MILLIMAN BRIEFING NOTE EIOPA’s Insurance Stress Test Exercise 2018 June 2018 Overview The names of the participating UK insurance groups are listed On 14 May 2018, the European Insurance and Occupational in the following table. Pensions Authority (“EIOPA”) launched its fourth (previously in 2011, 2014 and 2016) stress test exercise1 for the 42 largest Company insurance groups in the European insurance sector. EIOPA Aviva plc develops these regular EU-wide stress tests to support the stability and transparency of the financial system. Legal and General plc The 2018 EIOPA stress test exercise aims to assess the Prudential plc vulnerability of the EU insurance sector, and comprises of three specific hypothetical adverse scenarios which are informed by Standard Life Aberdeen plc current market conditions, the risk climate and their potential Scottish Widows/LBGI impact on the insurance sector. In addition to these stress tests, EIOPA have included, for the first time, a cyber risk The Royal London Mutual Insurance Society Limited questionnaire, asking firms for information on their exposure to, and management of, cyber risk. A separate Milliman paper2 Phoenix Group Holdings provides an analysis of the cyber risk questionnaire, and ReAssure Limited discusses the disclosure requirements and why firms outside of EIOPA’s target group might be interested in the questionnaire. RSA Insurance Group plc Although only the largest European insurance groups are A full list of the participating insurance groups is provided in required to participate, other non-participating insurers may find Appendix A. the 2018 stress tests and the results of interest, for example: . To gain an understanding the European regulator’s Motivation concerns; EIOPA’s previous stress test exercise in 2016 covered two . To inform the choice and calibration of their own scenarios: scenarios assessed in the Own Risk and Solvency . A prolonged low yield scenario; and Assessment (“ORSA”); and . A double-hit scenario: an abrupt increase in risk premia . For employing the stress scenarios and benchmarking combined with a prolonged low yield. the results to the participating insurance groups. EIOPA subsequently provided a number of recommendations3 Participating insurance groups to NCAs, including for them to encourage firms to assess the risk of prolonged low interest rates. Forty-two of the largest EU insurance groups (based on size, EU-wide market coverage and conducted business lines, both The 2018 stress tests follow up on a complex set of risks that were not tested in the 2016 exercise and aim to reflect the life and non-life) have been selected to participate in the 2018 changes in macroeconomics and market conditions that have stress test exercise. These insurance groups represent almost occurred over the past two years. EIOPA has stated that the 78% (based on consolidated Solvency II group assets) of the European market and therefore collectively have a significant key objectives of the 2018 exercise are: influence on European financial stability. This sample includes . To assess the vulnerability of the European insurance the top 30 groups plus 12 additional groups supervised by sector to specific adverse scenarios which could trigger different National Competent Authorities (“NCAs”). systemic risk across financial sectors and threaten the stability of European financial markets; 1 3 EIOPA's 2018 Stress Test Exercise EIOPA's Insurance Stress Test 2016 Recommendations 2 EIOPA's 2018 Stress Tests: Cyber Risk Questionnaire paper Milliman does not certify the information in this update, nor does it guarantee the accuracy and completeness of such information. Use of such information is voluntary and should not be relied upon unless an independent review of its accuracy and completeness has been performed. Materials may not be reproduced without the express consent of Milliman. Copyright © 2017 Milliman, Inc. 1 June 2018 MILLIMAN BRIEFING NOTE . To raise awareness of potential threats of the European . 2 central and eastern European floods; and insurance sector to European market stability; . 2 Italian earthquakes. To assess whether the European insurance sector can The two charts below provide a comparison of the risk-free withstand the challenges within the tested scenarios; curves in the Yield Curve Up and Yield Curve Down scenarios . To test the impact of adverse scenarios at group level to EIOPA’s base risk-free curves used for the calculation of the (the 2016 stress test exercise was tested at solo level); Solvency II Technical Provisions, and the Interest Rate Up and and Interest Rate Down curves used for the calculation of the Solvency II Solvency Capital Requirement (“SCR”). The curves . To enhance the transparency of the European shown are those for Pound Sterling, as at 31 December 2017, insurance industry towards the market and and do not include allowance for the Solvency II Volatility policyholders (voluntary disclosure of individual post- Adjustment. stress balance sheet and capital position will be requested by EIOPA). To summarise: Stress scenarios . The Yield Curve Up curve is lower than the Solvency II SCR Interest Rate Up curve (i.e. a lower up stress than The three adverse scenarios (Yield Curve Up, Yield Curve Down that required for the calculation of the SCR) until and Natural Catastrophe) to be tested in the 2018 exercise have approximately the 75 year term, and higher after this been chosen because they have the potential to produce a point (i.e. a more onerous stress). significant negative impact on European financial markets and . The Yield Curve Down curve is lower than the SCR the wider economy, while retaining plausibility. The scenarios Interest Rate Down curve for the entire curve duration, were composed to encompass a wide range of risks, including a implying a more onerous down stress than that combination of market and insurance specific risks. required for the calculation of the SCR (i.e. less The Yield Curve Up scenario includes: probable than a 1 in 200 event). A sudden significant increase in risk-free rate curves; Yield Curve Up vs EIOPA's Solvency II curves . Instantaneous market shocks to swap rates, 4.50% EIOPA government bonds, corporate bonds, Residential 4.00% Solvency II Base Mortgage Backed Securities, Equities, Stock prices, 3.50% 3.00% real-estate and other assets; 2.50% Yield Curve Up . A significant increase in lapse rates; 2.00% Interest Interest Rate 1.50% . An increase in claim provisions deficiency; and 1.00% EIOPA SCR 0.50% Interest Rate Up . A significant increase in inflationary pressures. 0.00% 0 10 20 30 40 50 60 70 80 90 110 120 130 140 150 The Yield Curve Down scenario includes: 100 Year . A prolonged low interest rate environment (via an instantaneous change of the relevant risk-free interest Yield Curve Down vs EIOPA's Solvency II curves rate term structure, including an adjustment of the 3.50% EIOPA ultimate forward rate); Solvency 3.00% II Base . Instantaneous market shocks to swap rates, 2.50% Yield government bonds, corporate bonds, Residential 2.00% Curve Down Mortgage Backed Securities, Equities, Stock prices, 1.50% Interest Interest Rate 1.00% EIOPA real-estate and other assets; and SCR 0.50% Interest An increase in longevity. Rate . 0.00% Down 0 10 20 30 40 50 60 70 80 90 110 120 130 140 150 The Natural Catastrophe includes a series of natural 100 catastrophes in a short time-frame: Year . 4 windstorms; Milliman does not certify the information in this update, nor does it guarantee the accuracy and completeness of such information. Use of such information is voluntary and should not be relied upon unless an independent review of its accuracy and completeness has been performed. Materials may not be reproduced without the express consent of Milliman. Copyright © 2017 Milliman, Inc. 2 June 2018 MILLIMAN BRIEFING NOTE Methodology Individual disclosure The 2018 stress test exercise is a bottom up exercise and As one of the aims is to increase transparency, the information insurers must calculate the impact of the 3 scenarios on their collected under the baseline and the stress scenarios will be group balance sheet, own funds and SCR (recalculation of the partly individually disclosed, upon the consent of the capital position was not required for the 2016 exercise). In participating groups, and partly reported at aggregated level. addition, the participating groups are asked to explain the main The individual disclosure will cover the impact of the scenarios drivers of the impact of the scenarios on their balance sheets on the group balance sheet, including the impacts on the and solvency position. The key points in respect of methodology Solvency II long-term guarantees measures such as the are listed below: Volatility Adjustment, the Matching Adjustment and the Transitional Measures. This is a key change to EIOPA’s . The reference date for the scenarios is 31 December previous stress test exercises, and we expect participating 2017; insurance groups to think carefully about this approach, . The base scenario is the pre-stressed group position at particularly if the scenarios result in a breach of SCR, given that the reference date, and must be aligned to the group’s the public may interpret this to be a sign of weakness. The 2017 Solvency II reporting; results of those participating groups which do not consent for the public disclosure of their results will be incorporated in the . The shocks in each scenario must be applied to the aggregated figures to the extent that they cannot be individually entire in-force business at the reference date and identified. should be assumed to occur instantaneously and permanently; . A static balance sheet should be assumed, not allowing Timeline for second order effects or future management actions (although firms may separately want to consider the The timeline for the 2018 insurance stress test exercise is as management actions available in these scenarios); follows: Mid-May – 3rd week of June 2018: Q&A process (the .