The European Insurance and Occupational Pensions Authority (EIOPA) launched its 2024 insurance stress test¹ back in April, with results due to be submitted to National Competent Authorities (NCAs) by mid-August and a final report from EIOPA due to be issued by December. The focus of the stress testing exercise is to explore the potential impact of geopolitical tensions, something which is certainly quite topical right now. In this blog, I explore the details of the stress test specified by EIOPA and examine whether there is value in considering it as part of the own risk and solvency assessment (ORSA). There are a number of quite interesting aspects to the stress test, and a number of potential advantages to including it (or some variant of it) in the ORSA.

Can you ignore this stress if your company is out of scope?

It is mainly the larger companies or groups (and their subsidiaries) that are in scope of the exercise. If your company is out of scope, you do not need to submit results of the stress test to your NCA. However, might there be value in considering the stress test in your company’s ORSA? I believe there is, and I will explain why. Let’s take a look firstly at the prescribed stress before considering the potential advantages and whether any adjustments might need to be made for your company.

Stress

There is just one central stress test prescribed, although there are a few variations in terms of the reporting, including considering the stress with and without management actions. The narrative for this scenario focuses on the economic consequences of a re-intensification or prolongation of geopolitical tensions. It “envisages a widespread resurgence of supply chain disruptions, leading to lower growth and higher inflation. Second-round effects stemming from a wage-price spiral would further exacerbate inflationary pressures, ultimately leading to a re-appraisal of market expectations of interest rates across tenors and currencies. Concerns about the persistent effects of severe adverse shocks are reflected in a larger increase of expected market rates at the short end of the yield curve than at the long end. This contributes to a further inversion of the yield curve. Despite expectations of decreasing inflationary pressures over time, growth will continue to be adversely affected. The resulting tightening of financing conditions would heterogeneously increase government bond rates and would weigh on corporate profitability, widen credit spreads and have a negative impact across other asset classes.”

Both market and insurance stresses are specified, with the stress test being multivariate, meaning all stresses occur simultaneously. Market-specific and insurance-specific shocks derived from the narrative are calibrated to be severe but plausible and affect both the asset and liability side of the balance sheet of insurers, as well as their liquidity in-flows and out-flows. Some of the key points are highlighted in the next two subsections, but full details are available in the technical specifications² published by EIOPA.

Market

Market shocks are assumed to represent one-off, instantaneous and simultaneous shifts in asset prices relative to their end-2023 levels.

The stresses include an increase to risk-free rates, increases to corporate and government bond spreads, equity downward stresses, property downward stresses and specified downward stresses to other asset types. Notably, the scenario does not consider potential credit rating downgrades, which would not be unusual in such adverse market conditions.

The shocks are quite significant, e.g. approx. 40% to 50% equity shocks, 100-300 basis points (bps) spread increase on AAA-rated corporates and 400-600bps spread increase on B-rated corporates, to give just a few examples. The shocks vary by currency and/or region.

Insurance

The prescribed insurance shocks cover the elements shown in the table in Figure 1, with some differences in scope between life and non-life business (”X” represents where a stress is to be applied).

Some of the key points include:

• Lapse: A 20% mass lapse of individual life products, excluding some product lines like term assurance and health insurance. The liquidity element is that these lapse claims are to be paid within 90 days.
• Claims: Only to be applied to non-life and health similar to life techniques (SLT) business. A 5% increase for claims in year 1, decreasing percentage shock for later years.
• Expenses: Inflation of 1.5% in year 1, lower and decreasing percentages for later years.
• Reinsurance inflows: Haircut of 5%.
• Written premia: Reduction of 10%.

Is there value in considering the stress test in your company’s ORSA?

I will now return to the key question posed earlier, on whether the stress above is worth including in your company’s ORSA process.

I see a number of potential advantages to inclusion:

• This is a topical scenario, of relevance to current events (i.e., geopolitical tensions), that may be very useful in keeping your company’s ORSA fresh and relevant. As we noted in a recent ORSA briefing note,³ better design and calibration of scenarios is a key theme. Most companies review and recalibrate scenarios on an annual basis, including introducing new scenarios reflecting current hot topics. We also noted the importance of assessing emerging risks in the ORSA. Use of this EIOPA scenario may help your company ensure that these important aspects are included in the next ORSA.
• Significant expertise and resources were dedicated by EIOPA, and other bodies like the European Systemic Risk Board (ESRB), to developing a narrative and consistent parameters for a significant stress scenario. These bodies offer an objective viewpoint. Your company might gain a lot by leveraging this work and expertise—and testing its resilience to this shock.
• The stress represents what seems to be a coherent and plausible (if, in some respects, severe) combined shock scenario, which is something that some companies struggle with developing. It is also something that regulators often want to see more of as opposed to companies focusing on individual stresses.
• It is quite a severe test with significant negative impacts. A test like this could give a good indication of how robust your company is to a severe shock, which is of course one of the central purposes of the ORSA. It may be more suitable than other severe stresses for some of the previous reasons given above, particularly its alignment to current geopolitical tensions (though that’s not to say other severe stresses shouldn’t also be considered).
• Many boards may be interested in understanding the impact of industry stresses on their companies.

Of course, if you are simply including the stress in your company’s ORSA and are not formally in scope of EIOPA’s exercise, you don’t need to complete the EIOPA submission templates, which are quite extensive, or adhere to the submission timelines. Therefore, you can integrate the EIOPA stress into your company’s own ORSA processes and timelines reasonably seamlessly. For any companies that have already completed the quantitative assessment work for their current ORSA at this stage, it might still be useful for you to consider the EIOPA stress qualitatively before the ORSA is finalised.

Will the stress scenario be fully suitable for assessing your company’s risks?

This is for individual risk functions and other stakeholders to determine. You can potentially adapt the stresses to your own company as you see fit. The market stresses are likely to be broadly applicable, noting that companies could also consider incorporating a credit rating downgrade stress where relevant. You may wish to tailor insurance stresses to your own risk profile for ORSA purposes. For example, some companies might consider it appropriate to apply a greater reduction than 10% to written premiums as part of an adapted version of the EIOPA stress test. Another example is that life (re)insurers may consider it appropriate to add a claims shock for one or more of mortality, morbidity and longevity risk, which isn’t part of EIOPA’s stress test.

Rather than considering the scenario with and without management actions, as required by the EIOPA reporting template, you can follow your company’s usual approach to management actions in the ORSA.

Conclusion

My personal opinion is that there is value in considering the EIOPA insurance stress test, at the scenario selection stage, as a possible scenario option for your next ORSA.

¹ EIOPA. Insurance Stress Test 2024. Retrieved 19 June 2024 from https://www.eiopa.europa.eu/insurance-stress-test-2024_en.

² EIOPA (22 April 2024). Insurance Stress Test 2024 Technical Specifications. Retrieved 19 June 2024 from https://www.eiopa.europa.eu/document/download/dc30f624-2688-409a-95f5-05676e375b0b_en?filename=EIOPA-BoS-24-087_2024%20Stress%20test%20-%20Technical%20specifications.pdf.

³ Clarke, S., Glynn, S. & Bowler, A. (April 2024). 10 Years of ORSA: Is It Adding Value to Your Business? Milliman Briefing Note. Retrieved 19 June 2024 from https://ie.milliman.com/-/media/milliman/pdfs/2024-articles/4-15-24_dublin-orsa-briefing-note.ashx.