Low reinvestment rates could cause major problems for European insurers, with one in four insurers expected to fall short of capital if low interest rates persist.
The European Insurance and Occupational Pensions Authority (Eiopa) released the results of its EU-wide industry stress tests on 30 November, the first conducted on a Solvency II basis.
Eiopa estimates that some insurers would have problems fulfilling their obligations in eight to 11 years' time, as cash flows turn negative.
Austria, Germany, the Netherlands and Sweden were identified as the most vulnerable countries because of the duration and return rate mismatch in balance sheets.
Unlike the banks, the watchdog did not disclose the names of the insurers considered more vulnerable.
The warning comes as the European Central Bank is weighing up extraordinary measures to ease monetary policy, since cutting interest rates to 0.05% in September.
Eiopa tested the resilience of the industry against a Japanese-like scenario, characterised by protracted low interest rates and subdued inflation. In such a case, 24% of the insurers that participated in the exercise would fall below the solvency capital requirement (SCR).
Low interest rates act as slow poison for insurers as they prevent them from reinvesting at previous return rates. This is a problem for firms selling products with long-term guarantees, in particular if assets and liabilities are not duration matched.
Eiopa urged national supervisors to ensure that companies assess the sustainability of guaranteed rates being offered.
"If companies continue offering unsustainable rates, supervisors are expected to take action to protect policyholders," Gabriel Bernardino, chairman of Eiopa said in a press conference.
The perfect storm for insurers, however, would be an abrupt fall in the value of assets accompanied by a decrease in the discount rate, which would push the value of liabilities up.
The study found that after this most severe 'double hit' 54% of insurers would still hold enough capital to meet SCR, but small firms were found to be in a worse shape than large entities.
Mass lapses, longevity and natural catastrophes were found to be the major vulnerabilities concerning insurance-specific stresses.
Bernardino said that insurers over the next year – before Solvency II comes into force - must address vulnerabilities and build the capacity to recover from those shocks.
Eiopa expects some firms to raise additional capital, but more generally companies will take action to manage the balance sheet, through de-risking asset portfolios or buying reinsurance protection.
Olav Jones, deputy director general at trade body Insurance Europe, claimed that the tests proved the resilience of the industry.
"The stresses used were very severe and covered all the major risks that insurers take on to protect their policyholders," he said. "The fact that the insurers' capital went down after these kinds of severe events is quite normal. To see that, even after such severe events, generally companies will still be able to meet their full solvency capital requirements is an indication that overall levels of solvency are very high."
