LONDON/FRANKFURT, (Reuters)—European insurers' prospects deteriorated in the second half of 2011, weighed by a worsening sovereign debt crisis, a slowing economy, and persistently low interest rates, the industry's pan-European regulator said on Tuesday.

"Sovereign risk and the lack of a comprehensive political response to the sovereign crisis are the main sources of risk" facing insurers in 2012, the European Insurance and Occupational Pensions Authority (EIOPA) said in a twice-yearly overview of the industry.

Policymakers must remove all doubts that the euro would remain intact, it said.

"If policy responses remain unconvincing to financial market participants, the European insurance and occupational pension sectors could be severely and adversely affected."

European insurance stocks have slumped 16 percent since the start of the year, reflecting fears the sector could be forced to raise capital to make good sharp falls in the value of its holdings of distressed European government debt.

EIOPA conducted two hypothetical tests of the resilience of 82 insurers to a prolonged period of low interest rates and found that in the more severe of the two, eight insurers would not have enough capital to cover the minimum regulatory capital requirement. EIOPA did not identify the companies involved.

Low interest rates weigh on insurers' investment returns, eroding profits, with companies that provide minimum guaranteed payouts to their customers most severely affected.

In the stress test scenario, the failed insurers would need about 6 billion euros ($7.8 billion) in total to reach the minimum capital ratio, EIOPA said.

The European Banking Authority in separate stress tests of the region's lenders found a capital shortfall of 115 billion euros that banks will need to find by mid-2012 to plump their capital cushions to the level required by the regulator.

The bloc's insurers on average showed resilient capital positions during 2010, with a solvency ratio for the sector of 309 percent, but this did not mean that every insurer was in a healthy position, EIOPA said.

"There is reason to highlight pockets of concerns with respect to both the weaker capitalised companies and the undertakings with asset holdings that have been adversely affected during 2011," it said.

EIOPA had already identified the sovereign debt crisis, triggered by fears critically-indebted eurozone countries may be unable to repay what they owe, as the main risk facing the insurance sector in an earlier report in July.

The European Central Bank this week said in a separate Financial Stability Review that it expected the financial condition of large euro area insurers to remain broadly stable in the next six to twelve months, though it too, said investment and underwriting risks could pose challenges for the sector.

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