2018 EIOPA Insurance Stress Test report

Executive Summary

  1. The 2018 insurance stress test is the fourth European-wide exercise initiated and coordinated by EIOPA. As in previous exercises, the main objective is to assess the resilience of the European insurance sector to specific adverse scenarios with potential negative implications for the stability of the European financial markets and the real economy. Hence, it cannot be considered as a pass-or-fail or capital exercise for the participating groups. In total 42 (re)insurance groups, representing a market coverage of around 75% based on total consolidated assets, participated. As this exercise is based on group level information, no country results are provided in the report.
  2. The exercise tests the impact of a prolonged low yield environment (Yield Curve Down – YCD – scenario) as well as of a sudden reversal of risk premia (Yield Curve Up – YCU – scenario), which are currently identified as key risks across financial sectors. In the YCD scenario, market shocks are complemented by a longevity shock. In the YCU scenario, market shocks are combined with an instantaneous shock to lapse rates and claims inflation. The market shocks prescribed in the YCD and YCU scenarios are severe but plausible and were developed in cooperation with the ESRB, based on past market observations. Additionally, a natural catastrophe (NC) scenario tests the resilience of insurers to a potential materialisation of a set of catastrophe losses over Europe.
  3. Groups were requested to calculate their post-stress financial position by applying the same models used for their regular Solvency II reporting. The use of LTG and transitional measures was taken into account and the impact of these measures had to be reported separately. Restrictions were prescribed in order to accommodate for the instantaneous nature of the shocks and the static balance sheet approach. In particular, the impact of the transitional measure on technical provisions was held constant in the post-stress situation and potential management actions to mitigate the impact of the scenarios were not allowed.
  4. The novelty of this year’s exercise is the assessment of the post-stress capital position of the participants, with an estimate of the post-stress Solvency Capital Requirement (SCR). Given the operational and methodological challenges related to the recalculation of the group SCR, participating groups were allowed to use approximations and simplifications as long as a fair reflection of the direction and magnitude of the impact was warranted.
  5. In the pre-stress (baseline) situation, participating groups have an aggregate assets over liabilities (AoL) ratio of 109.5% (the ratio ranges from 103.0% to 139.5% for participating groups). Overall, the participating groups are adequately capitalised with an aggregate baseline SCR ratio of 202.4%, indicating that they hold approximately twice as much capital than what is required by regulation.
  6. In the YCU scenario, the aggregate AoL ratio drops from 109.5% to 107.6%, corresponding to a drop of 32.2% in the excess of assets over liabilities (eAoL). Without the use of LTG and transitional measures the impact would be more severe, corresponding to a drop in AoL ratio to 105.1% (53.1% in the eAoL) with 3 groups reporting an AoL ratio below 100% (accounting for approximately 10% of total assets in the sample). The impact of the YCU scenario is driven by a significant drop in the value of assets (-12.8% for government bonds, -13.0% for corporate bonds and -38.5 % for equity holdings). Overall, the losses on the asset side outweigh the gains on the liability side. Technical Provisions (TP) decrease by 17.0%, attributed mainly to a decrease in life TP (-14.5%) due to the reduced portfolio (instantaneous lapse shock) and the increased discounting curve (upwards shock to the swap curves). However, an increase in TP was observed for those groups focusing mainly on non-life business. In this case, the impact of the claims inflation shock on the non-life portfolio leads to an increase in the TP, outweighing the beneficial effect of the increased discounting curve due to shorter-term liabilities.
  7. The capital position is materially affected in the YCU scenario, but the poststress aggregate SCR ratio remains at satisfactory levels of 145.2% corresponding to a drop of 57.2 percentage points. However, 6 groups report a post-stress SCR ratio below 100%. This is mainly driven by a significant decrease (-29.9%) in eligible own funds (EOF) following the shocks to the asset portfolio that are not fully compensated by the reduction of the TP, while the SCR decreases only slightly (-2.3%). LTG and transitional measures play a significant role in the post-stress capital position. Without the application of the transitional measures the aggregate SCR ratio drops by an additional 14.3 percentage points to 130.9%, while in case both LTG and transitional measures are removed, the SCR ratio drops to 86.6%, with 21 groups reporting a ratio below 100%. This finding confirms the importance of the aforementioned measures for limiting the impact of short-term market movements on the financial position of insurers, as expected by their design.
  8. In the YCD scenario, the aggregate AoL ratio decreases from 109.5% to 106.7%, corresponding to a drop in eAoL of 27.6%. Again, the impact is more severe without the use of LTG and transitional measures. The aggregate AoL ratio would drop to 104.8% in that case, corresponding to a decrease of 47.7% in eAoL, with 3 groups reporting an AoL ratio below 100% (accounting for approximately 10% of total assets in the sample). The impact of the YCD scenario can be mainly attributed to an increase in the TP on the liability side (+2.1%), driven by the increase of the life TP (+6.1%) due to the reduction of the discounting curve and the longevity shock. Total assets show a decrease (-0.8%) due to the drop in value of assets held for unit-linked contracts and equity holdings (-14.7%) which is partly offset by the increase in value of the fixed income assets (+3.1% government bonds and +2.3% corporate bonds). This scenario confirms that the European insurance industry is vulnerable to a prolonged low yield environment, also at group level.
  9. The aggregate SCR ratio in the YCD scenario drops by 64.9 percentage points, but remains at 137.4% after shock, although 7 participating groups report a ratio below 100%. The decrease in SCR ratio is driven by a material decrease in EOF (-23.5%) and a significant increase in SCR (+12.7%), both mainly due to higher technical provisions. The LTG and transitional measures partly absorb the negative impact of the prescribed shocks. Without the application of the transitional measures the SCR ratio drops to 124.1%, while excluding both LTG and transitional measures leads to an aggregate SCR ratio of 85.4%, with 20 participating groups reporting a ratio below 100%.
  10. In the NC scenario, participating groups report a drop of only 0.3 percentage points in the aggregate AoL ratio. The limited impact of the NC scenario on the participating groups is mainly due to the reinsurance treaties in place, with 55% of the losses transferred to reinsurers. The most affected participants are therefore reinsurers and those direct insurers largely involved in reinsurance activities. Furthermore, it should be noted that the losses are ceded to a limited number of counterparties, highlighting a potential concentration of risk. The high resilience of the groups to the series of natural catastrophes is confirmed by the limited decrease in aggregate eAoL (-2.7%). Without the LTG and transitional measures, the eAoL would decrease by 15.1% compared to the baseline.
  11. Overall, the stress test exercise confirms the significant sensitivity to market shocks for the European insurance sector. The groups seem to be vulnerable to not only low yields and longevity risk, but also to a sudden and abrupt reversal of risk premia combined with an instantaneous shock to lapse rates and claims inflation. The exercise further reveals potential transmission channels of the tested shocks to insurers’ balance sheets. For instance, in the YCU scenario the assumed inflation shock leads to a net increase in the liabilities of those groups more exposed to non-life business through claims inflation. Finally, both the YCD and YCU scenario have similar negative impact on post-stress SCR ratios.
  12. Further analysis of the results will be undertaken by EIOPA and by the National Competent Authorities (NCAs) to obtain a deeper understanding of the risks and vulnerabilities of the sector. Subsequently, EIOPA will issue recommendations on relevant aspects where appropriate. The responses received on the cyber risk questionnaire that are not part of this report, will be evaluated and discussed in future EIOPA publications.
  13. This exercise marks an important step in the reassessment of capital requirements under adverse scenarios and provides a valuable basis for continuous dialogue between group supervisors and the participating groups on the identified vulnerabilities. EIOPA is planning to further work on refining its stress test methodology in order to fully capture the complexity of the reassessment of capital requirements under adverse scenarios. EIOPA expects that participants use the acquired experience to foster their abilities to produce high quality data and to enhance their corresponding risk management capabilities. NCAs are expected to oversee and promote these improvements.

AoL without LTG Transition

SCR With and without LTC Transition

NC Reinsurance

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