Europe's insurance regulator said on Monday that about 10% of European insurers would fail to meet future minimum capital requirements in an adverse macroeconomic scenario, but overall, the sector is robustly capitalized and well prepared for shocks.
In a stress-testing exercise covering European insurers representing more than 60% of the market, the European Insurance and Occupational Pensions Authority, or EIOPA, examined the sector's ability to meet its obligations under three macroeconomic scenarios—a baseline case, an adverse scenario and an inflation shock. It looked at how each set of circumstances would affect insurers' market risks, credit risks and insurance risks.
The test was based on tougher capital requirements for insurers, known as Solvency II, that will come into effect Jan. 1, 2013. Under Solvency II, insurers will have to hold more capital against future losses and will face greater regulatory scrutiny, just as banks will under the so-called Basel III agreement. There will be a minimum capital requirement, or MCR, and a higher solvency-capital requirement, or SCR.
Some 90% of the 129 groups surveyed passed the test, even under the most adverse scenario, said EIOPA President Gabriel Bernardino.
But 10%, or 13 insurance groups, would fail under the adverse scenario, leaving the sector as a whole €4.4 billion short of its minimum capital requirement under Solvency II.
The adverse scenario included a focus on how an increase in the stresses facing European sovereign borrowers would affect insurers. Six groups, or 5% of the companies tested, would fail the sovereign-stress segment of the adverse scenario, resulting in an aggregate shortfall of €3.4 billion compared with the minimum required under Solvency II, he said. Ten groups, or 8%, wouldn't pass the inflation scenario, he said.
Taken together, the companies tested had aggregate eligible capital of €577 billion, equal to a so-called solvency surplus of €425 billion relative to the aggregate minimum capital requirement of €152 billion. In the adverse scenario, the aggregate solvencysurplus would shrink by €150 billion to €275 billion, but still be substantially above the minimum. In the sovereign-stress scenario, the aggregate surplus would be cut by €33 billion to €392 billion, Mr. Bernardino said.
The adverse scenario assumed a widening of government-debt spreads—the difference in yields on debt issued by riskier and more stable borrowers, such as Germany—to examine the sector's resilience to sovereign risk. For instance, it assumed a 2.55 percentage-point increase in yields on Greek sovereign debt, a 2.58 percentage-point increase on Irish government bonds, and a 2.46 percentage-point surge for Portuguese government bonds.
For Spanish sovereign debt, that figure was 1.65 percentage points.
The adverse scenario also tested whether insurers could weather a natural disaster of such great magnitude that it can be expected just once in 200 years, such as the multiple disasters that hit Japan in March.
It also looked at what would happen if inflation in claims increased 2 percentage points faster than currently expected, and whether that would cause a shortfall in reserves for property-and-casualty claims.
The test revealed that the sector is mainly vulnerable to adverse developments in stock markets, and pertaining to interest rates and sovereign debt, but also to increased claims inflation and natural disasters, he said.
The results don't mean that those companies that failed the test under the future regime will have to raise capital immediately, Mr. Bernardino said.
The current regime known as Solvency I, is appropriate for now, he said.
Participation was voluntary, and Mr. Bernardino defended EIOPA's decision to publish the aggregate results, but not results by company or by country.
Stress-test results for banks, including for individual lenders, are due in mid-July. He said he doesn't see the added value from naming the companies that failed, adding that credible regulation is in place. He pointed out that insurers came through the financial crisis relatively unscathed, compared to the banking sector.
"The stress test is a 'what-if' scenario for the future, it doesn't mean if a company fails on a particular stress, that it has to have the capital now," Mr. Bernardino said, adding that the issue in most situations was about strategies to mitigate future risks, rather than capital.
He said he wasn't able to say whether individual insurers failed in several of the tests, or whether more listed or unlisted companies fell short of the standards.
Mr. Bernardino stressed it was up to politicians to decide whether the names of the companies that failed would be published in future tests, possibly after Solvency II has been introduced.
Though the insurance stress tests aren't observed as widely as those for banks, they shed important light on the sector's resilience to challenging macroeconomic stress scenarios.
Michaela Koller, director general of the CEA, a European group representing insurers and reinsurers, said the test results show the sector's resilience "to withstand severe stress scenarios."
"It should be remembered that in insurance the MCR [minimum capital requirement] consists of technical provisions plus an additional risk margin," Ms. Koller said. "The technical provisions alone are sufficient to ensure that all policyholder claims can be covered in full."
All French groups tested had an MCR coverage ratio of above 100% in all scenarios, the Bank of France said in a statement. "These results demonstrate the solidity of France's insurance sector, and once again its capacity to overcome difficult macroeconomic situations," Bank of France Gov. Christian Noyer said.
National supervisors will now discuss the test results and strategies with individual companies. Those talks will cover whether the firms will need to raise capital at some point, or change their risk profile, Mr. Bernardino said.
EIOPA wanted to stress-test companies representing at least half of the gross written premiums generated in each country participating. About 221 insurers and reinsurers in the 27 member countries of the European Union, plus Iceland, Liechtenstein, Norway and Switzerland, participated in the test. Results of companies within groups were aggregated to the overall number of 129 participants.
Last year's stress test used the current capital regime for insurers, known as Solvency I.