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Stress tests suggest nat cat model weaknesses

December 11, 2017

The General Insurance Stress Test (GIST) carried out by the UK’s Prudential Regulation Authority (PRA) has suggested weaknesses in the natural catastrophe modelling of insurers.

The scenarios included in the stress test were designed, in part, to test risks that are either absent or not well captured in catastrophe models, for example flooding from rain associated with hurricanes or tsunamis following earthquakes.

The PRA noted that the results suggested few firms go beyond a simple loading to reflect weaknesses. The regulator encouraged firms to improve their ability to reflect these risks as their models evolve whilst it encouraged boards to understand what the limitations are with the catastrophe modelling, and their inherent uncertainty when applicable, especially for their key perils.

Additionally, for some firms, the stress test indicated areas for improvement in the way accumulations of exposures are captured, monitored and reported to the board. Specifically, the ability of firms to identify concentrations of exposures and adhere to their own risk appetite limits is an important risk management tool that should complement regular reporting of modelled loss output, according to the PRA statement.

Furthermore, the regulator said that numerous firms would benefit from being more granular in planning the management actions they would take in the event of a major loss, including reinstating exhausted reinsurance cover when appropriate. In addition, firms would benefit from considering asset liquidity, capital fungibility and strengthening their resolution planning.

The 26 largest general insurers in the UK, 16 large syndicates and the Society of Lloyd’s, participated in the GIST 2017.

Between them, they accounted for some £80bn of gross written premium (GPW), representing approximately 82 percent of the UK general insurance sector by GPW, and held some £61.5bn of eligible own funds (EOF) as at 31 December 2016.

The stresses included four natural catastrophe scenarios and an economic downturn scenario. In addition, GIST 2017 contained a separate section capturing the insurance exposures of UK general insurers to the different sectors of the UK economy.