EIOPA SII stress test positive for market but consolidation still likely

EIOPA found that only 14% of companies (representing 3% of total assets) have a Solvency Capital Requirement (SCR) ratio below 100%. Credit rating agency Fitch still believes that the demands of the new capital adequacy regime will force a consolidation process within the European insurance market. This is, however, unlikely to impact larger corporate insurance buyers as it will be smaller insurers that will be bought out. The new regime is also predicted to hit life companies more than non-life companies. Despite the generally positive findings of EIOPA's stress test, the European regulatory body did not suggest that the insurance sector can totally relax. It said that the sector is more vulnerable to a so-called 'double hit' stress scenario that combines a fall in asset values with a lower risk free rate.hideEIOPA said that in a prolonged low yield scenario 24% of insurers would not meet their SCR and certain companies could face problems in meeting their promises in 8-11 years' time. The body said that it had issued recommendations to National Supervisory Authorities (NSAs) to address the vulnerabilities identified 'in a consistent way' throughout the EU. The insurers that took part in the stress test estimated a 'baseline scenario' that used the upcoming Solvency II regime without internal models. They also tested a number of severe macro-economic and insurance-specific shocks that included a prolonged period of low yields ('Japanese-like' scenario) and a sudden reverse in interest rates ('inverse' scenario). The test found that some 56% of companies would have a sufficient level of capital under the most severe 'double hit' stress scenario. The major vulnerabilities among the insurance-specific stresses were mass lapse of life policies, longevity and natural catastrophes. "NSAs are recommended to engage in a rigorous assessment of the preparedness of insurance undertakings, in particular regarding the situations where capital increases and/or balance sheet management actions will be needed," stated EIOPA. It added that NSAs are recommended to engage with insurance companies to ensure that they have a 'clear understanding' of their risk exposures and their vulnerability to given stress scenarios and that they have the capacity to take recovery actions if those vulnerabilities materialise. Gabriel Bernardino, Chairman of EIOPA, said: "EIOPA's stress test 2014 was a truly preventive supervisory tool. It gave EU supervisors an updated picture of the undertaking's preparedness to comply with the upcoming Solvency II capital requirements and by applying a set of rigorous and severe stresses indicated to us the areas where undertakings are most vulnerable. EIOPA's recommendations will ensure that the vulnerabilities identified are addressed and that follow-up actions by NSAs will be taken in a consistent way." Olav Jones, Deputy Director General at Insurance Europe, was clearly pleased with the results of the test. He said: "Europe's insurers welcome the results of the EIOPA stress tests, which clearly demonstrate the resilience of the European insurance industry ahead of the implementation of Solvency II in January 2016. "The stresses used were very severe and covered all the major risks that insurers take on to protect their policyholders. The fact that the insurers' capital went down after these kinds of severe events is quite normal. To see that even after such severe events, generally companies will still be able to meet their full solvency capital requirements is an indication that overall levels of solvency are very high." Meanwhile credit rating agency Fitch said that M&A activity in the European insurance sector is likely to increase as firms make the transition to Solvency II and profitability remains under pressure, particularly in the life sector. Fitch said that low interest rates have driven down profits across Europe and business models have come 'under strain' from reforms in some countries, such as the UK, where pension law changes have hit the market for annuities. "This probably contributed to Aviva's recent preliminary agreement to buy rival Friends Life, which should help generate economies of scale for the combined business and would also be modestly positive for the sector as a whole by reducing competition following the pension reforms," suggested the rating agency. Fitch added that 'saturated' markets in most big European countries will tempt insurers into buying market share through consolidation. "But we believe deals are most likely among smaller insurers because the upcoming transition to Solvency II regulations is likely to be less problematic for bigger firms," it added. Fitch pointed out that under Solvency II larger insurers are more likely to receive a benefit for diversification as they calculate their capital charges, are likely to be better prepared for the new regulations and have better access to capital if necessary. "The rules do take account of an insurer's size using the principle of proportionality, which allows smaller, less complex firms to use approximations (for example to value their liabilities), but we believe the sharp increase in costs associated with Solvency II will be a greater burden for smaller firms, which are also likely to be less well prepared," stated the credit rating agency. Fitch's view is supported by a study recently carried out by BaFin, the German regulator. It found that if Solvency II were implemented now some 25% of German companies, with a combined market share of 10%, would not meet the capital requirements. This suggests that smaller firms were more likely to fall short, commented Fitch.

EIOPA SII stress test positive for market but consolidation still likely

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