Stress test looks at three scenarios
Stress tests have evolved into an indispensable instrument for identifying risk. Supervisory authorities are increasingly turning to stress tests, and are using them in more and more areas. Stress tests aim to reveal vulnerabilities in a financial institution or the financial system before they materialise. The two-yearly EIOPA stress test for insurers also serves this purpose. Specifically, it aims to establish the sensitivity of insurers to extreme scenarios and analyse its impact on financial stability. This means insurers were not assessed to see whether they passed or failed a specific test. Forty-two European insurance groups took part, including Aegon, NN Group and Achmea. At our request, a.s.r. and Vivat also took part in the stress test at national level. The test looked at the sensitivity to three different scenarios. The first scenario combines a drop in interest rates, including an immediate downward adjustment of the ultimate forward rate (UFR) – something which is unlikely to happen in practice – with an increased longevity risk. It is the combination of these shocks that makes this a severe scenario. The second scenario, which is more likely to materialise given current economic conditions, assumes a rise in interest rates, a fall in asset prices and an increase in lapse risk. The third scenario involves various catastrophes, such as windstorms and flooding. To assess the insurers’ vulnerability to the scenarios, their financial baseline position at year-end 2017 was compared with their post-stress positions. One indicator that illustrates the impact on an insurer’s own funds is the asset/liability ratio. Figure 1 shows this ratio, both for the five Dutch participating insurers on an aggregated basis and the European average, in the baseline and post-stress situations.
Dutch insurers are particularly vulnerable to further interest rate decline in combination with longevity shock
The results show that the average ratio is above 100%, both before and after stress scenarios were applied. At the same time, it becomes clear that Dutch insurers are particularly vulnerable to the scenario involving a decrease in interest rates combined with rising life expectancy (scenario 1). In that scenario, market interest rates fall even further from current levels, and the ultimate forward rate, which is the rate at which liabilities with duration exceeding 20 years are valued, is assumed to fall to 2.04%. The figure shows that this scenario has a substantial impact on own funds. Also, the impact is larger than on the European average for the insurers participating in the stress test. The impact is especially large if the mitigating effect of the long-term guarantee (LTG) measures, which reduce the sensitivity of Dutch insurers’ balance sheet to market movements, is disregarded.