EIOPA published a paper that sets out the methodological principles of insurance stress testing with a focus on the liquidity component. The paper sets out methodological principles that can be used to design bottom-up stress test exercises to assess the vulnerability of insurers to liquidity shocks. This second methodological paper is part of a series of papers, has been published post a stakeholder consultation, and represents a further step in enhancement of the stress testing framework of EIOPA.
The Solvency II regime is designed to ensure a sound capital position of insurance and reinsurance undertakings but it does not include quantitative requirements and relative metrics with respect to liquidity position. The absence of a commonly agreed approach to assess the liquidity sources and needs of insurers and reinsurers, the subsequent absence of standardized metrics such as Solvency Capital Requirement (SCR) for the capital position, and the lack of a specifically designed data collection makes a methodological discussion on the liquidity stress test more difficult. Considering this, the paper proposes a definition of “liquidity position” and specific metrics to measure this position for an insurance and reinsurance undertaking. Amid the increasing consideration given to liquidity risk by the insurance industry and by the supervisors at European and global levels as well as in the absence of a commonly adopted liquidity framework for industry in EU, the paper presents a conceptual approach to the assessment of the liquidity position of insurers under adverse scenarios.
The paper provides the background on liquidity risk in the insurance industry as well as a definition of liquidity risk for the sector. The paper describes the micro- and macro-prudential objectives of liquidity stress test exercise and elaborates on the scope of a stress test exercise. It further describes the building blocks of a liquidity stress test exercise starting from the exposures of insurers to liquidity risk and the potential metrics to measure them. The paper also presents the proposed approach to the design of scenarios to be used in liquidity stress test, including narrative, shocks, and their calibration. The guidelines on the application of the shocks with some examples on potential analysis and presentation of results are also included in the paper. The conclusions are based on the current understanding and knowledge of the liquidity risk in the insurance industry. Hence, this might evolve in the future to reflect the experience gained in the assessment of such risk at European and global levels. Other topics such as climate change and multi-period framework for the bottom-up insurance stress testing will be published at a later stage.
Keywords: Europe, EU, Insurance, Stress Testing, Liquidity Risk, Solvency II, Liquidity Stress Test, EIOPA
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