## 1cheea2019006 - EXECUTIVE SUMMARY

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### Executive summary: resilience and key trends
- Swiss insurers are broadly resilient against the market shocks evaluated in the stress test.
- Six insurance groups participated on a consolidated basis, covering a market share of 56 and 45 percent in the domestic life and non-life sectors, respectively.
- The Swiss Solvency Test (SST) is the solvency standard used; all six participants record solvency ratios well above the regulatory threshold of 100 percent.
- Investment holdings of participants (excluding unit-linked business) are concentrated in fixed-income securities:
  - 37 percent in sovereign bonds,
  - 29 percent in corporate bonds,
  - 11 percent in real estate.
- Bond investments are of good credit quality: 59 percent rated AAA or AA, and 96 being investment grade.
- Investment yields came down from 3.3 percent in 2013/14 to 2.5 percent in 2017; return on equity averaged 8 percent over the last five years.
- Life-insurance liabilities: 48 percent carry no guarantee or a rate of up to 1 percent; 29 percent have a guaranteed rate of more than 2 percent.
- Non-life insurers: combined ratios of primary non-life insurers were consistently below 90 percent over the last five years; return on equity averaged 17 percent.

### Main policy recommendations (summary)
- Regularly conduct stress tests for large insurers, based on macrofinancial scenarios, and analyze insurers’ potential for recovery after stress (Responsible: FINMA); Timing: ST; Priority: H.
- Closely monitor the credit spread and real estate exposures of insurers, including co-movements of risk factors and insurers’ risk mitigation techniques (Responsible: FINMA); Timing: ST; Priority: M.

### A. Scope of the stress test and insurers’ risk profile
- Methodology:
  - Resilience assessed through bottom-up (BU) and top-down (TD) stress tests.
  - Six insurance groups participated on a consolidated group basis, including all insurance activities worldwide; one large insurer was excluded due to an ongoing restructuring of its Swiss life insurance business.
- Business-model adjustments and market context:
  - Decline in new individual life business, especially traditional (guaranteed) life products.
  - Hybrid products introduced (partially unit-linked, partially guaranteed); regulatory maximum guarantees currently: 0.05 percent for single premium and 0.25 percent for annual premium.
  - Companies introduced shorter-term guarantees and “capital light” products with internal equalization reserves.
  - Group life: reduced capacity in full coverage insurance (“Vollversicherung”), increased reinsurance of death and disability risks.
  - Insurers expanded mortgage loan portfolios in search for higher yields, increasing exposure to real estate and potential liquidity risks.
- Geographic composition and ratings:
  - Sovereign bond exposures: Swiss government bonds 16 percent; U.S. government bonds 20 percent; German government bonds 11 percent.
  - In the sovereign bond portfolio, 83 percent carry a AAA or AA rating.

### B. Adverse scenario specification
- Scenario design:
  - Broadly aligned with the banking stress test’s macrofinancial shocks; focuses on market risks relevant for insurers.
  - Scenario assumes an instantaneous shock at the reference date; companies project business development for a three-year period after the shock.
  - Shocks cover: risk-free interest rates, equity and property prices, corporate and sovereign credit spreads, higher default rates for mortgage loans, and an appreciation of the Swiss franc versus major currencies.
  - Reference date for non-discretionary management actions and asset repricing: June 30, 2018 (instantaneous shock).
- Single-factor sensitivity (counterparty default) haircuts (not added to scenario results):
  - 100 percent write-off for equity exposures, subordinated bonds and loans, uncollateralized OTC derivative exposures, and guarantees for the counterparties’ liabilities.
  - 50 percent write-off for bonds and loans.
  - 15 percent write-off for deposits (beyond protected exposures), loaned securities, collateralized OTC derivative exposures.
- Additional scenario details:
  - For coherence with insurance time horizons, the stress scenario’s financial market variables are defined more granularly than in the banking test.
  - Appendix references provide detailed shocks by asset class and rating bucket.

### C. Capital standard and modeling assumptions
- Capital framework:
  - Stress tests and sensitivity analyses built on the Swiss Solvency Test (SST).
  - Main BU output: effect on risk-bearing capital (RBC) and subsequent coverage of the target capital; participants recalculated target capital after stress (no re-calibration of risk models requested).
- Modeling assumptions and data requests:
  - Three participating groups used internal models approved by FINMA.
  - Management actions allowed only if non-discretionary arrangements were in place at the reference date.
  - Undertakings provided three-year projections under baseline and adverse scenario for premiums, claims, lapse rates, investment returns, net earnings, insurance liabilities, risk-bearing capital, and target capital.
  - For TD exercises, required inputs included granular investment asset breakdowns (geography, ratings, maturities, coupon rates) and cash-flow projections for the upcoming 50 years.
  - TD stress test applied haircuts and re-valued fixed-income assets and technical provisions with stressed term structures; TD output: assets over liabilities ratio (no SST coverage ratio calculated in TD).

### D. Results of the stress tests (BU and TD)
- Pre-stress position:
  - All six participants recorded solvency ratios well above the regulatory threshold of 100 percent.
  - Median SST coverage: 224 percent.
  - Target capital decomposition (pre-stress): market risk and underwriting risk largest components, accounting for 54 and 52 percent of post-diversification target capital, respectively.
  - Quality of RBC: 90 percent core capital, 5 percent upper supplementary capital, 5 percent lower supplementary capital.
- Adverse-scenario outcomes (BU):
  - Median SST ratio drops from 224 to 176 percent; no company falls below 100 percent.
  - Assets decline by 4 percent (equivalent to 49 percent of risk-bearing capital).
  - Liabilities decline by 1 percent (equivalent to 10 percent of risk-bearing capital); best estimate of group life liabilities declines significantly.
  - Asset-class impacts (contribution to RBC reduction):
    - Fixed-income assets shrink by an amount equivalent to 24 percent of risk-bearing capital.
    - Equity holdings reduce RBC by 9 percent.
    - Real estate holdings reduce RBC by 11 percent.
  - Aggregate market losses: bond, equity and real estate losses together amount to 45 percent of risk-bearing capital.
  - Stress more pronounced for life business due to longer maturities and higher sensitivity to spread changes; non-life and unit-linked life businesses are less affected.
- TD versus BU (cross-checks and main TD findings):
  - TD calculations cannot mirror the granularity of companies’ BU calculations; risk-mitigating mechanisms can only be very roughly approximated.
  - For the median insurer:
    - Assets over liabilities drop from 117 percent before stress to 111 percent in the BU exercise and to 108 percent in the TD exercise.
  - TD modular impact decomposition:
    - Excess of assets over liabilities declines by CHF 57 bn.
    - Decline of assets by CHF 74 bn is partially compensated by lower liabilities.
    - The largest net impact stems from higher credit spreads for sovereign and corporate bonds (together 51 percent of the overall effect).
    - Sizable effects also attributed to the real estate shock and the equity shock.
    - Interest rate shock and currency shock contribute considerably less; the interest rate shock is slightly positive.
  - Impact from higher mortgage loan defaults is marginal given rather low Loan-to-Value (LTV) ratios in current portfolios.
- Solvency projections and profitability after stress:
  - Swiss insurers remain profitable after stress even when assuming no recovery in asset prices.
  - Companies project solvency rates to start improving gradually in the year following the stress based on solid underwriting business and favorable technical results.
  - Median company SST ratio trajectory:
    - Reference date (end of June 2018): 176 percent (median).
    - Year-end (end-2018): 168 percent (median).
    - Two years later (end-2020): 184 percent (median).
- Natural disasters and counterparty default shocks:
  - Natural disasters:
    - Largest losses expected after a U.S. hurricane or an earthquake in the Western U.S.
    - A 1-in-100-year event would cause gross losses of up to 6 percent of risk-bearing capital and 4 percent after reinsurance.
    - A 1-in-500-year event would reduce risk-bearing capital by only up to 12 percent before reinsurance coverage.
    - Domestic catastrophe risks could impact smaller insurers with concentrated local exposure; large groups would be only marginally affected.
  - Banking counterparty default:
    - Participating groups have no concentrated exposures towards the Swiss G-SIBs.
    - Default of the largest banking counterparty reduces the median SST ratio from 224 to 222 percent (first-round impact).

### E. Challenges in a prolonged low-yield environment
- Investment horizon and reinvestment risk:
  - Implementation of the SST improved asset-liability matching and lengthened investment horizons.
  - More than 50 percent of fixed-income investments will only expire after 2025.
  - For instruments expiring after 2025, the average coupon rate amounts to 3.1 percent.
  - Projecting a roll-over of maturing bonds at a constant future coupon of 1.0 percent will reduce the average coupon earned to 2.0 by the year 2027.
- Investment returns and spread over guarantees:
  - Insurers expect investment returns to decline even in the baseline scenario:
    - About 3.0 percent for the median company in 2015–17.
    - About 2.3 percent for 2018–20.
  - Insurers more active in non-life and unit-linked life business are less affected and could sustain a prolonged low-yield environment.
  - Companies with a high stock of guarantees on policies are likely to experience a drain on profitability.

### Key financial soundness indicators (selected)
- Solvency coverage ratio (SST) — life:
  - 2013: 153
  - 2014: 149
  - 2015: 147
  - 2016: 160
  - 2017: 178
- Solvency coverage ratio (SST) — non-life:
  - 2013: 203
  - 2014: 191
  - 2015: 201
  - 2016: 228
  - 2017: 231
- Investment yield — life:
  - 2013: 3.3
  - 2014: 3.3
  - 2015: 3.1
  - 2016: 2.9
  - 2017: 2.5
- Shareholder equity and reserves / total assets — life:
  - 2013: 7.7
  - 2015: 7.4
  - 2017: 7.3
- Shareholder equity and reserves / total assets — non-life:
  - 2013: 29.0
  - 2015: 29.2
  - 2017: 25.7
- Liquid assets / total investments excl. unit-linked:
  - 2013: 53.8
  - 2015: 53.4
  - 2017: 50.8

### Findings and policy recommendations (detailed)
- Key findings:
  - Starting capital positions are strong; median SST coverage 224 percent pre-stress, 176 percent after adverse scenario.
  - Market shocks (credit spreads, equity, real estate) are the main drivers of losses; interest rate and currency shocks contribute less.
  - Life business is more sensitive to the scenario than non-life business.
- Policy recommendations for FINMA:
  - Regularly conduct stress tests for large insurers, based on macrofinancial scenarios, and analyze insurers’ potential for recovery after stress.
    - Scenarios should reflect the current position in the financial cycle and comprehensively include all material risk factors.
    - A forward-looking perspective should be established by analyzing the ability of insurers to reestablish profitability and solvency after stress.
    - Stress test results should be used to challenge companies’ Own Risk and Solvency Assessments (ORSA) and underlying projections for future business, specifically expectations for premium growth and investment returns.
  - Closely monitor credit spread and real estate exposures of insurers, including co-movements of risk factors and insurers’ risk mitigation techniques.
    - Stress test revealed significant sensitivities of insurers’ risk-bearing capital to credit spread increases; follow-up is important.
    - For real estate exposures, FINMA should consider potential concentration risks, particularly for insurers that also invest in mortgages, and implications for liquidity.

*Source: IMF staff calculations based on company submissions.*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 4

### 1cheea2019006 - EXECUTIVE SUMMARY ___________________________________________________________________________ 4

### Executive summary: resilience and key trends
- Swiss insurers are broadly resilient against the market shocks evaluated in the stress test.
- Six insurance groups participated on a consolidated basis, covering a market share of 56 and 45 percent in the domestic life and non-life sectors, respectively.
- The Swiss Solvency Test (SST) is the solvency standard used. All six participants record solvency ratios well above the regulatory threshold of 100 percent.
- Investment holdings of participants (excluding unit-linked business) are concentrated in fixed-income securities:
  - 37 percent in sovereign bonds,
  - 29 percent in corporate bonds,
  - 11 percent in real estate.
- Bond investments are of good credit quality: 59 percent rated AAA or AA, and 96 being investment grade.
- Investment yields came down from 3.3 percent in 2013/14 to 2.5 percent in 2017; return on equity averaged 8 percent over the last five years.
- Life-insurance liabilities: 48 percent carry no guarantee or a rate of up to 1 percent; 29 percent have a guaranteed rate of more than 2 percent.
- Non-life insurers: combined ratios of primary non-life insurers were consistently below 90 percent over the last five years; return on equity averaged 17 percent.

### Main policy recommendations (Table 1)
- Regularly conduct stress tests for large insurers, based on macrofinancial scenarios, and analyze insurers’ potential for recovery after stress (Responsible: FINMA); Timing: ST; Priority: H.
- Closely monitor the credit spread and real estate exposures of insurers, including co-movements of risk factors and insurers’ risk mitigation techniques (Responsible: FINMA); Timing: ST; Priority: M.

### A. Scope of the stress test and risk profile
- Methodology:
  - Resilience assessed through bottom-up (BU) and top-down (TD) stress tests.
  - Six insurance groups participated on a consolidated group basis, including all insurance activities worldwide.
  - One large insurer was excluded due to an ongoing restructuring of its Swiss life insurance business.
- Business-model adjustments and market context:
  - Decline in new individual life business, especially traditional (guaranteed) life products.
  - Hybrid products introduced (partially unit-linked, partially guaranteed); regulatory maximum guarantees currently: 0.05 percent for single premium and 0.25 percent for annual premium.
  - Companies introduced shorter-term guarantees and “capital light” products with internal equalization reserves.
  - Group life: reduced capacity in full coverage insurance (“Vollversicherung”), increased reinsurance of death and disability risks.
  - Insurers expanded mortgage loan portfolios in search for higher yields, increasing exposure to real estate and potential liquidity risks.
- Geographic composition and ratings:
  - Sovereign bond exposures diversified: Swiss government bonds 16 percent; U.S. government bonds 20 percent; German government bonds 11 percent.
  - In the sovereign bond portfolio, 83 percent carry a AAA or AA rating.

### B. Adverse scenario specification
- Scenario design:
  - Broadly aligned with the banking stress test’s macrofinancial shocks; focuses on market risks relevant for insurers.
  - Scenario assumes an instantaneous shock at the reference date; companies project business development for a three-year period after the shock.
  - Shocks cover: risk-free interest rates, equity and property prices, corporate and sovereign credit spreads, higher default rates for mortgage loans, and an appreciation of the Swiss franc versus major currencies.
  - Reference date for non-discretionary management actions and asset repricing: June 30, 2018 (instantaneous shock).
- Single-factor sensitivity (counterparty default) haircuts (not added to scenario results):
  - 100 percent write-off for equity exposures, subordinated bonds and loans, uncollateralized OTC derivative exposures, and guarantees for the counterparties’ liabilities.
  - 50 percent write-off for bonds and loans.
  - 15 percent write-off for deposits (beyond protected exposures), loaned securities, collateralized OTC derivative exposures.
- Additional scenario details:
  - For coherence with insurance time horizons, the stress scenario’s financial market variables are defined more granularly than in the banking test.
  - Appendix references provide detailed shocks by asset class and rating bucket (scenario table included in source).

### C. Capital standard and modeling assumptions
- Capital framework:
  - Stress tests and sensitivity analyses built on the Swiss Solvency Test (SST).
  - Main BU output: effect on risk-bearing capital (RBC) and subsequent coverage of the target capital; participants recalculated target capital after stress (no re-calibration of risk models requested).
- Modeling assumptions and data requests:
  - Three participating groups used internal models approved by FINMA.
  - Management actions allowed only if non-discretionary arrangements were in place at the reference date.
  - Undertakings provided three-year projections under baseline and adverse scenario for premiums, claims, lapse rates, investment returns, net earnings, insurance liabilities, risk-bearing capital, and target capital.
  - For TD exercises, required inputs included granular investment asset breakdowns (geography, ratings, maturities, coupon rates) and cash-flow projections for the upcoming 50 years.
  - TD stress test applied haircuts and re-valued fixed-income assets and technical provisions with stressed term structures; TD output: assets over liabilities ratio (no SST coverage ratio calculated in TD).

### D. Results of the stress tests
- Pre-stress position:
  - All six participants recorded solvency ratios well above the regulatory threshold of 100 percent.
  - Median SST coverage: 224 percent.
  - Target capital decomposition (pre-stress): market risk and underwriting risk largest components, accounting for 54 and 52 percent of post-diversification target capital, respectively.
  - Quality of RBC: 90 percent core capital, 5 percent upper supplementary capital, 5 percent lower supplementary capital.
- Adverse-scenario outcomes (BU):
  - Median SST ratio drops from 224 to 176 percent; no company falls below 100 percent.
  - Assets decline by 4 percent (equivalent to 49 percent of risk-bearing capital).
  - Liabilities decline by 1 percent (equivalent to 10 percent of risk-bearing capital); best estimate of group life liabilities declines significantly.
  - Asset-class impacts (contribution to RBC reduction):
    - Fixed-income assets shrink by an amount equivalent to 24 percent of risk-bearing capital.
    - Equity holdings reduce RBC by 9 percent.
    - Real estate holdings reduce RBC by 11 percent.
  - Aggregate market losses: bond, equity and real estate losses together amount to 45 percent of risk-bearing capital (as noted in the summary).
  - Stress more pronounced for life business due to longer maturities and higher sensitivity to spread changes; non-life and unit-linked life businesses are less affected.
- Cross-checks and projections:
  - TD and BU results used to benchmark each other; TD main output was assets over liabilities ratio.
  - Participants provided 50-year cash-flow projections for TD modeling; BU projections covered three years post-shock with market values assumed constant after instantaneous shock (recoveries driven by underwriting and recurring investment income only).

### E. Challenges in a prolonged low-yield environment
- Medium-term risks:
  - Insurers likely to face declining investment returns as higher-coupon bonds mature and are reinvested at lower rates.
  - Implementation of SST has improved asset-liability matching, lengthening investment horizons and limiting short-term reinvestment risks on aggregate.
  - Participating groups still record positive spreads of investment returns over guaranteed interest rates on aggregate.
  - Firms more active in non-life and unit-linked life business can better sustain prolonged low yields; firms with a high stock of guaranteed policies face profitability drains.

### F. Summary of findings and recommendations
- Key findings:
  - Starting capital positions are strong; median SST coverage 224 percent pre-stress, 176 percent after adverse scenario.
  - Market shocks (credit spreads, equity, real estate) are the main drivers of losses; interest rate and currency shocks contribute less.
  - Life business is more sensitive to the scenario than non-life business.
- Recommendations (recap):
  - Regular stress testing of large insurers with macrofinancial scenarios and recovery analysis (FINMA); ST, High priority.
  - Close monitoring of credit spread and real estate exposures, including co-movements and mitigation techniques (FINMA); ST, Medium priority.

*Source: IMF staff calculations and company submissions as summarized in the Executive Summary of the insurance stress test chapter.*

### 15.      Top-down calculations confirm the findings from the bottom-up exercise. TD

### 15. Top-down calculations confirm the findings from the bottom-up exercise. TD

### Top-down versus bottom-up: solvency and assets/liabilities
- TD calculations cannot mirror the granularity of companies’ own BU calculations; risk-mitigating mechanisms (financial hedging, options, guarantees, loss-absorbing capacity of some life insurance contracts) can only be very roughly approximated.
- For the median insurer:
  - Assets over liabilities drop from 117 percent before stress to 111 percent in the BU exercise and to 108 percent in the TD exercise.
  - The dispersion in the sample is slightly larger in the TD model.
- Impact decomposition (TD modular calculations):
  - Excess of assets over liabilities declines by CHF 57 bn.
  - Decline of assets by CHF 74 bn is partially compensated by lower liabilities.
  - The largest net impact on the excess of assets over liabilities stems from higher credit spreads for sovereign and corporate bonds (together 51 percent of the overall effect).
  - Sizable effects also attributed to the real estate shock and the equity shock.
  - Interest rate shock and currency shock contribute considerably less; the interest rate shock is slightly positive.
  - Stress is more pronounced for life business where bond investments have longer maturities and sensitivities to spread changes are higher.
  - Impact from higher mortgage loan defaults is marginal given rather low Loan-to-Value (LTV) ratios in current portfolios.

### Solvency projections and profitability after stress
- Swiss insurers remain profitable after stress even when assuming no recovery in asset prices.
- Companies project solvency rates to start improving gradually in the year following the stress based on solid underwriting business and favorable technical results.
- Median company SST ratio trajectory:
  - Reference date (end of June 2018): 176 percent (median).
  - Year-end (end-2018): 168 percent (median).
  - Two years later (end-2020): 184 percent (median).

### Natural disasters and counterparty default shocks
- Natural disasters:
  - Largest losses expected after a U.S. hurricane or an earthquake in the Western U.S.
  - A 1-in-100-year event would cause gross losses of up to 6 percent of risk-bearing capital and 4 percent after reinsurance.
  - A 1-in-500-year event would reduce risk-bearing capital by only up to 12 percent before reinsurance coverage.
  - Domestic catastrophe risks (storms, floods, earthquakes) could impact smaller insurers with concentrated local exposure; large groups would be only marginally affected.
- Banking counterparty default:
  - Participating groups have no concentrated exposures towards the Swiss G-SIBs.
  - Default of the largest banking counterparty reduces the median SST ratio from 224 to 222 percent (first-round impact), with no major dispersion across the sample.

### Systemic risk and management actions
- Macrofinancial distortions caused by a simultaneous de-risking of the insurance sector are unlikely in the adverse scenario tested.
- All companies remained well above the regulatory standard capital requirement of 100 percent SST coverage; need for immediate management actions is very limited.
- Reported potential management actions mostly indicate de-risking by selling equity and buying sovereign bonds; transactions would be limited in size and unlikely to be rushed.

### Challenges in a prolonged low-yield environment
- Investment horizon and reinvestment risk:
  - Implementation of the SST improved asset-liability matching and lengthened investment horizons.
  - More than 50 percent of fixed-income investments will only expire after 2025.
  - For instruments expiring after 2025, the average coupon rate amounts to 3.1 percent.
  - Projecting a roll-over of maturing bonds at a constant future coupon of 1.0 percent will reduce the average coupon earned to 2.0 by the year 2027.
- Investment returns and spread over guarantees:
  - Insurers expect investment returns to decline even in the baseline scenario:
    - About 3.0 percent for the median company in 2015–17.
    - About 2.3 percent for 2018–20.
  - Insurers more active in non-life and unit-linked life business are less affected and could sustain a prolonged low-yield environment.
  - Companies with a high stock of guarantees on policies are likely to experience a drain on profitability.

### Key financial soundness indicators (selected)
- Solvency coverage ratio (SST) — life:
  - 2013: 153
  - 2014: 149
  - 2015: 147
  - 2016: 160
  - 2017: 178
- Solvency coverage ratio (SST) — non-life:
  - 2013: 203
  - 2014: 191
  - 2015: 201
  - 2016: 228
  - 2017: 231
- Investment yield — life:
  - 2013: 3.3
  - 2014: 3.3
  - 2015: 3.1
  - 2016: 2.9
  - 2017: 2.5
- Shareholder equity and reserves / total assets — life:
  - 2013: 7.7
  - 2015: 7.4
  - 2017: 7.3
- Shareholder equity and reserves / total assets — non-life:
  - 2013: 29.0
  - 2015: 29.2
  - 2017: 25.7
- Liquid assets / total investments excl. unit-linked:
  - 2013: 53.8
  - 2015: 53.4
  - 2017: 50.8

### Findings and policy recommendations
- FINMA should regularly conduct stress tests for large insurers, based on macrofinancial scenarios, and analyze insurers’ potential for recovery after stress.
  - Scenarios should reflect the current position in the financial cycle and comprehensively include all material risk factors.
  - A forward-looking perspective should be established by analyzing the ability of insurers to reestablish profitability and solvency after stress.
  - Stress test results should be used to challenge companies’ Own Risk and Solvency Assessments (ORSA) and underlying projections for future business, specifically expectations for premium growth and investment returns.
- FINMA should closely monitor credit spread and real estate exposures of insurers, including co-movements of risk factors and insurers’ risk mitigation techniques.
  - Stress test revealed significant sensitivities of insurers’ risk-bearing capital to credit spread increases; follow-up is important.
  - For real estate exposures, FINMA should consider potential concentration risks, particularly for insurers that also invest in mortgages, and implications for liquidity.

*Source: IMF staff calculations based on company submissions.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1cheea2019006.pdf_