UK PRA describes approach to 2025 stress test of life insurers
The UK’s Prudential Regulation Authority (the “PRA”) has published details of its approach to the 2025 stress testing of certain life insurance companies.
Perhaps the most eye-catching aspect of the life insurance stress test (“LIST”) 2025 is that the PRA will, for the first time, publish individual firm results for its core scenario, rather than reporting those outcomes at an aggregate sector level – a move that the government has supported as part of its reforms to the UK’s Solvency II framework. LIST 2025 will also be the first life insurance stress test to be run under the new ‘Solvency UK’ regime.
Which firms will participate?
Although LIST 2025 relates specifically to the life sector, not all life insurance companies will be directly involved. Instead, LIST 2025 will apply to those UK insurers which participate in the bulk purchase annuity (“BPA”) market and which have the largest annuity portfolios, namely:
- Aviva International Insurance Limited;
- Aviva Life & Pensions UK Limited;
- Canada Life Limited;
- Just Retirement Limited;
- Legal & General Assurance Society Limited;
- Partnership Life Assurance Company Limited;
- Pension Insurance Corporation plc;
- Phoenix Life Limited;
- The Prudential Assurance Company Limited;
- Rothesay Life plc; and
- Scottish Widows Limited.
These firms are seen by the PRA as holding increasing importance to both policyholders and the wider economy, making transparency about their financial resilience ever more important.
LIST 2025 will be run on a solo basis, i.e. participants will be the PRA-regulated insurance companies who contract directly with policyholders. The PRA says that it will continue to work with stakeholders to expand its stress testing to cover group-level results in future exercises.
Objectives
The PRA’s goals and broad parameters for this exercise are set out in an approach document. Here, the PRA makes clear that is has three objectives:
- to assess sector and individual firm resilience to severe but plausible events;
- to strengthen market understanding and discipline through individual firm publication; and
- to improve insight into risk management vulnerabilities.
The PRA has confirmed that the LIST will not be used to help set capital requirements or buffers (in contrast to some of the PRA’s stress testing in the bank sector). Recognising that the exercise will test firms with a ‘severe’ scenario and that some firms may not necessarily show solvency capital requirement coverage of 100% or more following the stress scenario, the PRA highlights that LIST 2025 is ‘not a pass-fail exercise’.
Three scenarios
To achieve its goals, the PRA will ask firms to complete three exercises, comprising one ‘core’ and two ‘exploratory’ scenarios (the latter designed to assess emerging risks). These are as follows:
- The core scenario will assess sector and firm resilience to a three-stage evolving financial market stress scenario, building on the previous PRA life insurance stress test carried out in 2022.
- An exploratory scenario will assess firm resilience to an additional downgrade stress to the asset type most material to their matching adjustment (“MA”) (excluding corporate bond and sovereign assets). The PRA hopes that this will provide insight into a firm’s reliance on a particular source of MA and their vulnerability to possible idiosyncratic risks, beyond a general economic downturn.
- An exploratory scenario will assess firm resilience to an additional stress of recapture of their most material funded reinsurance arrangements. The PRA’s focus in this area reflects the increased use of funded reinsurance by some firms which are active in the BPA market. The PRA adds that it intends for the funded reinsurance stress to become a regular feature of life insurance stress tests, with publication of results at the individual firm level in future exercises.
Publication of results
Individual results of the ‘core’ scenario
The results of the core scenario will be published at an individual firm level. The PRA’s intention, here, is that this will provide market participants with additional transparent, independent measures of a firm’s resilience and facilitate market education and discipline. At a minimum, the PRA expects to publish:
- Information on each insurers’ actual portfolio asset composition and risk exposure, including sources of MA, at the starting point.
- Solvency coverage ratio, and its most important components: eligible own funds and solvency capital requirements. These will be provided at the starting point and each stage, with a breakdown showing the most significant risk drivers, at the individual firm level.
- Additional metrics on each MA portfolio, demonstrating how the MA responds to stresses and the impact it has on the overall results.
Aggregate results of the ‘exploratory’ scenarios
By contrast, results from the two exploratory scenarios will be published at an aggregate level only. The PRA explains that the decision not to publish results of the exploratory scenarios at an individual firm level has been made because emerging risks can, by definition, be characterised by a lack of accurate historical data, market standards or agreed methodologies, making cross-firm comparisons challenging.
Other materials and request for input
Alongside the approach document, the PRA has also published a draft set of instructions, templates, a data dictionary and a document describing qualitative information that in-scope firms will be required to provide. It has requested technical input on these documents in a letter to firms, with comments requested by 6 September 2024.
Next steps
The PRA plans to launch LIST 2025 and publish the final scenario design and calibrations in January 2025. The results will be published in Q4 2025.
Future tests
The PRA is aiming to run life insurance stress tests every two years, with firms in scope of future exercises being notified one year prior to launch.
