The European Insurance and Occupational Pensions Authority (EIOPA) published today the results of its 2024 Insurance Stress Test in which it assessed European insurers’ ability to cope with the economic and financial fallout from a resurgence of geopolitical tensions. The exercise shows that insurers in the European Economic Area are overall well-capitalized and able to meet the Solvency II requirements even under the stress test’s severe but plausible shocks that stem from widespread supply-chain disruptions, low growth and renewed inflationary pressures.
Geopolitical Shock Scenario
The stress test subjected European insurers to an adverse scenario marked by an intensification of geopolitical tensions with a broad range of knock-on effects. The scenario consists of various events whose joint materialisation is calculated to be plausible but more severe than the existing capital requirements calibration. On top of subdued growth and higher inflation, these ripple effects include tighter financing conditions, a steeper inversion of the yield curve, widening credit spreads and a heterogenous increase of government bond yields amid concerns over debt sustainability. These macro-level market shocks are complemented by insurance-specific elements, such as mass lapse, claims inflation and reduced premium income.
Although the stress test is not a pass or fail exercise, its narrative offers relevant learnings for supervisors and financial entities alike on the sensitivity of European insurers to the high uncertainties surrounding the geopolitical landscape and the economic outlook.
Scope and Approach
EIOPA turned the above narrative into a set of shocks and assessed the insurance industry’s resilience to them from a capital as well as a liquidity perspective. 48 undertakings from 20 member states participated in the stress test, representing approximately 75% of the EEA market in terms of total assets.
Participants calculated their post-stress capital and liquidity positions in two different ways. Under the fixed balance sheet (FBS) approach, only embedded management actions were permitted. Under the constrained balance sheet approach (CBS), however, insurers were allowed to implement reactive management actions to respond to the shocks, provided these reactions were realistic and plausible. While the exercise had a primarily micro-prudential focus, the inclusion of such reactive management actions allowed EIOPA to assess potential spillovers to the wider financial sector.
Results and Main Takeaways on the Capital Side
The stress test’s scenario inflicted significant losses on insurers, but undertakings had sufficient capital to absorb the shocks. Insurance undertakings entered the exercise with a robust aggregate solvency ratio of 221.8%. After applying the shocks, and with no reactive management actions permitted, insurers’ solvency ratio dropped almost a 100 percentage points to 123.3%, resulting in a capital loss of over €270 billion. However, when insurers were allowed to take reactive management actions, they were able to recover their solvency ratio to 139.9%, demonstrating their ability to adapt and improve their positions in the face of adverse economic and financial conditions.
Looking at individual participants, 8 undertakings fell below the minimum regulatory capital requirements in the fixed balance sheet approach even though they still preserved enough capital to meet their obligations to policyholders. All 8 undertakings improved their capital position with reactive management actions and managed to restore their solvency ratio above the regulatory threshold of 100%. The most frequently used management actions included selling assets, retaining dividends, and raising capital through various means.
All participating undertakings maintained their asset-to-liability ratio above 100% in all scenarios. This remains the case even when excluding the contribution of transitional measures.
Liquidity Management
The stress test’s scenario triggered material liquidity outflows for insurers and underlined the importance of the ample buffer of liquid assets that insurers keep on their balance sheets.
Higher outflows in the adverse scenario due to surrenders and claims inflation combined with lower inflows caused by the cut in premium payments and reinsurance inflows resulted in a net technical outflow of €314 billion, which insurers could not fully cover with their cash holdings. To restore their liquidity position, insurers had to liquidate part of their liquid assets, turning from net buyers of €93.2billion into net sellers of €305.6 billion under the constrained balance sheet approach.
Petra Hielkema, Chair of EIOPA said: “This year’s exercise tested a highly relevant scenario at a time when the guiding principles of global cooperation are increasingly being called into question. While it’s reassuring to see that European insurers are well-positioned to deal with the consequences of a further escalation of geopolitical tensions, the capital and liquidity that insurers would need to draw on to cope with such adverse shocks is substantial. The results therefore underscore the need for prudent risk management and close supervision given the highly uncertain times we are facing. Despite the generally positive outcome of the exercise, we must note with a measure of regret that the majority of the participants remain unwilling to disclose their individual results, which limits the transparency of the stress test.”
Next Steps
The outcome of the exercise and the insights gathered throughout its implementation will inform the work of supervisors at the EU and national level and may result in specific recommendations on the risks identified.
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