The PRA has published a letter from Chris Moulder, its general insurance director, to the CEOs of the 26 general insurers and Lloyd’s syndicates that participated in its 2015 General Insurance Stress Testing exercise. The results will help inform the PRA’s supervision of participant and non-participant firms over the next 12 to 18 months (at least).

Here’s what to expect:

  • On the asset side of the balance sheet, the largest adverse impact on the largest number of general insurers is likely to occur in circumstances where corporate bond values fall as credit spreads widen. Insurers invest heavily in corporate bonds for matching and other reasons. That makes sense, but it leaves the sector exposed to a material economic-shock risk, if a credit-spread shock risk chrysalises. Result: the PRA is likely to focus on the bond portfolio diversity of, and the bond risk hedging strategies being used by, some general insurers;
  • On the insurance-liability side of the balance sheet, most of the largest general insurers are likely to be able to withstand a market-wide stress, such as US hurricane, without breaching their SCR. But that’s not always the case; and, “although spanning multiple events, the [stress test] scenario design was limited in focusing on a single geographic region, a single product, or a single industry“. Result: the PRA is likely to move its supervisory focus onto (a) smaller and/or less well capitalised insurers; and (b) the difficulties that some insurers will face, almost regardless of their size and basic own funds position, if (for example) there are multiple hurricanes across several geographic regions, instead of one;
  • The general insurance sector places significant reliance on reinsurance; but its reinsurance counterparty risks are usually well diversified. Result: the PRA is likely to focus some attention on those insurers that rely most heavily on reinsurance; and/or those where the counterparty risks are not as well diversified, or they’re higher than their peers’ counterparrty risks, for other reasons; and
  • Emerging and complex risks require common terminology and a common framework for the assessment of exposure before a wider assessment of firm and sector resilience can be determined on a consistent basis”. Result: the PRA may try to develop, or it may try to encourage the market and/or (perhaps) EIOPA to develop, some common terminology, so that future solo and sector-wide stress testing will be more useful. This effort may focus, in the first instance, on the risk that solar flares will cause major power outages in Europe and north America; and/or that a series of simultaneous or sequential cyber-attacks will be launched against large multinationals. This is because it’s likely to be easier to develop common themes, common understandings, and (consequently) common terminology in these areas, before moving on to scenarios that are likely to be more complex or controversial.

The 2015 stress test exercise for general insurers was limited to 26 of the largest general insurers and Lloyd’s syndicates. Participating insurers and syndicates weren’t asked to report their after the event balance sheets. They were, however, asked to assume that each scenario resulted in a single instantaneous event and a full immediate loss. The PRA took this approach because it wanted to reduce the stress testing workload on participating insurers, as they prepared for Solvency II compliance. So: the 2017 stress tests are likely to be more detailed and complex. More general insurers may also be asked to participate.