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(Adds industry reaction, news conference)
By Huw Jones
LONDON, Dec 15 (Reuters) - Insurers may have to scrap dividends after a test of their ability to withstand severe market shocks uncovered a 160 billion euro ($165 billion) hole in balance sheets, the European Union's insurance watchdog said on Thursday.
The European Insurance and Occupational Pensions Authority (EIOPA) published anonymised and aggregated results of this year's stress test of 236 life insurers, seen as the most vulnerable part of the industry due to low yields.
The results show national supervisors need to respond with measures including possible cuts to maximum guaranteed returns or reductions in "unsustainable" profit-sharing in new policies if business models begin to look unviable, it said.
"The results of this year's EIOPA stress test confirmed the significant challenges for the European insurance sector triggered by the current macro-economic environment," EIOPA Chairman Gabriel Bernardino said in a statement.
The sector is adequately capitalised overall, Bernardino said. "We don't anticipate that there will be a huge number of situations where you will need to have capital increases."
Struggling insurers that are part of a group could benefit from surplus capital being held elsewhere.
EIOPA said it will check how national regulators implement its recommendations to ensure a "coordinated response to situations that may pose a threat to the viability of the supervised entity and, collectively, to the system as a whole".
Insurance Europe, an industry body, said the tests showed the sector is "very resilient" and would have fared even better if non-life insurers had been checked as well.
The Association of British Insurers said the results are particularly reassuring for customers.
The stress test, taken every two years, simulates two extreme but "plausible" shocks to see how insurers could cope.
The first scenario focused on a prolonged period of low yields, an extreme version of what is already happening in markets, making it harder for insurers to find enough returns to cover policy payouts.
Insurers showed a 100 billion euro hit to balance sheets under this scenario.
Under a second, "double hit" scenario of prolonged low interest rates and a plunge in asset prices, the hit rose to 160 billion euros.
The hits to balance sheets would have been worse without the benefit of transitional arrangements in the EU's insurance solvency rules which phase in requirements over 16 years.
However, even under the test's pre-stress scenario, 32 insurers failed to meet EU solvency requirements when these transitional arrangements and long-term guarantees were stripped out.
While there was no pass or fail mark, EIOPA issued a range of recommendations for national regulators, such as requiring firms to review or cut guaranteed returns on some policies, and cancel or defer dividends if a business model is at risk.
The sample of companies tested included the region's biggest insurers, as well as small and medium-sized firms, covering 77 percent of the life insurance sector. Some 70 percent of the companies tested were from Italy, Germany, France and Britain.
The watchdog said it may be able to publish information on a firm-by-firm basis from the next test in 2018.
$1 = 0.9647 euros Reporting by Huw Jones; Editing by Ruth Pitchford and Adrian Croft