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EIOPA Insurance Stress Test 2016 – Call to Action!

Solvency II
EU / European Parliament / EIOPA, Life insurance

25 May 2016

On 24 May 2016, EIOPA published a set of scenarios that they would like a sample of insurance companies to apply so that they can test those firms’ resilience to various financial threats perceived to be currently relevant to the sector.  This article sets out briefly what those scenarios are, what firms have to do, comments briefly on the implications of these scenarios and explains how OAC can help.

Sample selection

The sample is to be chosen by each local regulator and is expected:

  • to focus on those firms offering interest guaranteed products;
  • to cover 75% market share (by technical provisions); and
  • to include solo and smaller insurers as well as mutuals.

It is not intended that the sample captures the very smallest firms eg those firms with less than 1% market share by technical provisions or those whose technical provisions are less than Euro50m (around £36m).

Insurers who are not invited to participate may well benefit from undertaking the exercise to help them with their risk management.

The results may be a useful part of firms’ ORSAs although that clearly depends on each firm deciding the extent to which they are appropriate to their business.

What are the scenarios?

The scenarios EIOPA is seeking to apply for 2016 reflect the currently perceived market risks of a:

  • prolonged low yield environment – the so called “low-for-long” scenario; and
  • an occurrence of both lower interest rates and a severe drop in asset prices – the so called “double-hit” scenario.

There are additionally a series of questions asking how firms might behave in such situations (a qualitative questionnaire).

The scenarios will be based on the Solvency II framework standards and reporting.

The reference date for the exercise will be 1 January 2016 ie Day 1.

The low for long scenario

This looks at a long lasting reduction in yields.  A comparison of yields in the UK with those assumed for the Day 1 reports at key terms is set out in the following table.  The results are also illustrated graphically.

Table comparing change to risk-free discount rates

Term (Yrs)

1

2

3

4

5

10

15

20

25

Day 1

0.73%

0.98%

1.19%

1.35%

1.48%

1.92%

2.10%

2.13%

2.09%

LFL Stress

0.82%

1.05%

1.20%

1.27%

1.31%

1.32%

1.25%

1.16%

1.06%

Chart comparing change to risk-free discount rates

Unexpectedly, the rates actually increase at very short terms and this may reduce the liabilities for short term claims in payment.  The approximate 0.6% reduction will increase the medium term liabilities with any long term liabilities increasing due to the 1% reduction.  

The double hit scenario

The tests, for various asset classes, are as follows:

Equities

  • listed on more than one exchange -33.4% (equivalent to FTSE 100 falling to 4157 from YE2015 levels)

UK property

  • Commercial -14.7%
  • Residential -14.2%

Corporate bonds – increase in yields (bps) 

Credit Rating

AAA

AA

A

BBB

BB

B<

Non-financials

24

120

135

214

260

323

Financial

16

116

198

372

432

484

Financial (covered)

20

72

115

162

207

230

Increase to UK gilt yields (bps) (at key terms)

2

5

10

15

20

25

46

94

94

95

73

61

Table comparing change to risk-free discount rates

Term (Yrs)

1

2

3

4

5

10

15

20

25

Day 1

0.73%

0.98%

1.19%

1.35%

1.48%

1.92%

2.10%

2.13%

2.09%

DH Stress

0.12%

0.32%

0.41%

0.58%

0.76%

1.29%

1.38%

1.49%

1.56%

Chart comparing change for both scenarios to risk-free discount rates

What will happen with the results?

The results of the scenarios will be reported to the local regulator (ie the PRA for insurers in the UK).  The reports cover three scenarios:

  • baseline (ie what they were for Day 1 reporting);
  • low for long scenario; and
  • double hit scenario.

The reports that will need to be submitted include:

  • balance sheet;
  • minimum capital requirements;
  • solvency capital requirements;
  • own funds;
  • liability cashflows; and 
  • response on the qualitative questions.

When should results be submitted?

No later than 15 July 2016.

OAC comment

Given the uncertainties that exist currently in the financial sector within the EU, it is not surprising that EIOPA are looking to understand better the resilience of insurers to significant market shocks.

The nature of the scenarios considered – low returns, and low returns combined with price shocks – is, in our opinion, right.

However, the strength of the double hit scenario is very significant indeed particularly as they are assumed to happen all at the same time.  It is clearly a matter of judgement as to the relative strength of this scenario but increasing sovereign yields combined with a fall in risk-free yields appears counter-intuitive.

The work needed to apply these scenarios is not insignificant – not merely to process the numbers, but perhaps more importantly what they mean for the business itself and what they will do as a result.  These are not matters that can be “rushed-through” and Boards and management teams will need time to consider the results (particularly given their strength) carefully.

The results may be a useful part of firms’ ORSAs although that clearly depends on each firm deciding the extent to which they are appropriate to their business.

How can OAC help?

OAC provides a full suite of actuarial function support.  We can:

  • calculate the impact of the stresses;
  • provide resource to help firms undertake the calculation themselves;
  • help firms’ management teams interpret the results; and
  • help firms’ management teams consider how they might respond in the specific situations specified.

For more information please get in touch.

 

Christopher Critchlow

For more information
Christopher Critchlow
Director | Head of Professional Services

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