As the PRA launches its biennial insurance stress test, Emma Ann Hughes looks at what the industry can expect-¦
The UK Prudential Regulation Authority (PRA) has launched its biennial insurance stress test.
The watchdog is asking the largest regulated life and general insurers to provide information about the impact of a range of stress tests on their business.
According to the regulator, the results of these stress tests will be used to inform the PRA's view of sector risks and assist the watchdog in the supervision of individual firms.
The regulator insisted it is "not a pass/fail exercise and it is not designed to set capital buffers".
The stress test includes an exploratory exercise in relation to cyber underwriting and climate change.
The set of climate scenarios explores the impacts to firms' liabilities and investments stemming from physical and transition risks.
The stress test also requires insurers to calculate what will happen to their business if there is a downward shift in risk-free interest rates of 100 basis points; a widening in corporate bond spreads dependent on their current credit rating (for example, 150 basis points for AAA-rated assets; or a simultaneous mass downgrade of credit assets plus a fall in other asset values including equities down 30%, commercial property down 40% and residential property down 30%).
Insurers have to reveal the outcome of certain stress tests by 30 September 2019, with the deadline for other tests set at 31 October 2019.
SCENARIO TESTING
Martin Shaw, chief executive of the Association of Financial Mutuals, said: "As an insurer, the one certainty you have about your business plan is that no matter how well crafted the plan and how carefully honed your budget, the outcome will never be the same as that predicted.
"As the second-best known quote by Donald Rumsfeld goes: 'Stuff happens.' The board of an insurance company therefore doesn't rely on a single view of the future but develops a range of scenarios to better understand how its business might perform in different market conditions.
"Regulatory stress tests are part of that process and enable the regulators to see the bigger picture. We think they are a vital part of ensuring markets function effectively and the new elements this year in the Bank of England stress tests, on the effects of climate change and on cyber underwriting, reflect some of the most significant sources of uncertainty for many insurers today.
"We hope the Bank of England publishes results from the stress tests that will provide the PRA and all insurers with a common understanding of the risks to factor in for the future. That said, we don't expect insurers to have to betray competitive advantage through this kind of exercise."
The PRA has confirmed it will publish a summary of the overall results and findings in the first quarter of 2020, but no individual firm results will be made public.
Emma Ann Hughes is communications director of the CII