## EXECUTIVE SUMMARY AND RECOMMENDATIONS

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---

### Background
- The insurance sector is relatively small: premium revenues relative to GDP are smaller than in many peer countries.
- The sector is concentrated:
  - The three largest life insurance companies account for about 80 percent of gross written premiums.
  - The non-life sector is also concentrated; 37 percent of the non-life sector is foreign-owned.
- Many insurers are part of financial conglomerates: at end-2013 the seven largest conglomerates accounted for 74 percent of total financial system assets.
- Insurers’ portfolio allocations reflect domestic market structure:
  - Life insurers hold larger shares of investments in bonds and real estate and smaller shares in equities, reflecting guaranteed-rate products and limited long-term local currency investment opportunities.
  - Insurers’ holdings of private sector bonds and real estate investments are larger than in many countries.
- Regulatory and valuation features:
  - Norway’s regulation is closely aligned with EU norms under EEA obligations.
  - Asset valuation is market-consistent except for held-to-maturity bonds; bonds held to maturity and loans may be valued at amortized cost (about 30 percent of total assets for life insurers, 20 percent for non-life insurers, and 10 percent for pension funds).
  - Insurance liabilities are valued by discounting future benefits at the (single) guaranteed premium rate; applying current low market rates would increase technical provisions.
  - The maximum guaranteed rate was reduced from 2.5 percent to 2.0 percent in 2015 for new premium accrual only (not affecting existing liabilities).
  - Biometrical risk assumptions were revised in 2007 and 2014; the 2014 mortality tariff is dynamic and includes a trend factor, with a maximum 7-year transition period for undertakings to increase existing technical provisions.

### Recent performance and structural features
- Product mix (life insurance):
  - 42% Public defined benefit pension; 15% Private defined benefit pension; 20% Paid-up policies; 6% Old individual contracts (old regulation); 1% One-year insurance products; 16% Unit-linked products.
- Guaranteed liabilities and interest-rate exposure:
  - Some 83 percent of life insurers’ liabilities carry guaranteed minimum rates of return.
  - At end-2013 the guaranteed return averaged 3.2 percent.
  - The five largest life insurers’ liability duration is about 16 years while asset duration is about 4 years.
- Longevity and mortality:
  - Life insurers rely on products bearing longevity risks and face vulnerability to rising longevity.
  - The new mortality tariff implemented in 2014 will significantly increase technical reserves; more than half of the increase in technical provisions is expected to be financed by policyholders through lower profit allocations.
- Non-life insurers:
  - The five largest non-life insurers’ liability duration is about 4 years compared with 2.5 years for asset duration.
  - Non-life insurers currently hold higher buffer capital and have less maturity mismatch than life insurers.

### Financial condition and performance under Solvency I
- General performance:
  - Insurers recorded low expense ratios and made "3-4 percent real returns on their investments in 2012–14".
- Life insurers:
  - Used about two-thirds of their profits after allocation of guaranteed returns to increase technical reserves to adopt the new mortality table and share profits with policyholders.
  - Recorded pre-tax profits of about "0.5 percent of total assets in 2010–14".
  - Capital buffer (under Solvency I) has steadily increased since 2011 and was about "10.2 percent at the end of 2014".
  - Tier 1 own funds is about "72 percent of total solvency margin capital" in life insurance.
- Non-life insurers:
  - Performed better, recording pre-tax profits of "27.7 percent of gross premiums".
  - Buffer capital was "significantly higher" than life insurers.
  - The solvency ratio in the non-life sector is among the highest in the world.
- Premium dynamics:
  - Insurers increased premiums in real terms in 2012, this reversed in 2013, and "in 2014, the premiums rose by 10 percent".
- Composition of solvency capital:
  - Solvency capital consists of own funds and specific insurance funds.
- Provisions and funds:
  - "Non-life insurers have large fluctuation provisions, which are included partly in the solvency margin capital. The Natural Perils Fund, which can only cover claims related to natural perils, is also partly included in the solvency margin capital."

### Key risks and vulnerabilities
- Interest rate and reinvestment risk:
  - "A continued low-interest rate environment would adversely impact earnings and claims-paying capacity over the medium term, as some 83 percent of life insurers’ liabilities carry guaranteed minimum rates of return."
  - "At end-2013, the guaranteed return averaged 3.2 percent, which was higher than the return on 10-year government bonds, and the difference seems to have widened in 2014–15."
- Liability/asset duration mismatches:
  - Life insurers’ liability duration is about "16 years" while asset duration is about "4 years".
  - Non-life insurers’ liability duration is about "4 years" compared with "2.5 years" for asset duration.
- Longevity risk:
  - Life insurers face rising longevity risks and increasing health care costs; life expectancy at birth in Norway is higher than the OECD average and has been growing.
- Asset concentration and market risk:
  - Life insurers hold relatively large shares of private bonds and real estate and are vulnerable to credit spreads, economic slowdown, interest rate declines, and real estate price declines.
- Search for yield and potential risk-taking:
  - Prolonged low interest rates could push insurers to shift towards riskier assets to maintain profitability.
  - Current regulations for guaranteed-rate products constrain insurers’ capacity to take investment risks, but authorities should closely monitor risk-taking and underwriting standards.
- Contagion and interconnectedness:
  - Regulations restrict intra-group loans/guarantees without MOF consent; exposures to bank debt instruments at end-2014 averaged "7 percent of total assets in the life sector and 9 percent in the non-life sector".
  - Contagion risks could be higher due to common exposures and potential spillovers from insurers selling claims on banks.

### Stress test framework and assumptions
- Approach:
  - Stress tests under Solvency II principles (“simplified approach”) combining top-down (TD) stress tests for asset-side risks and insurance liability risks and bottom-up (BU) stress tests for other liability risks.
- Coverage:
  - Three large life and three large non-life insurers were covered on a solo basis; these firms account for 80 percent and 51 percent of assets in the life and non-life sectors, respectively.
- Valuation and methodology:
  - Market-consistent valuation of assets and liabilities; reference date: 31/12/2014; solo-entity basis.
  - IMF&FSA staff estimates and companies’ internal models were used.
  - Stress tests applied Solvency II valuation principles; transition rules to Solvency II were considered in results.
  - FX positions are generally hedged; losses/gains related to FX hedges and counterparty risks were estimated; rollover risks were not separately estimated.
- Scenario design (selected numerical parameters; changes in percent unless otherwise specified):
  - Interest rates: increase +250 bp / decrease -100 bp (Scenario 3).
  - Equity prices: -26.0; -26.0; -50.0.
  - (Nominal) Real estate prices: -29.0; -33.0; -40.0.
  - Exchange rate (depreciation): -6.5; -5.6; -30.
  - Spread risk: 70-750; 70-750; 70-750.
  - LGD for concentration risk: 45 45 45.
  - Liability-side: two natural catastrophes with loss impact of "NOK 5 billion each (NOK 10 billion in total)".
  - Stress horizon: applying cumulative changes in 2015-19 of bank stress testing scenarios; instantaneous shocks in sensitivity analyses.
- Interpretation:
  - Combined severe shocks correspond to the Value-at-Risk of basic own funds at a confidence level of "99.5 percent over a one-year period" (could happen once in about 200 years).

### FSAP insurance stress test results — Life sector (solo sample)
- Solvency impact and capital shortfalls:
  - System’s buffer capital utilization (BCU) ratio would increase to 139 percent, 142 percent, and 180 percent under Scenarios 1, 2, and 3, respectively.
  - Companies’ capital shortfall to fully cover all the risks (without restoring capital) would amount to NOK 32.7 billion, NOK 35.4 billion, and NOK 66.4 billion in the three scenarios, respectively.
  - These shortfalls correspond to 39 percent, 42 percent, and 80 percent of the sample’s available capital before stress, respectively.
  - These shortfalls correspond to 1 percent, 1.1 percent, and 2.1 percent of 2014 GDP (1.3, 2.4, and 2.6 percent of mainland GDP), respectively.
- Main contributors to deterioration:
  - Equity price shock: contribution to BCU varies between 39–60 percent.
  - Credit spread risk: 48 percent of the buffer capital (assumed same under all three scenarios).
  - Real estate price shock: 34–46 percent of the buffer capital.
  - Interest rate shock: increases value of liabilities and affects insurers particularly under Scenario 3; net impact smaller due to partial offset on asset side.
- Aggregated market risk estimates:
  - Using the “diversification matrix,” overall market risks estimated between 126–167 percent (of buffer capital), instead of 136–193 percent if individual factors were summed.
- Effect of Solvency II transition rules:
  - With transition rules, the additional capital need under Scenario 3 would decline to NOK 25 billion (0.8 percent of GDP) from NOK 66 billion (2.1 percent of GDP).
  - Transition-rule impacts are minimal under Scenarios 1 and 2 where interest rates are assumed to increase.
- Other cushions:
  - Companies may retain profits.
  - Companies have higher capital at the conglomerate level (investments in subsidiaries fully deducted from own funds).
- Policy recommendation for life insurers:
  - Authorities should ask the institutions with weak capital adequacy ratios to prepare a plan to rebuild capital.
  - The FSA should continue to restrict dividend distributions by these institutions until comfortable levels of capital adequacy have been achieved.

### FSAP insurance stress test results — Non-life sector (solo sample)
- Resilience:
  - Non-life insurers show much higher resilience due to smaller asset-liability duration mismatches and current high capital adequacy ratios.
  - System BCU increases to 77 percent, 78 percent, and 85 percent under Scenarios 1, 2, and 3, with all companies at or below 100 percent.
- Main contributors to solvency decline:
  - Underwriting (non-life and health) shocks and market shocks are the main contributors.
  - Discounting technical provisions under Solvency II would improve capital adequacy for non-life.
- Catastrophe risk:
  - Limited effect due to wide-ranging coverage through the Norwegian Natural Perils Pool and associated foreign reinsurers.
- Regulatory transition impact:
  - Impact of Solvency II is expected to be more benign for non-life insurers because current regulatory requirements are stricter than Solvency II requirements.

### Aggregation with banking stresses and conglomerate-level considerations
- At the conglomerate level:
  - Most financial conglomerates could absorb combined banking and insurance losses.
  - Recapitalizing insurance entities would generally be within group capacity, though more difficult for conglomerates with larger insurance shares.
  - Recapitalizing insurance companies would be within capacity of corresponding conglomerates, given the small size of capital required relative to aggregate capital in the group.
- Recommendations for conglomerates and systemically important insurers:
  - The insurance business of conglomerates should be adequately capitalized on a solo basis.
  - Authorities should identify systemically important insurance companies, ask them to prepare a resolution plan as advised in the Financial Stability Board’s Key Attributes, and conduct their resolvability assessment.

### Regulatory design and transition to Solvency II
- Pillar structure:
  - Pillar 1: quantitative requirements (capital amount).
  - Pillar 2: governance and risk management, effective supervision.
  - Pillar 3: disclosure and transparency requirements.
- Technical provisions:
  - Comprise the best estimate of liabilities plus a risk margin; intended to represent the current amount to transfer obligations to a third party.
- Capital thresholds:
  - Solvency Capital Requirement (SCR) ensures the company can meet obligations over the next 12 months with probability of at least "99.5 percent".
  - Minimum Capital Requirement (MCR) corresponds to an "85 percent probability of adequacy over a one-year period" and is bounded between "25 percent and 45 percent of the SCR".
- Regulatory mitigations proposed by FSA:
  - The FSA has proposed to implement Solvency II through allowing "(i) a 16-year transition period for implementing the Solvency II valuation of technical provisions and (ii) the use of volatility adjustment."
- Guaranteed-rate policy rule change:
  - "The maximum guaranteed rate for new polices has been reduced several times, and will be reduced from 2.5 percent to 2 percent starting from January 2015. The new rate will be used in the valuation of only new liabilities and does not affect the valuation of existing liabilities."
- Conversion to unit-linked products:
  - Regulation entered into force on "September 1, 2014" allowing conversion of paid-up policies into unit-linked policies with safeguards:
    - Paid-up policyholder must relinquish guarantee regarding previously accrued rights.
    - Paid-up policyholder must be provided with sufficient information, including written examples of required annual returns.
    - A paid-up policy must be "fully provisioned before conversion to a unit-linked policy."

### Methodology highlights
- Solvency capital requirements estimated following EIOPA (2014) technical specifications, with some simplifications used in FSA’s stress tests.
- Market risks: estimated as sum of interest rate risk, equity risk (Type 1 and Type 2 equities), property risk, currency risk, spread risk, and concentration risk using EIOPA correlation matrices and specified shock factors.
- Life underwriting risk sub-modules: mortality, longevity, disability/morbidity, and lapse risk; life catastrophe sub-module restricted to obligations contingent on mortality.
- Operational risk formula: SCR_op = min(0.3*BSCR; Op) + 0.25*Exp_ul, where BSCR = basic solvency capital ratio; Op = basic operational risk charge; Exp_ul = expenses incurred during previous 12 months for life business where investment risk is borne by policyholders (excluding acquisition expenses).
- Buffer Capital Utilization (BCU) ratio defined as ratio of companies’ buffer capital (under Solvency II) to the solvency capital need; hurdle rate is 100 percent.
- Stress Test Matrix (STeM) summary:
  - Institutional perimeter: three large life and three large non-life insurers; life market share 80 percent (assets); non-life market share 60 percent (premiums) and 51 percent (assets).
  - Calibration examples: interest rates +250 bp / -100 bp; equity -26 percent; -45 percent for ordinary shares and -55 percent for others; real estate -29 percent, -33 percent, -40 percent; FX depreciation 6.5/5.6/30 percent; default of largest banking counterparty: 45 percent LGD on obligations.
  - Output presentation: impact on buffer capital; capital shortfall for companies with BCU above 100 percent; contribution of individual shocks.

### Key statistics and figures (preserved)
- 83 percent of life insurers’ liabilities carry guaranteed minimum rates of return.
- Guaranteed return averaged 3.2 percent at end-2013.
- Five largest life insurers’ liability duration: about 16 years; asset duration: about 4 years.
- Five largest non-life insurers’ liability duration: about 4 years; asset duration: about 2.5 years.
- Capital shortfall: about 1.0–2.1 percent of nominal GDP without Solvency II transition rule; up to 1 percent of GDP under the transition rule.
- Three large life and non-life insurers covered: represent 80 percent (life) and 51 percent (non-life) of sector assets (solo basis).
- At end-2013, seven largest conglomerates accounted for 74 percent of total financial system assets.
- Life sector solo-sample capital shortfalls: NOK 32.7 billion, NOK 35.4 billion, and NOK 66.4 billion under Scenarios 1, 2, and 3, respectively.
- Life sector shortfalls as percent of 2014 GDP: 1 percent, 1.1 percent, and 2.1 percent under Scenarios 1, 2, and 3, respectively (1.3, 2.4, and 2.6 percent of mainland GDP).
- System’s BCU ratios for life: 139 percent, 142 percent, and 180 percent under Scenarios 1, 2, and 3, respectively.
- System’s BCU ratios for non-life: 77 percent, 78 percent, and 85 percent under Scenarios 1, 2, and 3, respectively.

### Recommendations (summary)
- Allocate more resources to assess the liability-side risks and validate models and assumptions used in the bottom-up stress tests by insurance companies.
  - Implementation Time: NT
  - Agency: MOF, FSA
- Apply macroprudential stress scenarios for insurance companies.
  - Implementation Time: MT
  - Agency: FSA
- Continue building a top-down stress test framework for the insurance sector.
  - Implementation Time: MT
  - Agency: FSA
- Prepare a recovery plan and achieve recapitalization of weakly capitalized insurance companies. Continue to restrict dividend payouts by the companies with weak capital adequacy and ask the weakly capitalized institutions to prepare a recovery plan.
  - Implementation Time: MT, NT
  - Agency: FSA
- Identify systemically important companies, ask for a resolution plan, and conduct their resolvability assessments.
  - Implementation Time: MT
  - Agency: MOF, FSA
- Continue to build FSA capacity to conduct liability-side stress tests and verify reports by insurance companies; consider applying macro-prudential stress scenarios; implementing these recommendations would require additional resources for the FSA.

*Source: EXECUTIVE SUMMARY AND RECOMMENDATIONS, _cr15255 - EXECUTIVE SUMMARY AND RECOMMENDATIONS*

### EXECUTIVE SUMMARY AND RECOMMENDATIONS ____________________________________________ 5

### EXECUTIVE SUMMARY AND RECOMMENDATIONS

### Background
- The insurance sector is relatively small: premium revenues relative to GDP are smaller than in many peer countries.
- The sector is concentrated:
  - The three largest life insurance companies account for about 80 percent of gross written premiums.
  - The non-life sector is also concentrated; 37 percent of the non-life sector is foreign-owned.
- Many insurers are part of financial conglomerates: at end-2013 the seven largest conglomerates accounted for 74 percent of total financial system assets.
- Insurers’ portfolio allocations reflect domestic market structure:
  - Life insurers hold larger shares of investments in bonds and real estate and smaller shares in equities, reflecting guaranteed-rate products and limited long-term local currency investment opportunities.
  - Insurers’ holdings of private sector bonds and real estate investments are larger than in many countries.
- Regulatory and valuation features:
  - Norway’s regulation is closely aligned with EU norms under EEA obligations.
  - Asset valuation is market-consistent except for held-to-maturity bonds; bonds held to maturity and loans may be valued at amortized cost (about 30 percent of total assets for life insurers, 20 percent for non-life insurers, and 10 percent for pension funds).
  - Insurance liabilities are valued by discounting future benefits at the (single) guaranteed premium rate; applying current low market rates would increase technical provisions.
  - The maximum guaranteed rate was reduced from 2.5 percent to 2.0 percent in 2015 for new premium accrual only (not affecting existing liabilities).
  - Biometrical risk assumptions were revised in 2007 and 2014; the 2014 mortality tariff is dynamic and includes a trend factor, with a maximum 7-year transition period for undertakings to increase existing technical provisions.

### Recent performance and structural features
- Product mix (life insurance): 42% Public defined benefit pension; 15% Private defined benefit pension; 20% Paid-up policies; 6% Old individual contracts (old regulation); 1% One-year insurance products; 16% Unit-linked products.
- Guaranteed liabilities and interest-rate exposure:
  - Some 83 percent of life insurers’ liabilities carry guaranteed minimum rates of return.
  - At end-2013 the guaranteed return averaged 3.2 percent.
  - The five largest life insurers’ liability duration is about 16 years while asset duration is about 4 years (significant asset-liability maturity mismatch).
- Longevity and mortality:
  - Life insurers rely on products bearing longevity risks and face vulnerability to rising longevity.
  - The new mortality tariff implemented in 2014 will significantly increase technical reserves; more than half of the increase in technical provisions is expected to be financed by policyholders through lower profit allocations.
- Non-life insurers:
  - The five largest non-life insurers’ liability duration is about 4 years compared with 2.5 years for asset duration.
  - Non-life insurers currently hold higher buffer capital and have less maturity mismatch than life insurers.

### Risks and vulnerabilities
- Key vulnerabilities for life insurers:
  - Continued low-interest rate environment would adversely impact earnings and claims-paying capacity.
  - Significant sensitivity to market risks: equity prices, real estate prices, and credit spreads.
  - Asset-liability mismatch (liability duration ~16 years vs asset duration ~4 years for largest life insurers).
  - Longevity risk and the impact of updated mortality tables increasing technical reserves.
- Non-life insurers:
  - Underwriting (non-life and health) shocks and market shocks are main contributors to solvency declines, but non-life insurers would remain solvent even under the most severe shock due to current higher buffer capital and smaller maturity mismatches.
- Conglomerate-level considerations:
  - Most financial conglomerates could absorb combined banking and insurance losses; recapitalizing insurance entities would be within group capacity given the relatively small capital required versus aggregate group capital.
  - Conglomerates with larger insurance shares face greater recapitalization challenges.

### Stress test framework and assumptions
- The mission conducted stress tests under Solvency II principles (“simplified approach”) combining:
  - Top-down (TD) stress tests for asset-side risks and insurance liability risks (designed by the FSAP team and Finanstilsynet—FSA).
  - Bottom-up (BU) stress tests for other liability risks.
- Coverage:
  - Three large life and three large non-life insurers were covered; these firms account for 80 and 51 percent of assets in the life and non-life sectors, respectively, on a solo basis.
- Relevant methodological and valuation points:
  - Stress tests applied Solvency II valuation principles; transition rules to Solvency II were considered in results.
  - FX positions are generally hedged; losses/gains related to FX hedges and counterparty risks were estimated in the stress tests. Rollover risks were not separately estimated.

### FSAP insurance stress test results
- Life insurance results:
  - Stress tests under Solvency II confirm life insurers are vulnerable to severe shocks.
  - High sensitivity to market risks (equity, real estate, credit spreads) and to further declines in interest rates.
  - Insurers’ solvency ratios would decline sharply under shocks.
  - Capital shortfall estimates:
    - About 1.0–2.1 percent of nominal GDP without the transition rule.
    - Up to 1 percent of GDP under the transition rule.
  - The transition rule for Solvency II would significantly reduce the immediate need for insurers to raise capital.
  - Authorities’ “Stresstest I” (under Solvency II) produced similar results; authorities’ “Stresstest II” (under Solvency I) and the companies’ own consolidated stress tests suggest much less vulnerability.
- Non-life insurance results:
  - Non-life insurers would remain solvent even under the most severe shock.
  - Main drivers of solvency declines: underwriting (non-life and health) shocks and market shocks.
- Aggregation with banking stresses:
  - At the conglomerate level, most institutions could weather combined banking and insurance losses.
  - Recapitalization of insurance entities would generally be within group capacity, though more difficult for conglomerates with larger insurance shares.

### Key statistics and figures (preserved)
- 83 percent of life insurers’ liabilities carry guaranteed minimum rates of return.
- Guaranteed return averaged 3.2 percent at end-2013.
- Five largest life insurers’ liability duration: about 16 years; asset duration: about 4 years.
- Five largest non-life insurers’ liability duration: about 4 years; asset duration: about 2.5 years.
- Capital shortfall: about 1.0–2.1 percent of nominal GDP without Solvency II transition rule; up to 1 percent of GDP under the transition rule.
- Three large life and non-life insurers covered: represent 80 percent (life) and 51 percent (non-life) of sector assets (solo basis).
- At end-2013, seven largest conglomerates accounted for 74 percent of total financial system assets.

### Recommendations
- Table 1. Summary of Recommendations (text preserved)
  - Allocate more resources to assess the liability-side risks and validate models and assumptions used in the bottom-up stress tests by insurance companies.
    - Implementation Time: NT
    - Agency: MOF, FSA
  - Apply macroprudential stress scenarios for insurance companies.
    - Implementation Time: MT
    - Agency: FSA
  - Continue building a top-down stress test framework for the insurance sector.
    - Implementation Time: MT
    - Agency: FSA
  - Prepare a recovery plan and achieve recapitalization of weakly capitalized insurance companies. Continue to restrict dividend payouts by the companies with weak capital adequacy and ask the weakly capitalized institutions to prepare a recovery plan.
    - Implementation Time: MT, NT
    - Agency: FSA
  - Identify systemically important companies, ask for a resolution plan, and conduct their resolvability assessments.
    - Implementation Time: MT
    - Agency: MOF, FSA

*Source: EXECUTIVE SUMMARY AND RECOMMENDATIONS, _cr15255 - EXECUTIVE SUMMARY AND RECOMMENDATIONS*

### 11.      The financial condition of insurance companies under Solvency I has generally been

### 11.      The financial condition of insurance companies under Solvency I has generally been

### Financial condition and performance under Solvency I
- Insurers recorded low expense ratios and made "3-4 percent real returns on their investments in 2012–14".
- Life insurers:
  - Used about two-thirds of their profits after allocation of guaranteed returns to increase technical reserves to adopt the new mortality table and share profits with policyholders.
  - Recorded pre-tax profits of about "0.5 percent of total assets in 2010–14".
  - Capital buffer (under Solvency I) has steadily increased since 2011 and was about "10.2 percent at the end of 2014".
  - Tier 1 own funds is about "72 percent of total solvency margin capital" in life insurance.
- Non-life insurers:
  - Performed better, recording pre-tax profits of "27.7 percent of gross premiums".
  - Buffer capital was "significantly higher" than life insurers.
  - Solvency ratios have remained stable at comfortable levels; "The solvency ratio in the non-life sector is among the highest in the world."
- Premium dynamics:
  - Insurers increased premiums in real terms in 2012, this reversed in 2013, and "in 2014, the premiums rose by 10 percent".
- Composition of solvency capital:
  - Solvency capital consists of own funds and specific insurance funds.
- Note on provisions and funds:
  - "Non-life insurers have large fluctuation provisions, which are included partly in the solvency margin capital. The Natural Perils Fund, which can only cover claims related to natural perils, is also partly included in the solvency margin capital."

### Key risks and vulnerabilities
- Interest rate and reinvestment risk:
  - "A continued low-interest rate environment would adversely impact earnings and claims-paying capacity over the medium term, as some 83 percent of life insurers’ liabilities carry guaranteed minimum rates of return."
  - "At end-2013, the guaranteed return averaged 3.2 percent, which was higher than the return on 10-year government bonds, and the difference seems to have widened in 2014–15."
  - Liability/asset duration mismatches:
    - Life insurers’ liability duration is about "16 years" while asset duration is about "4 years".
    - Non-life insurers’ liability duration is about "4 years" compared with "2.5 years" for asset duration.
- Longevity risk:
  - Life insurers face rising longevity risks and increasing health care costs; life expectancy at birth in Norway is higher than the OECD average and has been growing.
- Asset concentration and market risk:
  - Life insurers hold relatively large shares of private bonds and real estate and are vulnerable to credit spreads, economic slowdown, interest rate declines, and real estate price declines.
  - Non-life insurers have shorter maturities of assets and liabilities, reducing market risk.
- Search for yield and potential risk-taking:
  - Prolonged low interest rates could push insurers to shift towards riskier assets to maintain profitability.
  - Current regulations for guaranteed-rate products constrain insurers’ capacity to take investment risks, but authorities should closely monitor risk-taking and underwriting standards.
- Contagion and interconnectedness:
  - Regulations restrict intra-group loans/guarantees without MOF consent; exposures to bank debt instruments at end-2014 averaged "7 percent of total assets in the life sector and 9 percent in the non-life sector".
  - Contagion risks could be higher due to common exposures and potential spillovers from insurers selling claims on banks.

### Solvency II transition impacts and regulatory responses
- Measurement and capital implications:
  - Under Solvency II, liabilities will be measured at fair value (market interest rates used to estimate future liabilities), compared with current practice of discounting liabilities using the guaranteed rate.
  - This will make it difficult for life insurers to meet capital requirements under Solvency II because of current low interest rates.
  - Increased capital requirements on paid-up policies under Solvency II pose a particular challenge.
- Regulatory mitigations proposed by FSA:
  - The FSA has proposed to implement Solvency II through allowing "(i) a 16-year transition period for implementing the Solvency II valuation of technical provisions and (ii) the use of volatility adjustment."
- Effects by sector:
  - For non-life insurers, transition to Solvency II is expected to lead to a reduction of technical provisions because current rules (including fluctuation provisions) are more demanding than Solvency II's "best estimate" plus risk margin approach; discounting liabilities using market rates will reduce present values and improve reported capital adequacy.
- Guaranteed-rate policy rule change:
  - "The maximum guaranteed rate for new polices has been reduced several times, and will be reduced from 2.5 percent to 2 percent starting from January 2015. The new rate will be used in the valuation of only new liabilities and does not affect the valuation of existing liabilities."
- Conversion to unit-linked products:
  - Insurers have been encouraging conversions of paid-up policies to unit-linked (nonguaranteed) products, shifting risks to policyholders.
  - Regulatory change: In June 2014, the Ministry of Finance adopted regulations allowing conversion of paid-up policies into unit-linked policies; regulation entered into force on "September 1, 2014".
  - Key safeguards:
    - Paid-up policyholder must relinquish guarantee regarding previously accrued rights.
    - Paid-up policyholder must be provided with sufficient information, including written examples of required annual returns.
    - A paid-up policy must be "fully provisioned before conversion to a unit-linked policy."
  - Impact on attractiveness:
    - Full provisioning requirement reduces advantage for insurers and may delay conversion offerings, reducing attractiveness for target groups.

### Stress testing framework, assumptions, and findings
- FSA framework and reporting:
  - Since 2008 insurers and pension funds regularly report stress tests to the FSA; most small non-life report biannually, others quarterly.
  - Two stress tests specified:
    - "Stresstest I"—a simplified version of Solvency II calculations ("Solvency II light").
    - "Stresstest II"—assesses ability to absorb losses without breaching Solvency I and capital adequacy requirements.
  - Companies submit ORSA reports requiring multiple stress tests, including reverse stress tests.
- Stresstest I design:
  - Based on EIOPA technical specifications; covers market and other risks via single-factor shocks; sensitivities assumed instantaneous and combined using a "diversification" matrix.
- Typical shock assumptions used in FSA Stresstest I (moderate-to-severe):
  - Equity price shock of "45–55 percent (for Type 1 and Type 2 assets)".
  - A domestic interest rate increase/decline of "0.64/0.56 basis points" and a foreign interest rate increase/decline of "0.55/0.46 basis points."
  - A "25 percent decline in real estate prices."
  - An exchange rate movement of "25 percent."
  - Spread risk applying to corporate bonds, covered bonds, subordinated debt investments, etc.
  - Liability-side: two natural catastrophes with loss impact of "NOK 5 billion each (NOK 10 billion in total)", affecting insurers through participation in the Natural Perils Pool (proportionate to market share).
    - This amount is more than the loss experienced during a severe storm in 1992, "approximately NOK 2 billion in present value (in 2014 kroner)."
- Severity interpretation:
  - Combined market, underwriting, counterparty default, and operational shocks correspond to the Value-at-Risk of basic own funds at a confidence level of "99.5 percent over a one-year period".
  - These combined severe shocks "could happen once in about 200 years."
- Limitations and approach:
  - Authorities do not currently conduct scenario analyses and rely on companies’ assessments of most liability-side risks.
  - FSA focuses on verifying companies' calculations by reviewing insurers’ internal models; it currently lacks sufficient data and resources to conduct liability-side stress tests independently.
- FSAP engagement:
  - The mission worked with the FSA on stress tests; market and liability top-down assumptions were jointly agreed, while other liability-side risks were estimated by insurers (bottom-up) based on FSA assumptions.

### Regulatory capital design (Solvency II summary points)
- Pillar structure:
  - Pillar 1: quantitative requirements (capital amount).
  - Pillar 2: governance and risk management, effective supervision.
  - Pillar 3: disclosure and transparency requirements.
- Technical provisions:
  - Comprise the best estimate of liabilities plus a risk margin; intended to represent the current amount to transfer obligations to a third party.
- Capital thresholds:
  - Solvency Capital Requirement (SCR) ensures the company can meet obligations over the next 12 months with probability of at least "99.5 percent".
  - Minimum Capital Requirement (MCR) corresponds to an "85 percent probability of adequacy over a one-year period" and is bounded between "25 percent and 45 percent of the SCR".
  - SCR and MCR form supervisory intervention ladders ("soft" and "hard" floors, respectively).

### Recommendations
- Continue to improve the stress test framework:
  - The FSA should "continue to build its capacity to conduct liability side stress tests and verify the reports by insurance companies."
  - Authorities should consider applying "macro-prudential stress scenarios."
  - Implementing these recommendations would "require additional resources for the FSA."

*Source: _cr15255 - 11.      The financial condition of insurance companies under Solvency I has generally been*

### 26.      Three large life and non-life insurance companies were covered on a solo basis.

### _cr15255 - 26.      Three large life and non-life insurance companies were covered on a solo basis.

### Coverage and data
- Three large life insurance companies and three large non-life insurance companies were covered on a solo basis.
- They represent 80 percent and 51 percent, respectively, of assets in the life and non-life sectors.
- Market-consistent valuation of assets and liabilities; reference date: 31/12/2014; solo-entity basis.
- IMF&FSA staff estimates and companies’ internal models were used.

### Stress test scenarios and key assumptions
- Scenario design:
  - Scenario 1: Combination of shocks similar to the adverse banking scenario with a monetary policy response; applies cumulative changes from 2015 to 2019 instantaneously to insurers.
  - Scenario 2: Based on the banking adverse scenario without a (monetary) policy response (stronger shock).
  - Scenario 3: Ad-hoc combination of shocks tailored to insurers’ vulnerabilities (e.g., interest rates decline by 100 bps instead of a 250 bp increase).
- Additional assumed events:
  - Default of the largest banking counterparties with loss given default (LGD) on all contractual obligations, as per EIOPA formula.
  - Two catastrophic events with an increased reinsurance reinstatement premium.
- Selected numerical stress parameters (changes in percent unless otherwise specified):
  - Interest rates: increase +250 bp / decrease -100 bp (Scenario 3).
  - Equity prices: -26.0; -26.0; -50.0.
  - (Nominal) Real estate prices: -29.0; -33.0; -40.0.
  - Exchange rate (depreciation): -6.5; -5.6; -30.
  - Spread risk: 70-750; 70-750; 70-750.
  - LGD for concentration risk: 45 45 45 (as listed).
- Stress horizon: applying cumulative changes in 2015-19 of bank stress testing scenarios; instantaneous shocks in sensitivity analyses.
- Risks assessed: Interest rates, equity, property, FX, credit spreads, lapses, concentration risks; underwriting risks; counterparty risks; operational risks.
- Buffer considerations: absorption effect of technical provisions (profit sharing and policyholder buffer funds) for some products; limited behavioral adjustments (rules in place at reference date).

### Life insurance stress-test results and key statistics
- Solvency impact:
  - System’s buffer capital utilization (BCU) ratio would increase to 139 percent, 142 percent, and 180 percent under Scenarios 1, 2, and 3, respectively.
  - Companies’ capital shortfall to fully cover all the risks (without restoring capital) would amount to NOK 32.7 billion, NOK 35.4 billion, and NOK 66.4 billion in the three scenarios, respectively.
  - These shortfalls correspond to 39 percent, 42 percent, and 80 percent of the sample’s available capital before stress, respectively.
  - These shortfalls correspond to 1 percent, 1.1 percent, and 2.1 percent of 2014 GDP (1.3, 2.4, and 2.6 percent of mainland GDP), respectively.
- Main contributors to deterioration:
  - Equity price shock: contribution to BCU varies between 39–60 percent.
  - Credit spread risk: 48 percent of the buffer capital (assumed same under all three scenarios).
  - Real estate price shock: 34–46 percent of the buffer capital.
  - Interest rate shock: increases value of liabilities and affects insurers particularly under Scenario 3; net impact smaller due to partial offset on asset side.
- Aggregated market risk estimates:
  - Using the “diversification matrix,” overall market risks estimated between 126–167 percent (of buffer capital), instead of 136–193 percent if individual factors were summed.
- Effect of Solvency II transition rules:
  - With transition rules, the additional capital need under Scenario 3 would decline to NOK 25 billion (0.8 percent of GDP) from NOK 66 billion (2.1 percent of GDP).
  - Transition-rule impacts are minimal under Scenarios 1 and 2 where interest rates are assumed to increase.
- Other cushions:
  - Companies may retain profits.
  - Companies have higher capital at the conglomerate level (investments in subsidiaries fully deducted from own funds).
- Recommendation related to life insurers:
  - The authorities should ask the institutions with weak capital adequacy ratios to prepare a plan to rebuild capital.
  - The FSA should continue to restrict dividend distributions by these institutions until comfortable levels of capital adequacy have been achieved.

### Non-life insurance stress-test results and key statistics
- Resilience:
  - Non-life insurers show much higher resilience due to smaller asset-liability duration mismatches and current high capital adequacy ratios.
  - System BCU increases to 77 percent, 78 percent, and 85 percent under Scenarios 1, 2, and 3, with all companies at or below 100 percent.
- Main contributors to solvency decline:
  - Underwriting (non-life and health) shocks and market shocks are the main contributors.
  - Scenarios reduce asset values and thus available capital; discounting technical provisions under Solvency II would improve capital adequacy for non-life.
- Catastrophe risk:
  - Limited effect due to wide-ranging coverage through the Norwegian Natural Perils Pool and associated foreign reinsurers.
- Note on regulatory change:
  - Impact of Solvency II is expected to be more benign for non-life insurers because current regulatory requirements are stricter than Solvency II requirements.

### Aggregation across banking and insurance; conglomerates
- At the conglomerate level:
  - Financial institutions could weather combined losses from banking and insurance operations.
  - Recapitalizing insurance companies would be within capacity of corresponding conglomerates, given the small size of capital required relative to aggregate capital in the group.
  - Raising capital would be a challenge for conglomerates whose core activity is insurance.
- Recommendation for conglomerates and systemically important insurers:
  - The insurance business of conglomerates should be adequately capitalized on a solo basis.
  - Authorities should identify systemically important insurance companies, ask them to prepare a resolution plan as advised in the Financial Stability Board’s Key Attributes, and conduct their resolvability assessment.

### Methodology highlights (Appendix I and II)
- Solvency capital requirements estimated following EIOPA (2014) technical specifications, with some simplifications used in FSA’s stress tests.
- Market risks: estimated as sum of interest rate risk, equity risk (Type 1 and Type 2 equities), property risk, currency risk, spread risk, and concentration risk using EIOPA correlation matrices and specified shock factors.
- Life underwriting risk sub-modules: mortality, longevity, disability/morbidity, and lapse risk; life catastrophe sub-module restricted to obligations contingent on mortality.
- Operational risk: SCR_op = min(0.3*BSCR; Op) + 0.25*Exp_ul, where BSCR = basic solvency capital ratio; Op = basic operational risk charge; Exp_ul = expenses incurred during previous 12 months for life business where investment risk is borne by policyholders (excluding acquisition expenses).
- Buffer Capital Utilization (BCU) ratio defined as ratio of companies’ buffer capital (under Solvency II) to the solvency capital need; hurdle rate is 100 percent (above which capital would be depleted).
- Stress Test Matrix (STeM) summary:
  - Institutional perimeter: three large life and three large non-life insurers; life market share 80 percent (assets); non-life market share 60 percent (premiums) and 51 percent (assets).
  - Calibration examples: interest rates +250 bp / -100 bp; equity -26 percent; -45 percent for ordinary shares and -55 percent for others; real estate -29 percent, -33 percent, -40 percent; FX depreciation 6.5/5.6/30 percent; default of largest banking counterparty: 45 percent LGD on obligations.
  - Output presentation: impact on buffer capital; capital shortfall for companies with BCU above 100 percent; contribution of individual shocks.

*Source: _cr15255 - 26.      Three large life and non-life insurance companies were covered on a solo basis.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15255.pdf_