UK insurers set to survive any nat cat onslaught, if reinsurance holds

UK insurers and  Lloyd’s syndicates would largely survive a heavy dose of major US nat cat, UK wind storm or cyber with only a handful of stragglers suffering the kind of loss to put solvency ratios into danger zones, thanks chiefly to a heavy reliance on reinsurance, the Bank of England’s 2022 stress tests indicate.

“The results indicate that the UK insurance sector is resilient to the PRA-specified scenarios, subject to a number of mitigating measures, while highlighting and supporting the need for ongoing focus in a number of priority areas,” the Bank of England’s executive director for insurance supervision Charlotte Gerken wrote in an introduction to the results.

Cat modelling looks “more sophisticated” than at prior reviews, with more novel aspects of the scenarios addressed. But gaps remain, including the quantification and assumptions of loss modifying factors such as claims inflation, PLA, and secondary uncertainties.

The aggregate solvency capital requirement (SCR) coverage for the general insurance segment remains above 120% in all scenarios with only a US hurricane stress scenario pushing any sizeable number of firms and syndicates below the 100% level.

A 1:150 year US hurricane scenario, similar to the 2019 season, includes three major hurricanes of varying profiles rendering a total industry loss in excess of $210 billion. The panel would cede about 60% of the gross loss, but capital solvency ratios would still fall by a heady 42 percentage points from 166% to 124%. Some 5 of the 28 affected entities would fall below the 100% mark and 7 Lloyd’s syndicates would post net losses in excess of 30% of their economic capital assessment (ECA), the minimum syndicate-level capital set by Lloyd’s.

A 1:250-year double-punch California earthquake scenario near the San Francisco Bay was hypothesized to render a total insured loss neighbourhood $70-80 billion. After ceding 66% of the gross loss to reinsurance, carriers would suffer a 36 percentage point (pps) hit to solvency from 165% to 129% with 4 entities breaking the 100% threshold and two syndicates suffering net losses in excess of 30% of ECA.

A series of three large and separate UK windstorm and flood events were hypothesized to render c. £20 billion of insured losses in aggregate in the UK. UK insurers would cede a full 77% of the loss and hold the hit on the capital solvency ratio to 24 points to 151% for the group as a whole. Only one insurer would fall below a 100% reading and no syndicate would suffer a net loss to reach 30% of its ECA.

A series of cyber scenarios took up to 20 pps from solvency and did more to reveal lingering gaps in the industry’s grasp of the issues.

A defined scenario for a £4.4 billion systemic ransomware would be 57% ceded to reinsurers and ultimately take 12 pps from the aggregate capital solvency ratio to 147%.  A £6.9 billion data exfiltration event would be 52% ceded and ultimately take 16 pps to 143%. A cloud outage was said to render a £9.2 billion in gross losses, but would be 56% ceded reinsurers and leave a 20 pps hit to CSR to 135%. Only individual cases of severe strain were reported.

But assessment of the likelihood of tail risks was highly variable, authors warned. Carriers show “significant variation” in the perceived likelihood of the cyber scenarios and regulators suspect the industry has now been around long enough for greater consensus. The ability to identify the implications of contract uncertainty was called “mixed.”

Reinsurance, as the “primary mitigant” against losses, drew calls for firms to “proactively manage reinsurance counterparty concentrations” despite signs of strong diversification.

Participants showing material gross losses in the exercises commonly hit the likelihood of needing to reinstate limits for lower layers of vertical ‘per risk’ and ‘nat cat event’ programmes. In some cases these lower layers were exhausted in full, although full exhaustion of all reinsurance limits was not common

The Bank of England expects to get back to general insurers in Q3 2023 concerning the timing and design of the next round of stress testing.

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