The headlines following the release of the latest European insurance stress test results on 30 November made depressing reading. However, the actual position is somewhat more positive.
The exercise addressed both adverse market and insurance industry scenarios. A separate exercise was also conducted, looking at the impact on life insurers who are most affected by the low interest rate environment of either an elongated period of low, or of a sudden reversal in, interest rates.
Few headlines picked up on EIOPA’s first bullet in its own press release – that the insurance sector is in general sufficiently capitalized in Solvency II terms.
Instead they quoted that 14% of companies could not cover their solvency capital requirement (SCR) at the end of 2013.
It is worth noting that the level of participation varied significantly across insurance markets (the three largest insurance markets - UK, Germany and France – were able to achieve in the order of 50 – 60% coverage with few participants, whereas some of the smaller European insurance markets had coverage of nearer 100%). This means that the overall statistics can present a distorted picture and explains why these 14% of companies only account for 3% of assets.
In addition, the exercise only tested the standard formula calibration of the SCR. With around 175 full or partial internal models being applied for across Europe, which is likely to include many of the participants, this number could have been significantly lower had firms been permitted to use their own Solvency II SCR basis. This is likely to be the case for the only Top 30 European insurers that was unable to meet its SCR. For the rest of the Top 30, over 60% had a baseline result showing coverage in excess of 150% of SCR.
The insurance scenarios tested were extreme, but on average, none of these reduced capital levels by more than 10%.
The market stress results were distorted by the simplifying approach of not recalculating the SCR post stress (which would happen in reality) and a significant number of the smaller firms participating not making use of the long-term guarantees (LTG) measures that would be available to them. The true position in such extreme events would therefore be stronger than the results reveal.
Unsurprisingly, insurers are most exposed to a combination of both asset values decreases and low interest rates. However, even under such extreme conditions and without the mitigants available to them, while there was a significant reduction in the SCR ratio, policyholder liabilities would still be covered.
The impact of the low yield environment has been recognized as a concern for some time. However, while the results reconfirm this, while a significant proportion of firms would fail to meet their SCR (24% under the continuation scenario and 20% under the sudden reversal scenario) they also show that it would take around a decade of low interest rates before some insurers could become potentially unable to meet all policyholder payments.
This would allow time for most insurers to respond to the new norm and develop action plans to reduce any customer detriment.
Insurers should consider the potential impact on their own businesses. This will include the extension of reverse stress testing to more fully consider the impact on their business model, policyholders and the wider economy, and to determine the mitigating actions that would be available. In some respects, a first step towards recovery plans.