Insurance undertakings must always be aware of the risks to which they are exposed. The own risk and solvency assessment (ORSA) report consolidates the information insurers require for this purpose (see info box “ORSA”). Stress tests are an important element of the ORSA, particularly when it comes to assessing situations like the current coronavirus crisis. BaFin has carried out spot checks on ORSA reports and found that in many cases the requirements for undertaking-specific stress tests were not adequately met. What are these requirements?

Requirements of the ORSA

When determining their actual overall solvency needs, undertakings must take into account all developments that may materially affect their risk or own funds position, such as planned strategic measures and possible adverse events or scenarios. In order to be able to reflect adverse events or scenarios relevant to the insurance undertaking or insurance group adequately in the ORSA, the undertakings must design a sufficiently broad range of stress tests tailored to their individual risk profile. They must cover at a minimum the essential drivers for the material risks, take into account the risk concentrations and diversification effects between the risks, and reflect events or scenarios with different degrees of severity (see section 10.3 of the MaGO). Moreover, BaFin expects the undertakings to use previous stress test results in their assessment of whether there has been a material change in their risk profile.¹ Different types of stress tests with varying degrees of severity and changing types of scenarios can be used, such as sensitivity analyses, scenario analyses and reverse stress tests.

The undertakings are required to document the frequency and content of the stress tests. Paragraph 1.53e of the Guidelines on system of governance published by the European Insurance and Occupational Pensions Authority (EIOPA) also requires insurers to define situations that would warrant ad-hoc stress tests. In addition, the insurers must identify and assess all risks to which they are exposed over both the short and long terms. In accordance with section 27 (3) of the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG) and Article 262(1)(a) of the Solvency II Implementing Regulation, these include risks that arise from changes in the economic and financial environment, for example.

Although Solvency II requires insurers to prepare an ORSA report, the principle of proportionality applies with regard to the type, scope and frequency of this assessment (see info box “Applying the principle of proportionality with regard to the ORSA”).

What BaFin expects

When analysing the ORSA reports, BaFin’s reviewers often found it difficult to understand how and to what extent the above-mentioned requirements were actually implemented by the undertakings. This was the case, for example, when the report failed to define the criteria which the insurer had applied when selecting a stress test for a certain risk.

At least once a year, the undertakings must evaluate the appropriateness of their stress tests and justify the results in the ORSA. If the selected events or scenarios prove to be unrealistic, the stress tests must be adjusted. In turbulent times such as we are now facing with the COVID-19 crisis, BaFin expects the undertakings to take particular care when verifying their stress test assumptions. If undertakings state that the stress tests remain appropriate without any changes, they must always provide justification for this. However, experience shows that this is often not done or only in rudimentary form. BaFin expects undertakings that use scenarios to also analyse the extent to which risks of different categories correlate and whether it would make sense from a risk perspective to combine such risks for assessment.

Complex interdependencies

In their ORSA reports, insurers very often focus on stress tests for individual risk factors such as equities, spreads or yield curves, but they rarely consider combinations of market and underwriting risks or sustainability stress tests. Furthermore, the reviewers noticed that the ORSA reports only occasionally included reverse stress tests, although their use can reveal when defined strategic targets are not being met. In a reverse stress test, undertakings can analyse, for example, the default of counterparties, distortions on the capital markets and increases in the combined ratio.

With regard to the analysis of the stress test results and the question of how these affect corporate management, BaFin expects undertakings to comment on the appropriateness of the parameters considered. For example, insurers need to explain the role that the complexity of the scenario or the number of the risks involved has played for the estimation of the own funds or the solvency capital requirement (SCR).

Insurers are also required to perform stress tests with different degrees of severity (margin no. 199 of the MaGo). The degree of severity can be determined, for example, by stress parameters and the extent of change in the target parameters considered. BaFin’s analysis revealed that by no means do all insurers differentiate between degrees of severity in their ORSA.

Evaluation of the results

Furthermore, the reviewers noted that numerous stress tests produced results that had no material impact on the target parameters. In many cases, undertakings did not evaluate their stress test results at all. General statements such as "risk-bearing capacity continues to be satisfactory" or "no material impact" are often not sufficient. This is because BaFin expects the undertakings to submit a detailed evaluation of material stress test effects, which also includes an explanation of the measures taken or intended to improve their situation. Insurers should take this into account in particular with regard to the COVID-19 situation. The MaGo requires insurers to state possible measures in the ORSA report if a plausible scenario shows that the SCR ratio may not be met. Such measures could be premium adjustments, a change in reinsurance coverage or the use of tools to provide capital relief.

However, there were also some good examples of evaluations of stress test results. For instance, results were much more pronounced in cases where undertakings explained the causal relationships and examined in more detail how the stress effect was reflected in partial variables by looking at the own funds and the SCR separately, rather than just focusing on the coverage ratio.

BaFin encourages undertakings to look beyond the performance of stress tests with stable SCR coverage, for example by adding what-if considerations that include other potential adverse developments and possible impacts.

Conclusion

The review has shown that the ORSA can only help the management board to make an informed choice if it reflects, to the extent necessary, the assumptions and methods on which the stress tests are based, as well as their results and the conclusions and measures subsequently taken. The information provided in the ORSA must also enable the supervisory authority to make its own assessment of the appropriateness of the business processes. BaFin will monitor whether the current COVID-19 situation will lead to an increase in ad-hoc ORSA reports with adjusted stress assumptions.

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