LONDON/FRANKFURT, (Reuters)—European insurers' prospectsdeteriorated in the second half of 2011, weighed by a worseningsovereign debt crisis, a slowing economy, and persistently lowinterest rates, the industry's pan-European regulator said onTuesday.

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

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

"If policy responses remain unconvincing to financial marketparticipants, the European insurance and occupational pensionsectors could be severely and adversely affected."

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

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

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

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

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

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

"There is reason to highlight pockets of concerns with respectto both the weaker capitalised companies and the undertakings withasset holdings that have been adversely affected during 2011," itsaid.

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

The European Central Bank this week said in a separate FinancialStability Review that it expected the financial condition of largeeuro area insurers to remain broadly stable in the next six totwelve months, though it too, said investment and underwritingrisks could pose challenges for the sector.