UK insurance sector ‘robust’ to COVID-19 downside stresses, PRA says

Written by Adam Cadle

18/06/2020

The UK insurance sector was robust to downside stresses caused by the COVID-19 pandemic during April, the PRA has said, with the highest uncertainty centred on certain general insurers’ liabilities.

In a letter addressed to insurance firms participating in the 2019 Insurance Stress Test (IST 2019) exercise and the PRA’s more recent engagement on COVID-19 stresses, the regulator said “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 PRA’s analysis during April, used both the illustrative scenario outlined in the May 2020 Monetary Policy Report (MPR) and further severe asset and insurance shocks tailored to stress the different risks to which different types of insurance firm are exposed.

The IST 2019 for general insurers, the third biennial stress test, has again suggested the industry is resilient to natural catastrophe risks. As in previous exercises, this is reliant on significant levels of reinsurance, particularly from Bermuda. Results from the PRA’s 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 ILS structures.

On the life side, the PRA invited 17 UK regulated life entities across 12 groups to complete the exercise. It chose these firms as they had large annuity exposures within MA portfolios. The high impact areas where firms made significant approximations were around the recalculation of the MA in stress, recalculation of the SCR in stress, recalculation of the risk margin in stress and recalculation of TMTP in stress.

The post-stress best estimate liability (BEL) calculation relies on an accurate recalculation of post-stress MA. A number of firms did not fully assess the matching position of the MA portfolio post-stress, despite this being explicit in the instructions and a PRA requirement within capital models. This led to some uncertainty in the level of MA benefit claimed in stress. The PRA’s instructions reflected the complexity for internal model firms in calculating the SCR after an extreme scenario, and outlined “acceptable” simplifications, it said. A small number of firms followed this approach, and a number of other internal model firms attempted a more sophisticated calculation. However, in the majority of cases firms relied on pre-stress calibrations of the SCR model, without considering whether this remained appropriate following an extreme stress.

In addition, the regulator said:“TMTP will become an increasingly material component of the balance sheet after each stress. Unfortunately, some firms applied approximations with limited/no validation, and no firm considered whether the level of TMTP would be ‘affordable’ given its projected business model over the transition period.”

“For some firms, some inconsistencies in asset data were identified across different data submissions. Although these were ultimately reconciled, this came at the expense of additional time and cost for the PRA and firms. For firms, this indicates the need for further work on data quality and controls to support concurrent stress testing; and for the PRA this has highlighted where the design specification can be improved to avoid any overlaps or inconsistencies.”

The IST 2019 – climate scenario - was exploratory, enabling the BoE/PRA to understand market capabilities and to help inform the design and specification choices for the BoE/PRA climate biennial exploratory scenario (BES).

The exercise was designed to provide market impetus in developing climate scenarios, and for many firms this was the first time they had conducted such a stress test. For the industry, the exercise has highlighted gaps in capabilities, data and tools to evaluate climate-related scenarios, the PRA underlined.

“These will need to be filled before firms can start to align their strategy to specific emission transition trajectories,” the PRA stated.

Related Articles