Posted on Jul 07, 2011 by Sergio Ulloa
In what could be seen as positive news for the international insurance industry, around 90 percent of European insurers and reinsurers have met minimum solvency requirements and passed the second stress test conducted by the European Insurance and Occupational Pensions Authority (EIOPA) this week. These tests are important as they examine how insurance companies would cope with varying degrees of macroeconomic crisis.
EIOPA, a body set up recently to oversee insurers and pension funds alongside local European regulators, surveyed the earnings of 221 insurance companies across Europe, representing roughly 60 percent of the continent's combined insurance market. Between March and May of this year, the balance sheets were first tested against basic macroeconomic scenarios provided by the European Central Bank and then subject to simulated fiduciary shock scenarios that would be particularly applicable to insurance companies. These stress scenarios took into account severe macroeconomic assumptions about interest rates, falling equity and real-estate markets and a series of major natural disasters
, and assessed how this would impact future capacity to handle changes to credit and insurance risk. It is the second such set of tests issued for insurance companies, now occurring parallel to a similar assessment of the banking sector by the European Banking Authority.
The stress tests are geared towards preparing for the European Union's proposed Solvency II capital requirements. Starting in 2013 or perhaps 2014
, the new capital regime will prioritize greater risk-based capitalization and require insurance and reinsurance companies based in the 27 Member States to set aside sufficient capital for future investments that regulators deem risky. The rationale behind these solvency rules is to ultimately develop a singular market for insurance services in Europe and offer adequate protection for all policyholders within. However, many countries have been critical of the EU's requirements and have instituted their own reforms, leading to a muddled patchwork of market regulations across the continent. Short term concerns persist that Solvency II could lead to insurers increasing their capital position at the expense of tackling new business ventures
and damaging their overall competitiveness on the global insurance marketplace.
Once initiated, Solvency II will implement fundamental changes in the way the European insurance industry evaluates risk and risk management practices. The EU's new capital requirements will force a convergence of all aspects of risk quantification and decision making processes within the insurance trade. All businesses that have operations and affiliates in Europe, offer insurance products in Europe or do other business with European insurers, should now be preparing for these across-the-board changes.
The participating European insurers had on aggregate a size-able solvency surplus of €425 billion (US$615 billion) before all stress test scenarios were applied. According to the EIOPA, once adverse economic scenarios were applied the group's surplus fell to €275 billion (US$398 billion) and €367 billion (US$531 billion) under more specific inflation circumstances. In addition, around 10 percent, of the group wouldn't be able to meet new Solvency II capital requirements under more severe market conditions. These insurers who could not meet the threshold show a solvency deficit of €4.4 billion (US$6.4 billion) if the adverse market scenario were to occur and €2.5 billion (US$3.58 million) if the inflation scenario were to materialize, EIOPA reported
Gabriel Bernardino, chairman of the EIOPA, told reporters that the results from the stress test show ""The insurance industry in Europe remains robust at an aggregate level [and] overall the European insurance industry has a good shock absorber in its capital position. Now each company will have an analysis of the areas where they are more exposed, and they can take action." The regulator underscored however that all tests were based on hypothetical data and that severe stress scenarios were not a forecast of what it necessarily expected to happen. Despite the failure of some companies, there is hope that most Europe-based insurers would still be able to obtain new clients and produce significant revenue in a more adverse market environment.
EIOPA maintained that it would not be appropriate at this time to reveal the identify of the insurers who failed stress tests and are potentially facing a shortfall because further adjustments to the Solvency II regime could occur before 2013. Industry analysts have speculated that those who failed were probably small mutually owned insurers and that the larger publicly-traded companies, such as Allianz SE, Axa SA and Munich Re, are expected to have passed comfortably. The supervisory body did disclose however that European insurers main vulnerabilities would remain unfavorable developments in both yield curves and sovereign-bond markets or a future string of severe natural catastrophes. The industry's exposure to critically indebted peripheral eurozone nations remained manageable in the foreseeable future, despite news this week that German insurer Allianz would reissue a €300 million (US$430 million) bond to the Greek government. "We do not expect a major stress from exposure to Portugal, Ireland, Italy, Greece and Spain," Bernardino added.
Critics of the exercise believe that the results may lack credibility as the tests assessed companies according to whether they achieved minimum capital requirements and furthermore that the insurers that did fail have not yet been named. There are also concerns that the stress scenarios were not taxing enough, both the simulated 15 percent drop in equity markets and adverse 12 percent fall in property values were far below the actual values experienced during the recent global financial crisis or the dot com bust in the nineties.
While the insurance industry in Europe has emerged from the financial crisis in better shape than the banks, a recent slew of losses and the impact of government bailouts on the sector have prompted regulators to inspect the industry more closely. The EIOPA tests may allay some concerns. Most companies appear to be able to reduce their surplus capital before being put at significant financial risk. Cumulatively, the European insurance sector's €425 billion (US$608.2 billion) surplus absorbs the shortfall brought about in the stress tests and may demonstrate that the industry is still financially robust overall.