EIOPA EU-wide Stress Testing Framework
The European Insurance and Occupational Pensions Authority (EIOPA) launched a European Union (EU) wide stress test for the European insurance sector on 24th May 2016. The exercise aimed to assess insurers’ vulnerabilities and EIOPA expressly noted that it should not be interpreted as a ‘pass-or-fail’ test. EIOPA noted that the stress test was designed to assess the resilience of the insurance sector in the EU to severe adverse market developments based on a common analytical framework. EIOPA further noted that stress tests represent one of a number of supervisory tools that can be used to help it assess this resilience, and to extract valid conclusions to support the stability of the financial system.
EIOPA Stress Testing Timeline
|13 April 2016||Workshop with industry participants|
|24 May 2016||Launch of an EU-wide Insurance Stress Test 2016|
|June 2016||Questions and Answers (weekly updates every Wednesday)|
|15 July 2016||Submission deadline for industry participants to the national supervisory authorities (NSAs)|
|August 2016||Collection and validation of undertakings’ data by the national supervisory authorities (NSAs)|
|September 2016||Centralised validation by EIOPA of all the submitted results|
|15 December 2016||Disclosure of the results of the stress test analysis|
The 2016 Stress Testing Exercise
The stress test focused on two major market risks:
(1) the prolonged low-for-long yield scenario environment;
(2) the so-called “double hit” scenario, i.e. a negative market shock to asset prices combined with a low risk free rate.
A low-for-long yield scenario seeks to emulate a situation of entrenched secular stagnation where there exists a lack of long-term investment opportunities, and there is permanently low productivity growth combined with an extended scarcity of risk-free assets. This scenario drives down yields at all maturities.
A double-hit scenario is a hypothetical scenario which reflects the European Systemic Risk Board (ESRB) assessment of prevailing systemic risks to the European financial system, i.e. a further increase in risk premia combined with a low yield environment.
The stresses were applied to the asset and liability portfolios effectively held by participants on 1st January 2016. It included 236 solo companies from 30 countries. The companies that were selected for participation underwrite long-term business involving investment guarantees and are therefore vulnerable to a scenario with an extended period of low interest rates. The companies had 75% of their total technical provisions linked to life (excluding unit-linked) and less than 2% was linked to non-life business.
Stress Test Results and Recommendations
The Findings Report showed that the two stress scenarios implied approximately a 2% point reduction of the average assets over liabilities ratios at aggregate level. In the double-hit, this led to a decline of the total assets of almost 610 billion euro. This had a negative impact on the balance sheet of insurers of about 160 billion euro. For the low-for-long scenario, the impact for the insurance sector represented a fall in excess of assets over liabilities of about 100 billion euro, a decline of 18%.
These highlighted vulnerabilities called for a supervisory response. Indeed, EIOPA put forward three recommendations in its Insurance Stress Test 2016 Recommendations Report.
|Date ||National Supervisory Authorities Should:|
(1) encourage undertakings, when relevant, to assess the risk of the prolonged low interest rate scenario and the risk of a sudden increase in risk premia in their forward looking analysis as part of their Own Risk and Solvency Assessment.
(2) during their normal supervisory process, assess whether undertakings, induced by the current low yield environment, are revising their risk appetite or are pursuing portfolio allocations that go beyond their risk bearing capacity.
(3) assess the viability of business models that are more vulnerable to the low-for-long scenario. This assessment could take place within the Risk Assessment Framework, taking into account that the impact of this scenario is spread over a number of years that may well exceed the decade, but without neglecting the risks involved due to the slow burning nature of the scenario.
(1) review and assess undertakings’ models regarding the behaviour of management and policyholders, including the legal capacity and willingness to take the decisions that are modelled. Particular attention should be given to those dynamic models that can have significant effect on the value of the best estimate of technical provisions.
(2) the clauses of the guarantees, their typologies, and the optionalities they carry should be analysed to assess the value of the guarantees which companies are exposed to, the associated risks and whether the valuation of the technical provisions can be considered proportionate and prudent.
(1) assess the importance of the stress test impact for the group, based on the vulnerabilities (loss of excess of assets over liabilities) at the solo level. In this context, the measures that groups are able to take to support their related undertakings, should be assessed.
(2) as part of the work of the Colleges of Supervisors, collect information on the impact and potential support at group level, considering management actions as well as diversification effects. Group supervisors are recommended to apply the proportionality principle in deciding the scope of this assessment.
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