20 German life insurance undertakings participated in the stress test which – measured based on their gross technical provisions excluding index-linked and unit-linked business – account for approximately 75 percent of the market. In accordance with the EIOPA requirements, the selection of German participants included small, medium-sized and large life insurance undertakings.

Identifying and assessing systemic risks

The results of the EIOPA stress test are intended to assist in the identification and assessment of possible systemic risks for the insurance industry which may result from highly adverse market developments. As regards the conclusions which can be drawn from the test, the report emphasises: "The EIOPA stress test is designed as a vulnerability analysis and does not constitute a pass or fail exercise". Therefore, the results of the stress test do not focus on individual undertakings and will not result in additional regulatory requirements for own funds.

The basis for all calculations was the Solvency II balance sheet with the reference date of 1 January 2016. In order to assess the impact of stress, EIPOA takes changes in assets and liabilities into consideration. In the "double-hit" scenario (see description below), the value of the assets and liabilities of the German participants falls by 8.6 percent and 6.0 percent respectively. In the "low-for-long" scenario, the value of the assets increases by 7.2 percent and that of liabilities increases by 11.5 percent. Therefore, both scenarios impact own funds negatively. As expected, in the low-for-long scenario, the sensitivity of the German undertakings involved is higher than the European average.

BaFin's assessment confirmed

With a view to the German life insurance industry's susceptibility and vulnerability to the prolonged low interest rate environment, the results confirm the assessment also reached by BaFin in its surveys in recent years. "In particular, the 2016 EIOPA stress test demonstrates that the German life insurance undertakings involved react especially sensitively to the low-for-long scenario compared to the European average," says Dr Grund, adding: "this is not at all surprising".

BaFin and the legislature responded to this early on with targeted measures aimed at appropriately increasing undertakings' risk-bearing capacity. This includes, among other measures, the introduction of the Zinszusatzreserve (an additional provision to the premium reserve introduced in response to the lower interest rate environment) in 2011, the passing of the German Life Insurance Reform Act (Lebensversicherungsreformgesetz – LVRG) in 2014 and repeated reductions of the maximum technical interest rate permitted for new business, most recently to 0.9 percent effective from 1 January 2017.

In addition to these measures, which affect all undertakings, BaFin has subjected any insurers that are particularly affected by the prolonged low interest rate environment to intensified supervision in recent years. In doing so, it has made particular efforts to ensure that discretionary benefits are decreased in due time and that the undertakings' equity is strengthened. Total equity and hybrid capital thus increased from 6.6 billion euros in 2000 to 18.1 billion euros in 2015 by means of profit retention, the strengthening of equity and the raising of hybrid capital. In the business years 2014 and 2015 in particular, these items recorded a substantial increase of 3.3 billion euros.

Background

The stress test was carried out on the basis of the Solvency II evaluation standards with the transitional provisions and the long-term guarantee measures taken into consideration.
The participating undertakings had to carry out calculations for one baseline scenario and two stress scenarios ("low-for-long" and "double-hit") and also had to answer qualitative questions. In the baseline scenario, the same assumptions as those in Day 1 reporting under Solvency II were applied.

In the low-for-long scenario, EIOPA recalibrated the relevant risk-free interest rate term structure with consideration given to historical lows. In this way, the scenario was applied with an immediate shock to the interest rate. In addition, the extrapolated part of the curve was projected using a reduced ultimate forward rate (UFR) of 2.0 percent. This deviation from the current Solvency II evaluation framework, which prescribes a UFR of 4.2 percent, was made because an unchanged UFR would not have corresponded to the underlying assumption of a prolonged low interest rate environment.

The double-hit scenario involves a combination of lower, risk-free interest rates with a fall in value of virtually all investment classes under the implicit assumption that virtually no issuer is considered a safe haven any more. As with the low-for-long scenario, the double-hit scenario is applied with an immediate shock. In the double-hit scenario, changes in risk-free interest rates and changes in credit spreads were decoupled. To date, such a fall in risk-free interest rates with a simultaneous increase in all credit spreads – including for government bonds with the highest credit quality – and substantial decreases in the price of shares, property and other investment classes have not been historically observed. The selected calibration can thus be described as a "perfect storm" scenario, i.e. an amalgamation of extremely rare and unfavourable conditions.