Europe's insurance sector is vulnerable to falling asset prices and Japanese-style prolonged low interest rates, and 44% of the companies failed the toughest of several stress test scenarios, but the sector has sufficient capital overall to ride out potential severe shocks, the European insurance regulator said Sunday.European insurers had to prove to the European Insurance and Occupational Pensions Authority, or Eiopa, the sector's resilience to three macroeconomic scenarios-a baseline scenario, an adverse scenario in which Europe's stock market is the source of stress, and a second adverse scenario in which the nonfinancial corporate bond market is the cause of distress.
Insurers had to ensure they can withstand the impact of substantial equity market declines and widening corporate bond spreads, respectively, on interest rates, corporate and sovereign bond markets and property markets. They also had to prove they can shrug off a persistent low interest rate environment, which is currently the sector's main headache. Property-casualty insurers had to bear the impact of major disasters and gaps in their reserves while life insurers had to withstand higher longevity, mortality and lapse risks.
Under the most adverse scenario, 56% of the companies would have a sufficient level of solvency capital while 44% wouldn't, Eiopa found.
Protracted low interest rates as in Japan "could see some insurers having problems in fulfilling their promises to policyholders in 8-11 years' time," Eiopa found. About 24% of companies wouldn't meet solvency capital requirements under the Japan-styled scenario.
In the baseline scenario, 14% of companies representing 3% of total assets would have a solvency capital ratio below the 100% minimum but 86% of companies representing 97% of total assets would top that, the test found.
Eiopa said it has issued recommendations to national supervisors to address the weaknesses, such as how insurers calculate guaranteed payouts.
The stress tests were carried out on insurers representing between 55% and 60% of the European market including Switzerland, Norway and Iceland, using year-end 2013 earnings, one-and-a-half years before the EU insurance regulation on capital and risk management known as Solvency II comes into effect. The test was based on the new, tougher requirements that mean insurers will have to hold more capital against future losses and face greater regulatory scrutiny, similar to the enhanced capital requirements for banks being introduced under Basel III. There will be a minimum capital requirement, or MCR, and a higher solvency capital requirement, or SCR.