PRA Letter Shares Insights from Supervisory Review of Solvency II Data

In the letter, PRA highlights that two of the areas of concern—bias in reserve estimates and possible weakening in case reserve estimates—persist in the analysis of the latest Solvency II reporting as at year-end 2019. The analysis indicates that reserving assumptions may have weakened over time, while data show that the claims experience continues to deteriorate. The board is encouraged to satisfy itself that the key assumptions related to the rate of future claims development remain appropriate, that the case reserving has not weakened over time, and that there is no unjustified anchoring to optimistic business plan loss ratios. In addition, PRA notes that COVID-19 has given rise to additional complexity and uncertainty in estimating ultimate losses, which has been grouped into four key areas:

• Data—A number of firms have not been able to accurately identify and track COVID-19 exposed policies. Firms should ensure that this uncertainty is reflected in the reserve estimates and that, where possible, appropriate procedures are put in place to identify and track exposed policies.
• Discontinuities in historical trends—A number of firms’ estimates for COVID-19 losses on casualty classes may be optimistic. Consequently, PRA encourages firms to make sufficient allowance for the uncertainty related to both the direct impact of COVID losses as well as the indirect impacts on claims arising from the downturn in the wider economy.
• Appropriateness of common reserving methodologies—Given that the historical claims experience may not be a good guide for estimating future COVID-19 losses, alternative approaches such as the use of benchmarking and exposure-based analyses will be particularly useful to consider alongside more common reserving methodologies.
• Reinsurance adequacy—Where there is a material reliance on reinsurance to protect against losses, be it intragroup or third party, PRA encourages the board to satisfy itself that those arrangements are adequate. It would be prudent to stress-test the assumptions related to reinsurance recoveries to understand the impact of reinsurance not responding as expected, and then to ensure sufficient allowance is made for this uncertainty when setting reserves.

With respect to the exposure management frameworks across market, PRA has observed that the frameworks for non-property classes of business are less mature than for property classes. Another observation is that the state of man-made catastrophe risk assessment remains significantly behind that of the natural catastrophe risk assessment. Firms can expect PRA to increase its focus on firms that are materially exposed to man-made catastrophe risk and where progress toward better practice remains slow. In the letter, PRA is also encouraging firms to actively consider whether current risk and capital management frameworks—including current stress and scenario testing—sufficiently address the risks posed by contract uncertainty and unintended exposures. It may be useful to consider the identification, definition, and monitoring of all risk related to contract wording, including any key assumptions related to expected coverage. This includes the risk related to reinsurance contract wordings where coverage may not fully align with all assumed perils or events detailed in the underlying insurance contracts. 

Related Link: Letter

Keywords: Europe, UK, Insurance, Reinsurance, COVID-19, Reserving, Exposure Management, Solvency II, Reporting, Benchmarking, Stress Testing, PRA