Next week, the data will be transferred to the European Insurance and Occupational Pensions Authority (EIOPA), where they will be validated at central level and subsequently evaluated. EIOPA will publish its final report at the end of the year.

Objective of the stress test

The stress test aims to identify and assess potential systemic and concentration risks, including contagion risks, that might affect insurers under very adverse market conditions. EIOPA's analysis will concentrate in particular on macroeconomic results, i.e. it will assess how stress events would affect individual business lines, the national insurance markets and the European Economic Area as a whole – and thus the financial stability of the European insurance sector. The stress test focuses on the impact of the low interest rate environment on the life insurance industry.

In addition to the macroeconomic assessment, EIOPA will also analyse the effects of stress events on the individual insurers. However, as EIOPA put it, “it is not a pass or fail exercise”. The stress test results will therefore not lead to additional own funds requirements for individual insurers. EIOPA will publish the results anonymously and assess them in relation to the results of the other participants.

In Germany, numerous measures have already been taken to manage the risks arising to policyholders and insurers from the persistent low interest rate environment. These include the introduction of the Zinszusatzreserve (an additional provision to the premium reserve) for valuations under commercial law and various provisions set out in the Life Insurance Reform Act (Lebensversicherungsreformgesetz - LVRG). The industry is also reacting to the current situation on the capital markets and the new regulatory framework conditions by adjusting its business models and developing new products. The period for transitional measures under Solvency II allows these measures to be continuously developed.

Scope of the stress test

The stress test includes the calculation of a baseline scenario, two stress scenarios as well as the answering of qualitative questions. The baseline scenario is subject to the same assumptions as for Day 1 reporting under Solvency II, i.e. the quantitative reporting templates under the new supervisory regime that insurers are required to submit for the first time as at 1 January 2016, whereas the stress scenarios focus on the impact that extreme but conceivable developments on the capital markets could have on the level of own funds in the European life insurance industry.

Similar to the EIOPA stress testing of 2014 one of the two stress scenarios focuses on the risk of a sustained period of low interest rates. Taking account of historical lows, EIOPA has recalibrated the relevant risk-free interest rate curve for this "low-for-long" scenario. The scenario therefore simulates an instantaneous interest rate shock. In addition, a reduced ultimate forward rate (UFR) of 2.0% was set for the extrapolated part of the curve. This deviation from the current Solvency II valuation framework, which stipulates a UFR of 4.2%, does not prejudice a change in the regulatory framework. Any stress test based on an unchanged UFR would not meet the underlying assumption of low-for-long interest rates. The interpretation of the results should therefore take into account that this scenario is not aimed at an isolated event expected to occur in the near future but rather at the possible implications of long-term adverse developments. Due to the duration gap between assets and liabilities typical for the life insurance sector, this scenario has negative effects on the own funds in the aggregate.

The "double-hit" scenario combines low risk-free interest rates with a drop in prices of nearly all asset classes, implicitly assuming that practically no issuer can be regarded as a safe haven anymore. It is, like the low-for-long scenario, an instantaneous shock scenario. EIOPA determined the stress parameters together with the European Systemic Risk Board (ESRB). The term "double-hit scenario" refers to the fact that, before application of the long-term guarantee measures, i.e. specific measures for valuing long-term guarantees under Solvency II, both sides of the solvency statement are subject to negative changes with regard to the level of own funds. While the reduction of the risk-free interest rate curve results in an increase in technical provisions affecting the liabilities side, the investment stresses lead to considerable market value losses with impacts on the asset side. In this context it should be noted that the double-hit scenario assumes decoupling of risk-free interest rates from changes in credit spreads. A reduction of risk-free interest rates with a simultaneous increase in all credit spreads, including government bonds of the highest credit ratings as well as substantial price losses for shares, real estate and other investment classes, has not yet been historically observed. The selected calibration can therefore be described as a "perfect storm" scenario, i.e. a confluence of extremely rare and adverse events that drastically aggravate a situation.

All in all, both scenarios simulate extreme situations. It is, however, the nature of stress tests that they examine events that, although highly unlikely, can nevertheless not be completely ruled out. From a supervisory perspective, the question is, in particular, whether supervisors have sufficient room for manoeuvre and adequate tools at hand should such extreme circumstances actually occur one day. It is particularly against this background that BaFin will analyse the qualitative and quantitative results of the stress tests.

Participants in the stress test

The stress test participants were selected in the individual countries based on criteria specified by EIOPA. According to these criteria, the national market coverage, based on the technical gross provisions for life insurance business, had to be at least 75%. Inclusion of unit- and index-linked business was not permitted. EIOPA also determined that in addition to large insurance undertakings, small and medium-sized insurers should also participate in the test. However, insurers with a national market coverage of under 1% or technical gross provisions of less than 50 million euros were excluded. Based on these criteria, 20 life insurance undertakings participated in the stress test in Germany. Since the test was carried out at solo level, support measures within groups were not taken into consideration.

Although the focus of the stress test was on life insurance business, the criteria chosen may result in a heterogeneous group of participants if the European insurance market as a whole is taken into account. Since the segregation of business, which is customary in Germany, does not apply in all EU member states, it seems likely that in other countries composite insurers were also included in the stress test. The pro rata inclusion of property and casualty insurance business could prove beneficial to the overall stress test results of undertakings since this business is less exposed to interest rate risk. The analysis and interpretation of the results should therefore take the national differences of the selection of participants into account, especially when making direct comparisons of countries or insurance undertakings.