(Bloomberg) — One in four European insurers may struggle to meet promises to policyholders in a prolonged period of low interest rates, the European Union’s insurance watchdog said following a stress test of the industry.
These insurers will need to raise capital and watch their balance sheets and investments more closely, the European Insurance and Occupational Pensions Authority, or Eiopa, said today during a conference call from Frankfurt. It has been running tests on the industry since April to see how it would be hurt if interest rates remain low for the foreseeable future.
About 24 percent of insurers wouldn’t meet their solvency capital ratio in a Japanese-style low-yield environment, which could leave some struggling in eight to 11 years, the regulator said. The capital shortfall under the low interest rate scenario is about 8.3 billion euros ($10.3 billion) and the companies, which it didn’t identify, will need to close this gap.
“We recommend national authorities to examine thoroughly the asset, liability and the risks management strategies and practices of these insurers,” Gabriel Bernardino, chairman of Eiopa, told reporters during the conference call. If companies continue with an “unsustainable business model,” then local regulators should intervene to protect policyholders.
In general, the test showed the industry is “sufficiently capitalized,” Eiopa said.
The European Union plans to introduce risk-based capital requirements for insurers starting in 2016. Called Solvency II, the rules specify how much carriers such as Allianz SE or Axa SA must hold to meet future obligations and to safeguard customers’ money.
Eiopa, which is one of the three European supervisory bodies for the financial industry, used the historical Japanese swap curve from December 2012 as the basis for valuing insurer assets and liabilities during an enduring low-yield environment. In another scenario, it looked at equity market and corporate bond distress effects on insurers’ balance sheets.
The test gave EU supervisors an updated picture of insurers’ “preparedness to comply with the upcoming Solvency II capital requirements and by applying a set of rigorous and severe stresses indicated to us the areas where undertakings are most vulnerable,” according to Bernardino.
Insurers, which typically invest the majority of capital in fixed-income securities, are seeing earnings depleted by years of record-low interest rates. The European Central Bank has cut its benchmark rate to a record-low 0.05 percent and began buying covered bonds, those backed by cash flows from loans, to boost inflation and rekindle economic growth.
About 225 companies from 28 EU countries and Norway were subjected to the low-yield test, Eiopa said.
Jonathan Hill, the EU commissioner for financial services, said today the stress tests, designed to prevent some of the issues detected, were serious and thorough.
See also: LTCI Watch: Rates.