PRA Outlines Next Steps for Stress Testing the Insurance Sector
PRA published a feedback letter intended for general and life insurers that participated in the insurance stress test for 2019 and the COVID-19 stress testing. This was the third PRA exercise for general insurers and the first one for life insurers since the introduction of Solvency II. The exercise incorporated asset and liability shock scenarios as well as a number of exploratory scenarios, including a climate change exercise. For general insurers, in recognition of the reliance on Bermuda-based reinsurers, PRA conducted the first joint exercise with the Bermuda Monetary Authority for natural catastrophe scenarios, supporting the joint commitment to supervisory cooperation, in line with the Insurance Core Principles of IAIS. To assess ability of the insurance sector to withstand the stresses arising the COVID-19 pandemic, PRA also conducted further resilience testing of firms during April.
The analysis for resilience testing in context of the COVID-19 pandemic showed that the sector was robust to downside stresses, with the highest uncertainty centered on certain general insurers' liabilities—particularly those arising from the business interruption claims. To ensure that the sector remains robust in this evolving situation, PRA expects firms to continue to closely monitor the additional risks presented by COVID-19 pandemic, update their risk and capital assessments as the situation evolves, and take appropriate management actions, where necessary.
Additionally, this third biennial stress test suggested that the industry is resilient to natural catastrophe risks. PRA highlighted three areas for further work by industry in the estimation of insured losses from natural catastrophe scenarios. These work areas relate to the allowance for risks not captured within standard models, allowance for secondary perils in light of recent experience (such as inland flooding following a hurricane), and data quality. The exploratory scenarios identified areas for further development in the industry’s ability to assess cyber-related and sectoral (across economic sector) exposures. The responses highlighted the areas on which PRA and the industry will need to focus on, to develop climate stress testing capabilities further. For the industry, the exercise has highlighted gaps in capabilities, data, and tools to evaluate climate-related scenarios. These gaps will need to be filled before firms can start to align their strategy to specific emission transition trajectories. For the PRA/BoE, the exercise has provided valuable lessons on scenario design, specification, and reporting—and PRA will take forward work on these areas.
PRA expects boards to assess whether the findings apply to their firms and present an action plan to their supervisors to address these findings. Given the current uncertainty and demands arising from COVID-19, PRA understands that firms may need more time to address these issues. Looking further ahead:
- For the next insurance stress test, the aim will be to alleviate the burden on firms in light of the COVID-19 impact and allow them and PRA/BoE to focus on COVID-19 stresses; the next concurrent insurance stress test will occur in 2022.
- With respect to the Climate Biennial Scenario, recognizing current pressures on firms and, in light of the responses to the December 2019 discussion paper on the Climate Biennial Exploratory Scenario, the Prudential Regulation Committee and the Financial Policy Committee have agreed to postpone the launch of the exercise until at least mid-2021.
- For the development of a cyber-stress test, PRA intends to engage with the general insurance industry to develop a cyber-scenario in time for the 2022 insurance stress test exercise.
Related Link: PRA Feedback to Insurers
Keywords: Europe, UK, Insurance, Stress Testing, Life Insurance, General Insurance, COVID-19, Climate Change Risk, Cyber Risk, PRA, BoE
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