Bank of England puts insurers on Black Swan alert as economy lags

The Bank of England has put UK insurers on Black Swan alert, warning that long-unseen economic distress could give rise to “novel risks” and put cracks in existing risk models.

Insurers likely face “novel risks, changes in risk correlations and increases in distressed assets,” the Bank of England’s executive director for insurance supervision, Charlotte Gerken, warned in a missive to the industry’s CEOs.

Risk models could crack around the edges and insurers must “reassure themselves of [their] continued validity” given the “multiple concurrent stresses” now sprouting up throughout the risk environment.

The upshot: the Bank of England could put risk management and control frameworks under closer scrutiny. “Proactive steps” are required in risk management as firms are asked to “respond to market and credit risk conditions different from those that prevailed for a long time.”

The headline threats follow from a troubling macroeconomic situation, the Bank of England supervisor said, citing a grim outlook painted by the bank's own monetary authorities.

Gerken cited a “very challenging outlook for the UK economy, which is expected to be in recession for a prolonged period with CPI inflation remaining elevated in the near term.”

For general insurers, that chiefly means a continuation of pressures from rampant claims inflation, she indicated.

But beyond that headline, the forecast gets blurry quickly. The inflation outlook remains burdened by heavy doses of uncertainty concerning severity and duration of claims inflation, the lag to its visibility in claims, and to late settlement costs.

"Therefore, we expect general insurers to factor general and social inflation risk drivers into their underlying pricing, reserving, business planning, and capital modelling," Gerken said.

Life insurers, for their part, may be exposed to greater credit and concentration risk on the asset side, requiring "robust" stress testing of capital planning.

Elsewhere in the Gerken letter to CEOs:

Exposure management capability in relation to non-natural catastrophe risk (including cyber) remains "immature" and the regulator will step in during 2023 to "work with the industry to enhance practice and better manage risk in this area."

A rush into longevity reinsurance may be creating concentration risks with offshore names and may require policy action.

The BofE expects to complete its assessment of foreign branches now on the Temporary Permissions Regime and set out a supervisory approach to foreign branches, all in 2023.

Operational risk supervision will continue apace and insurers have a bar to clear on outsourcing and third-party risk management.

Smaller insurers must catch up on regulatory demands concerning resolution planning.

Financial risks from climate change:  insurers will be asked to report on progress vis-a-vis the bank's supervisory statement on “Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change.”

DE&I: The bank plans to issue a consultation paper in 2023 setting out proposals to introduce a new regulatory framework on DEI in the financial sector.

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