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Erscheinung:30.06.2016 | Topic Solvency IMF publishes stress test results for German life insurers

The International Monetary Fund (IMF) examined the German financial sector from November 2015 to March 2016 as part of its Financial Sector Assessment Program (FSAP), which also included stress tests of the German life insurance sector. The results published yesterday by the IMF show that the majority of German life insurers will meet the solvency capital requirement (SCR) under Solvency II even in the event of a severe shock.

The insurance stress test covered a total of 75 German life insurers whose technical provisions accounted for a market share of roughly 93%. Calculation date was 31 December 2014. When applying the transitional measure for technical provisions, 62 undertakings showed an SCR coverage ratio of more than 100% even under stress test conditions. Without the application of transitional measures, the coverage ratio was less than 100% at 34 undertakings under the baseline scenario and 58 undertakings under stress scenario conditions. Again, without applying transitional measures, the gap between SCR coverage of 100% and the level of own funds was roughly €12 billion under the baseline scenario and €39 billion under the stress scenario. The underlying stress scenario included, in particular, an adverse development of the capital markets in the form of falling interest rates and a decline in the market values of investments.

The results of the IMF's stress test of the insurance sector support the evaluations of the surveys on the solvency situation of German life insurers conducted by BaFin during the past two years: the transitional measures have the desired effect and facilitate a smooth transition to Solvency II, even under stress scenarios. But, on the other hand, the results also show that German life insurers will have to make considerable efforts to strengthen their capital base during the 16-year transitional period. It can be expected that without transitional measures, the capital gap will significantly increase under a harsh stress scenario.

Background:

The insurance stress test assumed the occurrence of the most important market stresses under the standard formula, which combined equalled a 1 in 200 year event. Since the standard formula generally does not reflect sovereign credit risks, a stress on government bonds was also included. It was then examined whether life insurers would have sufficient own funds to cover their SCR even after such a scenario had occurred and whether they would be able to compensate for another 1 in 200 year event. The confidence level on which the IMF insurance stress test was based thus clearly exceeded the level stipulated by Solvency II: Under Solvency II, insurers are required to hold sufficient own funds to compensate for own funds losses suffered in a 1 in 200 year event. Under the scenario of the IMF insurance stress test, however, a 100% coverage means that the insurers' own funds would even be sufficient to compensate for two successive 1 in 200 year events.

In methodological terms, this is called a top down stress test, which is carried out on the basis of data available to insurance supervisors without requesting information from the undertakings. This is why it was necessary to base the calculations on estimates and strongly simplifying assumptions. Ultimately, the assumptions used were rather conservative. One example of the simplification was to assume that if a stress event were to occur, the undertakings would not take any countermeasures to reduce their risks or increase their own funds, for instance. In reality, however, insurers could reduce their risks in such an event by, for example, restructuring their investments or taking capitalisation measures.

Furthermore, it was assumed that the volatility adjustment to the risk-free interest rate term structure remained unchanged in the stress scenario. In reality, the volatility adjustment would increase under the conditions simulated in the scenario – and therefore, the interest rate curve used to calculate the technical provisions would rise as well. However, since the precise consequences of this mitigating effect could not be reliably estimated in a top down stress test, quantification was not done, as a precautionary measure.

Another aspect evaluated in the stress scenario was the change in the SCR. The stress scenario resulted in a smaller amount of future surplus participation being available to offset losses; as a consequence, the SCR was generally higher under shock than in the baseline scenario.

All in all, it should be noted that the stress scenario applied was, as a whole, an extreme scenario, and that the calculations were based on very conservative assumptions. This has been confirmed by first indications resulting from Solvency II reports by German life insurers for the first quarter of 2016. The valuation date of the IMF stress test of the insurance sector was 31 December 2014. As at 31 March 2016, the situation on the capital markets had deteriorated considerably compared with 31 December 2014. In the first quarter of 2016, in particular, interest rates again fell sharply. A first analysis showed, however, that the actual results of the German life insurers as at 31 March 2016 were significantly better than the results of the IMF insurance stress test. BaFin intends to publish further findings in relation to the Solvency II reporting of German life insurers as at 31 December 2015 and 31 March 2016 in August.

Due to the very conservative and strongly simplifying assumptions and the extreme parameters used in the stress scenario, the results of the IMF insurance stress test are not suitable for deducing that additional capital requirements are necessary. However, they give a first indication of which undertakings could be subject to increased vulnerability under stress assumptions. BaFin will therefore take into account the results of the IMF insurance stress test in its ongoing risk assessment of German life insurers.

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