Key drivers of solvency II stress test

On 1st January 2016, after a long period of political and technical negotiations the Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) was implemented and insurance companies of EU countries began to work under new conditions. The persistent low yield environment is heavily affecting the EU financial services industry and it is becoming a severe threat for the life insurers in terms of solvency and sustainability of their business models. The current low interest rate environment poses two types of risk for insurance companies (EIOPA Financial Stability Report, 2013). First risk consists that cash flow risks arise from a narrowing yield spread, as new premiums and returns on maturing investment are reinvested at lower yields relative to the yields that insurers have committed to pay. The available margin on this business is thus gradually eroded by a low yield environment if no action is taken to alter the underlying position. Second risk - valuation risks are linked to the calculation of present values of assets and liabilities of insurance companies, which means that under low interest rates, a decline in benchmark interest rates will be also reflected in the discount rate applied to liabilities. The main purpose of this paper is to present the key drivers of of Solvency II stress test.