is well prepared for potential future shocks as tested in this exercise. However, data showed that approximately 10% (13) of the participating groups and companies do not meet the MCR under the adverse scenario. 8% (10) fail to meet the MCR in the inflation scenario.

Based on data as of 31 December 2010, the European insurers which participated in the stress test showed an aggregate solvency surplus of €425 billion before the stress test scenarios are applied. The aggregate surplus decreases to €275 billion (minus €150 billion) when the adverse scenario is applied and to €367 billion (minus €58 billion) in the inflation scenario.

The insurance groups and companies who did not meet the MCR 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 materialise.

At the aggregate level, EIOPA identifies 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.

Sovereign bond exposure was covered separately in a supplementary test. The results of the shock on sovereign bond yields show that approximately 5% (6) of the participating groups and companies would not meet the MCR. The aggregate surplus of €425 billion decreases to €392 billion (minus €33 billion) in this particular scenario.

While the exercise was completed by 221 insurance and reinsurance groups and companies, headquartered in the European Union, Iceland, Liechtenstein, Norway and Switzerland, the results reported are for 58 groups and 71 companies due to aggregation of the results of companies within groups. This represents approximately 60% of the overall European insurance market and is above EIOPA’s aim to include at least 50% of the insurance market of each country as measured by gross premium income.

EIOPA emphasises that it is important to consider that the stress test is based on a future regulatory system and is not necessarily indicative of any current solvency problems. It rather highlights an exposure to the hypothetical risks and must be understood in the light of the current status of Solvency II during the development of the fifth Quantitative Impact Study. Over the coming months, the National Supervisory Authorities will discuss the results of the stress test with individual insurers.

Stress Test

Under its regulation, EIOPA is required to initiate and coordinate Union-wide stress tests to assess the resilience of financial institutions. This stress test included three main scenarios: a baseline, an adverse and an inflation scenario. Risks relating to both the asset and liability sides of insurers’ balance sheets were included. These risks are: interest rate, equity market, real estate, spread, life and non-life.

Stress Test Scenarios

This stress test intends to replicate macroeconomic scenarios and aims to identify and quantify the impact of three different stress scenarios: baseline, adverse and inflation scenarios. The baseline scenario is defined as a severe stress while the adverse scenario includes an even more severe deterioration in the main macroeconomic variables. The inflation scenario assumes an increase in inflation, which forces central banks to rapidly increase interest rates.

Publication of Results

EIOPA publishes aggregate results for the whole market since the exercise is based on the future regulatory system Solvency II. This provides comparable and market-oriented results, depicting the impact of stress scenarios more realistically than under the current Solvency I regime. However, Solvency II has not yet been finalised and may in the end differ from the specifications used for the purpose of this stress test exercise.

Minimum and Solvency Capital Requirements

The Minimum Capital Requirement (MCR), which represents the minimum level below which the amount of financial resources should not fall, is defined as the potential amount of own funds that would be consumed by unexpected events whose probability of occurrence within a one year time frame is 15%. In order to ensure the smooth functioning of graduated supervisory intervention (often referred to as “the ladder of intervention”), the linear result produced by the MCR calculation is bounded between 25% and 45% of the SCR, subject to an absolute minimum.

These principles for SCR and MCR are applied at solo and group level, with the exception of the MCR, which only applies at solo entity level.

The Solvency Capital Requirement (SCR), which is the starting point for the adequacy of the quantitative requirements, is defined as the potential amount of own funds that would be consumed by unexpected large events whose probability of occurrence within a one year time frame is 0.5%. This definition based on a probability measure allows (and sometimes mandates) the replacement of all or part of the standard formula with an internal model, when this can be shown to be better able to fulfil the directive requirements in relation to an undertaking’s particular risk profile. EIOPA points out though that individual internal models have not been approved yet to calculate the capital requirements under Solvency II.

Sovereign Risk

Country-specific yield curve movements were defined on the basis of macroeconomic assumptions for EU-Member States, Norway, Iceland, Switzerland and Liechtenstein. The magnitude of the resulting adverse yield curve movements was calibrated to reflect the outlook per member state and would therefore affect the pricing of sovereign bond holdings in insurance undertakings’ assets.

The European Insurance and Occupational Pensions Authority (EIOPA) was established as a result of the reforms to the structure of supervision of the financial sector in the European Union. The reform was initiated by the European Commission, following the recommendations of a Committee of Wise Men, chaired by Mr. de Larosi�re, and supported by the European Council and Parliament.

EIOPA is part of the European System of Financial Supervision consisting of three European Supervisory Authorities, the National Supervisory Authorities and the European Systemic Risk Board. It is an independent advisory body to the European Parliament and the Council of the European Union.

EIOPA’s core responsibilities are to support the stability of the financial system, and transparency of markets and financial products, as well as the protection of insurance policyholders, pension scheme members and beneficiaries. This stress test has been conducted in corporation with Finma the Swiss Financial Market Supervisory Authority For more information visit https://eiopa.europa.eu.