Regulator Stresses Insurers Need to Address Test Gaps

UK Regulator the Prudential Regulatory Authority has warned the country’s insurers they have to rigorously monitor their exposures to business interruption claims following the results of the stress test into how well the industry can withstand the impact of COVID-19.

Executive Directors, Insurance at the PRA Anna Sweeney and Charlotte Gerken have written a joint letter to CEOs of the UK’s insurance firms to highlight the results of the recent stress tests and set out the steps for the future.

The industry took part in the 2019 Insurance Stress Test (IST 2019) exercise and, more recently the COVID-19 stresses.

The letter explained that for general insurers, in recognition of the reliance on Bermuda-based reinsurers, the PRA conducted its first joint exercise with the Bermuda Monetary Authority (BMA) for natural catastrophe scenarios.

On the impact of the current pandemic the letter stated: “In order to assess the ability of the insurance sector to withstand potential further stresses which might be caused by the Covid-19 pandemic, we conducted further resilience testing of firms during April. Our analysis used the illustrative scenario outlined in the May 2020 Monetary Policy Report and further severe asset and insurance shocks tailored to stress the different risks to which different types of insurance firm are exposed.

“Our analysis showed that the sector was robust to downside stresses, with the highest uncertainty centred on certain general insurers’ liabilities – particularly those arising from business interruption claims. To ensure that the sector remains robust in this evolving situation, we expect firms to maintain close monitoring of the additional risks presented by Covid-19, update their risk and capital assessments as the situation evolves and take appropriate management actions where necessary.”

The third biennial stress test found the industry is resilient to natural catastrophe risks. The PRA said as in previous exercises, this is reliant on significant levels of reinsurance, particularly from Bermuda. “Results from our joint exercise with the BMA indicate that Bermuda-based reinsurers are resilient to the stresses examined in the exercise; and that they also rely heavily on reinsurance, and in particular the capital markets via Insurance Linked Security structures. “

The letter also called for further work by the industry in the estimation of insured losses from natural catastrophe scenarios:

  • Allowance for risks not captured within standard models (typically because the product, such as contingent business interruption, or type of event, such as a secondary peril, is not captured in the model).
  • Allowance for secondary perils in light of recent experience (such as inland flooding following a hurricane).
  • Data quality.

The stress test carried out by the PRA ion the exposure to climate change, whilst described as a” challenging undertaking threw up a number of issues.

“For the industry – the exercise has highlighted gaps in capabilities, data and tools to evaluate climate related scenarios,” said the letter. “These will need to be filled before firms can start to align their strategy to specific emission transition trajectories.”

Looking to the future the letter warned that the PRA would be looking for action to remedy the shortfalls the exercises had highlighted.

“We will work closely with industry to take these findings forward. We expect boards to assess whether the findings apply to their firm and present an action plan to their supervisors to address them. Given the current uncertainty and demands arising from Covid-19, we understand that firms may need longer to address these, and this will be taken into consideration.”

The letter also received that the PRA are set to develop a cyber-stress test for the general insurance underwriters, with a cyber-scenario in place in time for the 2022 insurance stress test exercise.

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