A year of change for insurance stress tests

At a glance
 

• The PRA will launch its Life Insurance Stress Test (LIST) and Dynamic General Insurance Stress Test (DyGIST) early next year, both which include new material features that insurers will need to consider carefully.
• The LIST 2025 is more complex, prescriptive, and extensive than previous exercises and, notably, the PRA will publish individual firm results. Since banks have been publishing their individual results for the last decade, there are several lessons that insurers can learn from banks as they embark on a similar stress testing journey.
• Life insurers should prepare for the LIST by revisiting previous feedback from the PRA to both insurers and banks around stress testing. The PRA has, for example, been critical of the lack of Board involvement and credibility of management actions in the stress and scenario testing process.
• The PRA will also launch its DyGIST next year. Although there are no plans to disclose individual firm results, it will be the first stress test of this kind and will be more akin to a live simulation – with scenarios only known on the day.

Who this blog is for: Board Members, Risk, Strategy, Actuarial, Regulatory Affairs, and Public Relations teams of insurers participating in the LIST and DyGIST.

I. Context and changes in the insurance stress testing landscape
 

2025 will be a year of change for insurance stress testing in the UK. General insurers will face a “dynamic” stress test exercise where they will be required to react to a sequence of live adverse events. Life insurers, on the other hand, will need to prepare for a more detailed and prescriptive LIST exercise where individual results for the core scenario will be published.

In the next 16 months, the largest UK bulk purchase annuity (BPA) providers will need to prepare for LIST 2025 whilst also managing many other priorities such as the implementation of SUK reforms, the remaining elements of the System Wide Exploratory Scenario (SWES), and new Funded Reinsurance (FundedRe) rules, putting finance and actuarial units under significant strain.

For life insurers, the new extensive scenarios with several restrictions around management actions (see our client note) and the public disclosure of individual results could prove challenging. Banks have, however, already acquired significant stress test experience through the Annual Cyclical Scenarios (ACS), including individual stress test results’ publication since 2014. This article builds on the lessons learnt from the banking sector and previous LIST feedback to identify no-regret actions for life insurers ahead of the 2025 exercise. We will also briefly discuss what the DyGIST 2025 means for general insurers and what actions they can take to prepare for it.

II. Some insights from banks and key considerations

1. Preparing

Identify what’s new and engage with the PRA

Life insurers need to understand what is different in the LIST 2025, and should conduct a gap analysis to identify where their current stress testing framework might need strengthening.

Key material changes in LIST 2025 include:

• The individual firm results of the LIST 2025 core scenario results will be made public - firms may therefore have to adapt their governance and control processes to improve the overall quality and reliability of stress testing.
• The LIST 2025 is more complex and prescriptive than previous exercises. For example, the LIST 2022 provided only one scenario that examined the impact of a severe financial market shock in four stages (including a longevity stress); the LIST 2025 includes one core scenario and two additional exploratory scenarios that build on the first. Life insurers will need to dedicate more resources to execute, challenge and sign off on stress testing processes and results.
• Management actions are more prescriptive and restrictive in the LIST 2025 compared to previous exercises. In the LIST 2025, in Stage 3 of the core scenario, firms will be required to rebalance their MA portfolios by bringing 25% of each asset downgraded in Stage 2 of the scenario to its previous credit quality step. Firms now also need to be able to explain in writing how they can implement management actions within appropriate timeframes.
  
  

Learn from previous exercises

We expect the PRA to focus on feedback identified in previous exercises. Firms can collate development areas from previous stress tests and include them on their LIST 2025 checklist. For example:

• Preliminary results from the SWES highlighted “significant liquidity needs from margin calls for most participating Non-Bank Financial Institutions - NBFIs”. This will likely reinforce the BoE’s focus on the feasibility of trading management actions.
• The LIST 2022 results identified issues with credit downgrades and property shocks as well as the lack of Board engagement with the stress testing process. The PRA also highlighted that some firms relied on unrealistic management actions, which might explain the decision to increase the level of prescriptiveness in LIST 2025.
   

Identify synergies

Developing stress testing has been costly and labour-intensive for banks - successful banks leveraged ACS data and processes for other deliverables such as the ICAAP or internal stress testing. Similarly, life insurers should look for synergies between LIST and other relevant regulatory programmes, such as:

• ORSA: outcomes of some of the LIST scenarios can be included in the ORSA to supplement qualitative information.
• FundedRe: the PRA has included an exploratory scenario on FundedRe in its LIST 2025; at the same time, insurers will need to comply with the PRA’s new expectations around FundedRe.
• Solvent Exit Planning and Recovery & Resolution: the LIST 2025 can be helpful for firms in modelling risk drivers to inform their Solvent Exit Analysis (SEA) as well as recovery and resolution planning. Some important elements can be used for both processes to improve efficiency (i.e., feasibility of management actions, trigger warning metrics, and risk modelling techniques).

Finally, automation has played a significant part in banks’ optimisation of stress test processes. Life insurers should consider automation of their stress test process (to the extent this is not the case) where feasible to increase efficiency and quality of the results. In particular, firms may want to review the SST modelling capabilities and how it fits with the wider modelling ecosystem to generate efficiency and consistency, and identify any areas within asset stressing that could potentially be automated..

2. Delivering
 

Focus on quality assurance

Low data quality was an issue in early iterations of the ACS, with the PRA highlighting a “wide variation in banks’ ability to provide accurate data and in the strength of banks’ modelling approaches”. Whilst there may not be the same concerns with insurers, the PRA will go through its usual key data quality assurance process”. Firms might want to plan their own validation programmes over stress testing to mitigate the risk of resubmissions.

The Results and basis of preparation report will be a key opportunity for firms to set out their rationale for scenario results, data/modelling limitations and assumptions. Getting the level of detail right will be important; preparing the equivalent report for banks proved to be a very material and resource-heavy process in the early days. Investing enough time and resource early on will be critical.
 

Board involvement

In previous exercises, insurers did not always formally involve the Board prior to submission (see Exhibit 3). The PRA expects a much more hands-on approach from Boards in the LIST 2025. In the banking sector, Board involvement for stress testing exercises is higher and has increased significantly across the years. Insurers will need to ensure the Board is more involved in the firm’s approach this time around.

3. Managing the publication of results

Understanding the impact on the market and the firm

Publishing individual results has the potential to move the market, and could have an impact on insurers’ cost of capital/ creditworthiness, as well as on potential BPA deal opportunities.

Insurers should map out which areas of the business might experience a material impact from the publication of the results. For example, the Finance and Transaction teams of BPA insurers will need to consider the impact of the new disclosures in their communications to Pension Scheme Trustees and on upcoming BPA deals. In the same vein, PR teams and Strategy teams might want to consider in advance the impact of different results’ scenarios (crisis and baseline).
 

Managing the narrative

LIST participants should have a process in place to manage the narrative around the results, both to the PRA and the wider market, agreeing a set of messages before and after publication. Firms could consider setting up analyst briefings to take questions after the publication of the results; or dedicate time to it during investor calls. When developing a narrative, insurers should aim for consistency with other disclosures and information publicly available, including e.g., the Solvency and Financial Condition Report (SFCR), investor update slides, and climate risk disclosures. As stress test results reflect the firms’ solvency position from the previous year, firms should also keep track of improvements made in their operational processes, solvency and liquidity position over 2025 to highlight the progress made since the test. This is a strategy that has been used by banks as a narrative to support results.
 

4. Looking ahead
 

In the months ahead, life insurers might want to learn from the experience of stress testing in the banking sector. This could include learning how the exercises are likely to be received by the market and how the PRA could respond through policy and supervisory action.

We expect new and emerging risks currently within the exploratory scenarios to move into the core scenario at some point. Key risks that we expect will become more important over time include:

• FundedRe is the basis for one exploratory scenario in the LIST 2025 and the PRA indicated it will be a regular feature of the LIST and that individual results be published going forward.
• The LIST 2025 core scenario explores liquidity risk through a rapid financial market shock, while early SWES results point towards enhanced supervisory attention in this area. In our experience firms that develop a liquidity strategy and invest in enhanced liquidity risk monitoring will be better prepared for supervisory scrutiny, including through stressing test.
• Credit risk already features in the LIST 2025, but over time we expect to see even more granular credit risk scenarios, requiring firms to capture more specific risk characteristics.
• Stress testing will continue to be a key tool to test firms’ resilience to climate risk.

Conclusion

The PRA’s industry-wide insurance stress tests are changing for both life and general insurers, indicating a move towards a more complex and demanding process in line with the evolution of bank stress testing.

For life insurers, the key change ahead is the publication of individual results; they have to prepare to run the exercise with robust governance and Board involvement, ensuring the completeness of data and taking a strategic approach to the supporting narrative. General insurers, on the other hand, will experience a brand-new type of exercise, more akin to a live simulation. The PRA will use this exercise to test, and ultimately enhance, the overall risk management and stress testing capabilities of the general insurance market.

The results of the LIST and the DyGIST will inform regulatory policy and supervisory activity going forward. Insurers should invest in their preparations to ensure a smooth process in 2025.