The European Insurance and Occupational Pensions Authority (EIOPA) has published the results of a stress test, in which it assessed European insurers’ ability to manage the economic and financial fallout from a resurgence of geopolitical tensions.
According to EIOPA, the test subjected European insurers to an adverse scenario marked by an intensification of geopolitical tensions with a wide range of knock-on effects.
From what we understand, the scenario consists of various events whose joint materialisation is calculated to be plausible, but more severe than the existing capital requirements calibration.
In addition to subdued growth and higher inflation, EIPOA confirmed that these ripple effects also include tighter financing conditions, a steeper inversion of the yield curve, widening credit spreads, as well as an increase of government bond yields amid concerns over debt sustainability.
In terms of approach, EIOPA turned the narrative into a set of different shocks and used that to assess the insurance industry’s resilience to them from a capital and liquidity perspective.
All in all, 48 undertakings from 20 member states participated in the stress test, which represents approximately 75% of the European Economic Area (EEA) market in terms of total assets.
Results from the stress test’s scenario inflicted significant losses on insurers, but undertakings had sufficient capital to absorb the shocks, with insurance undertakings entering the exercise with a solid aggregate solvency ratio of 221.8%.
After applying the shocks, and with no reactive management actions permitted, insurers’ solvency ratio dropped almost 100 percentage points to 123.3%, resulting in a capital loss of over €270 billion.
Interestingly though, when insurers were allowed to take reactive management actions, they were able to recover their solvency ratio to 139.9%.
As a result, this clearly demonstrates that insurers have the ability to adapt and improve their positions in the face of adverse economic and financial conditions.
Looking at individual participants, eight undertakings reportedly fell below the minimum regulatory capital requirements in the fixed balance sheet approach, despite managing to preserve enough capital to meet their obligations to policyholders.
However, all eight undertakings managed to improve their capital position with reactive management actions and managed to restore their solvency ratio above the regulatory threshold of 100%, with the most frequently used management actions including, selling assets, retaining dividends, and raising capital through various means.
Petra Hielkema, Chair of EIOPA, commented: “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.”
