EIOPA Publishes Discussion Paper on Insurer Stress Testing Framework

The section on climate change sets out methodological principles to incorporate climate change risks in a stress testing framework, which can be used when developing future EIOPA bottom-up stress test on climate change risk. The climate change section covers transition and physical risks. Given the forward-looking, long term, and exploratory nature of the exercise, the proposal is based on a step-by-step approach initiating from the assessment of vulnerability of the insurers based on their current exposures, complemented by a forward-looking assessment of the potential changes in the business models and their implications to policyholders and potential spillover to other markets. Technically, the proposed approach is based on a medium-to-long term time horizon, with end-of-modeling horizon impacts evaluated as an instantaneous shock without reactive management actions. The main challenges in modeling the transition risk are granularity of the asset classification and calibration of the shocks. Given the long-term nature of the risks, the proposed metrics are mainly based on the Solvency II balance sheet. 

The section on liquidity stress testing sets out methodological principles that can be used to design stress test exercises to assess the vulnerability of insurers to liquidity shocks. It proposes a step-by-step approach starting from the micro-objective of assessing the vulnerability of the insurers to liquidity shocks, complemented by a quali-quantitative questionnaire on the potential reactions to the adverse scenario. The stress test builds over the definition of the liquidity sources and of the liquidity needs of the insurance company. The metrics are specifically designed for liquidity purposes, thus no standard Solvency II capital-based indicators are requested. 

The section on multi-period framework for the bottom-up insurance stress testing aims presents, from a theoretical perspective and without the aim of completeness, the major challenges implied in the introduction of a multi-period approach in a bottom-up insurance stress test exercise. The focus on the main theoretical endeavor is the definition of the guidelines on how to treat the future business and the reactive management actions over the period of the exercise. Process-wise, the discussion covers the limitation of the process applied so far by EIOPA in its bottom-up stress test exercises and suggests a new approach based on the iterative calculation/validation process. As a final remark, the multi-period approach is considered doable but at a high cost, thus an accurate cost-benefit analysis would be requested before initiating an exercise.

Related Links

• Press Release
• Discussion Paper (PDF)

Comment Due Date: October 02, 2020

 Keywords: Europe, EU, Insurance, Stress Testing, Methodological Principles, Bottom-Up Stress Testing, Climate Change Risk, Liquidity Risk, ESG, Solvency II, EIOPA