The capital strength of European insurers is shakier than it looks. Recent stress tests by the European Insurance and Occupational Pensions Authority found that only 14 percent of insurers fell below a baseline level of capital strength under so-called “Solvency II” reforms. That’s not the end of the story, however.
EIOPA’s stress test didn’t name and shame those it failed. But it did attempt to model for the biggest risk currently facing the sector – ongoing low rates that prevent insurers from generating enough money from their assets to pay their liabilities. That looks a real risk, with the euro zone on the brink of deflation.
Under EIOPA’s “Japanese-style” scenario, where interest rates hover around 2 percent even at very long maturities, some 24 percent of insurers failed to achieve a so-called Solvency Capital Requirement of 100 percent – the level below which regulators start to get antsy. German insurers are particularly afflicted. With liabilities longer than their assets and expensive historic guarantees, their buffers would plunge by over 20 percentage points – more than in any other European Union country.
Japanese-style returns sound scary, but EIOPA could have been tougher. Allowing insurers to discount their liabilities using Japan’s bond yields as of December 2011 gives them an easier ride than if they had to assume actual, current Japanese or German bond yields: these are even lower.
The regulator can point to the fact that yields have fallen 100 basis points since last December, where its data set came from. More importantly, valuing insurer liabilities is more art than science, and Solvency II gives some scope for leeway. Still, EIOPA could have chosen a (lower) Japanese yield curve from last year, rather than one from 2011.
German insurers can point to the fact that even after the EIOPA Japanese scenario, their absolute level of capital is still roughly 180 percent of SCR. But that’s an average, which includes well-capitalised behemoths like Allianz. And even under EIOPA’s stress, the mismatch of assets and liabilities means that some German insurers start to lose money after ten years. The risk is that smaller companies have much lower headroom – and will struggle even more if or when Europe deflates.