The European Insurance and Occupational Pensions Authority (Eiopa) said the exercise has been designed to assess the resilience of the sector to “adverse market conditions”.
The test will focus on two major risks; the impact of prolonged low interest rates and a “double-hit scenario” combining a sudden drop in asset prices with rock-bottom interest rates.
In recent years, European insurers have seen their profits battered by low interest rates and the new Solvency II capital rules, forcing them to adjust their business models and offload less profitable units.
“Persistent low risk free rates and relevant volatility in equity markets characterise the current EU financial sector, making market risks the main source of concerns regarding the stability of the insurance industry,” said Eiopa on its website.
The last test in 2014 was conducted prior to the Solvency II legislation coming into effect.
75% market share
The trade body said that although no insurance groups will be included in the test, the number of small and medium-sized insurers has been increased from a 50% share of each national market in 2014 to a 75% share this year.
Set up in 2011, Eiopa’s mandate is to support and ensure the transparency of the EU’s financial system, as well as protect insurance policyholders, pension scheme members and beneficiaries.
To limit the burden on the insurance industry, the regulator said it will use the exercise to also collect information on the Solvency II equity and Long Term Guarantees (LTG) measures.
Gabriel Bernardino, chairman of Eiopa, said: "The current challenging macroeconomic environment has to be acknowledged in such a stress test exercise. Therefore, Eiopa decided to conduct severe stress scenarios.
“I am confident that the results of the simulation of such shocks will provide us with a high-resolution picture of the European insurance sector and its most critical vulnerabilities.”
Not a 'pass-or-fail' test
The organisation was keen to assure firms that the test was not a ‘pass-or-fail’ exercise and on completion would not require them to calculate their solvency position.
The deadline for submission is 15 July, with the results coming out in December this year.