PRA launches Insurance Stress Test 2019 including climate scenario
The PRA today launched its 2019 Insurance Stress Test, introducing for the first time a climate change exploratory exercise alongside a suite of market and catastrophe scenarios. The package follows the PRA’s earlier announcement that, from April 2019, UK insurers would be asked to assess physical and transition climate risks as part of a market-wide exercise.
Key investment- and balance-sheet-relevant features of the 2019 exercise include:
### A new climate change module
that asks insurers to assess how different physical and transition climate pathways affect both their liabilities and investment portfolios, extending climate risk analysis beyond underwriting exposures. The PRA said the climate scenarios are exploratory and are intended to capture impacts on assets as well as on claims.
### Climate stress testing structured around high-level
data-driven narratives of how physical and transition risks evolve over time, which insurers must translate into quantitative metrics to gauge the impact on their balance sheets and on the wider financial system. This requires firms to link scenario stories to portfolio-level numbers rather than relying solely on historical loss data.
### An explicit requirement
from April 2019, for UK insurers to consider how their businesses would be affected under different physical and transition climate risk scenarios as part of the market-wide stress test, formalising climate risk as a core element of the PRA’s supervisory toolkit. Mark Carney had previously outlined these plans at a European Commission conference on sustainable finance.
### A focus on how insurers
are managing “difficult to assess” risks, with Section C of the exercise gathering information on firms’ approaches and including the new climate change exploratory component. The PRA is using this section to compare practices across the market rather than to apply pass–fail thresholds.
• A parallel downward 100 basis point shift in risk-free interest rates as the core economic shock in Scenario 1, requiring general insurers to revalue their balance sheets under a lower-yield environment. This rate shock is also embedded in several of the catastrophe and claims scenarios, testing combined market and underwriting stresses.
### Six “severe but conceivable” scenarios
in the general insurance specification, comprising four natural catastrophe events, a dedicated claims inflation scenario and a new cyber underwriting loss scenario, broadening the range of non-market shocks tested.
### A combined market and catastrophe shock in Scenario 2
which layers the 100 basis point fall in risk-free rates with a cluster of three US hurricanes making landfall in the continental United States, generating $181bn of aggregate losses. The scenario is designed to test capital resilience to simultaneous investment and large-loss events.
• A UK-focused catastrophe scenario in Scenario 5, which combines the interest rate shock with a large UK windstorm and a large UK flood, leading to around £22bn of aggregate losses for the UK insurance sector. The PRA is using this to assess sector-wide exposure to domestic weather-related events alongside market moves.
### A claims-reserving stress in Scenario 6
pairing the 100 basis point rate fall with a deterioration in technical provisions caused by claims inflation running 2.0% per year above the level assumed in firms’ reserving bases, over and above consumer price inflation. This scenario targets the sensitivity of reserves and capital positions to persistent underestimation of inflation.
### The PRA’s climate work in
the stress test is aligned with its broader supervisory expectations set out in Supervisory Statement SS3/19, issued in April 2019.This focuses on how UK banks and insurers should manage climate-related financial risks and embed them into their risk frameworks. The stress test climate module provides one mechanism for firms to show how they are meeting these expectations.
### The PRA has previously noted
a “cognitive dissonance” between how UK insurers manage climate risks on the liability side and on the asset side, with underwriting often more advanced than investment risk management. By explicitly requiring assessment of climate impacts on investments as well as liabilities, the 2019 exercise is intended to surface any gaps between the two.
• The climate scenarios in the 2019 test sit within a wider regulatory timetable that gave UK-based insurers until year-end 2021 to implement an approach to managing climate-related financial risks, including in investment and capital planning. The stress test outputs are expected to inform how firms build and refine those approaches.
• The PRA’s move comes ahead of EIOPA’s planned inclusion of climate and sustainability risks in its 2020 stress tests, placing UK insurers among the first in Europe to be formally assessed against climate-linked scenarios. Both authorities are moving towards integrating climate risk into routine solvency and risk management assessments.
• The 2019 exercise also forms part of a longer regulatory trajectory that includes the PRA’s later policy statement PS25/25.This updates SS3/19 and further enhances expectations for banks’ and insurers’ approaches to managing climate-related risks, with the final policy taking effect on 3 December 2025. The stress test climate module provides early data and experience ahead of that strengthened framework.
• To support implementation of SS3/19, the PRA followed up in July 2020 with a “Dear CEO” letter clarifying its expectations and setting out examples of good practice and next steps for firms in embedding climate risk management. The 2019 stress test results are one of the inputs the PRA can use when assessing whether insurers are moving towards those practices.
• The PRA has said it is conscious that climate risks pose threats to UK insurers, and the combination of the 2019 stress test, SS3/19 and subsequent policy updates is intended to bring climate considerations into mainstream prudential supervision across both assets and liabilities.
--- Sources: https://www.bankofengland.co.uk/prudential-regulation https://www.pwc.co.uk/financial-services/assets/pdf/pra-to-include-climate-risks-in-stress-tests-for-insurers.pdf https://www.bankofengland.co.uk/prudential-regulation/letter/2019/insurance-stress-test-2019
