Briefing: Upcoming industry ‘stress test’ should pose no problems for UK insurers

By Yiannis Kotoulas  

Yesterday (4 October 2023), the Prudential Regulation Authority (PRA) – the regulatory arm of the Bank of England – announced that it would conduct a general insurance stress test in 2025. 

In its statement, the PRA said that its intention was to assess the industry’s solvency and liquidity resilience to an as yet unspecified, but simulated “sequential set of adverse events,” which would also assess the risk management response of insurers and inform the regulator’s planning for a potential real life catastrophe. 

While previous stress tests have been run, the upcoming 2025 iteration will represent “a significant change” from previous exercises in terms of its scope, with the PRA planning to engage with the industry over the next six months – and provide more details during the first half of 2024. 

This plan is an example of good regulation – especially considering that planned British government amendments to the Solvency II regulatory regime would deliberately allow more risk into the system. 

Last year (17 November 2022), chancellor of the exchequer Jeremy Hunt confirmed that the government would forge ahead with its package of Solvency II reform.

Chief among these announced changes was a promise to introduce legislation that would reduce the risk margin for general insurance businesses by 30%. 

Current Solvency II regulation requires insurers to hold a solvency coverage ratio (SCR) of at least 100%, meaning they must hold eligible assets in reserve to the value of 100% of what they could be liable to lose over the next year.

The government’s plan to lower this threshold by 30% would mean that insurers would only be required to hold a SCR of 70%.

Naturally, everyone in insurance will understand that you should only introduce more risk into a portfolio if you can be sure the advantages won’t outweigh the risks – and the planned stress test should provide more information there.

Through the motions

Despite the good intentions of the PRA – and the need to conduct due diligence – I believe the general insurance industry should pass the regulator’s test with flying colours. 

At the time the government’s reforms were announced, data analytics and consulting firm GlobalData revealed that current solvency capital requirements were not a factor limiting investment from UK general insurers in the economy. 

Indeed, research from the firm found that most UK insurers were operating with SCRs well above the 100% requirement. 

Recent research has confirmed this trend – in his latest analysis for Insurance Times, published today (4 September 2023), Insurance DataLab cofounder Matt Scott revealed that UK insurers reported their second highest aggregate SCR of the last five years in 2022/23. 

This figure, which takes an average SCR from across the UK general insurance market, reached 177.8% in the latest period.

Even among the very largest quartile of insurers by gross written premium, where you may expect lower SCRs, the average still sat at 174.8%. 

What this shows is that, while requirements for capital reserving will be relaxed by government, insurers themselves are by no means confident that the current economic environment presents a good opportunity to let down their guard. 

One of the advantages the insurance sector holds over other industries is its considerable, historic stability. It will take more than a political play from the UK government to make it take such considerable risks with policyholders’ capital. 

Indeed, the upcoming stress test should do nothing but provide further evidence of the sector’s strong financial stability.