A supervisory exercise subjecting a sample of insurers to one adverse scenario, to measure a system effect that individual ratios do not show.
A stress test applies one adverse scenario to a sample of undertakings, whether a rate shock, an equity collapse, a run of natural catastrophes or a pandemic, and asks each to recompute its balance sheet under it. Its purpose is not to grade participants but to bring out a system effect, namely what the sector would do if every undertaking responded to the same shock at the same time, a question no individual ratio can pose. The method has known limits that deserve stating: the scenario is single where the world produces others, declared management actions are intentions rather than commitments, and firm-level publication encourages cautious rather than candid answers. Its value lies elsewhere, in the comparability of the exposures it reveals and in the discipline of modeling scenarios nobody would have examined unprompted. The exercises run in Europe since 2014 have in this way installed climate and liquidity shocks in balance sheets that did not carry them.
The European Insurance and Occupational Pensions Authority published in December 2021 the results of its stress test built on a prolonged low-rate scenario compounded by a market shock, an exercise in which forty-four insurance groups from the European Economic Area took part.
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