A Life Insurance Stress Test Explainer

What is the Life Insurance Stress Test, and why does the PRA do it?

The PRA has conducted sector-level life insurance stress tests (LIST) since 2019, and published an assessment of the sector’s resilience in 2023 following the previous LIST exercise. Going forwards, they aim to run life insurance stress tests every two years, and to notify firms in scope of each test twelve months in advance.

The PRA’s purpose in running this exercise is to assess resilience at both firm and sectoral levels, and to create more transparency across the market by publication of key results. This advances the PRA’s overall aim for the UK insurance sector to be able to provide financial protection and security to its policyholders in both good and bad times.

Different life insurance stress tests over time will target different parts of the sector. The aim for LIST 2025 is to target insurers with a significant presence in the fast-growing bulk purchase annuity (BPA) market. The PRA has several reasons to target this part of the sector:

• The extent to which retirement benefits are provided directly by life insurers has been increasing quickly and is projected to ncrease quickly for a number of years.
• Insurers invest in long-term assets to support this business, and the scope of non-traditional assets held by these insurers has already broadened greatly over the last decade. As the BPA market grows, and as Solvency UK reforms come into effect, further broadening is expected.
• Insurers have been making increased use of funded annuity reinsurance (FundedRe). FundedRe is an important part of how many insurers operate in the BPA market, and the PRA recently published a policy statement (PS13/24) setting out its expectations about risk management of FundedRe and modelling of SCR associated with FundedRe.

Note that the LISTs are separate from the biennial exploratory scenario exercises run by the Bank of England, which can include some life insurers.

What firms are in scope, and what do they have to do?

The PRA has stated publicly that the following firms are in scope for LIST 2025:

• 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 have been chosen on the basis that they are active in the BPA market and have the largest annuity portfolios.

There will be one core scenario, and two exploratory scenarios. Results from the core scenario will be published at individual firm level. While this has been routine for bank stress tests in the past, it is unusual for insurers. The exploratory scenarios are intended to focus on emerging risks, where there will be more challenges in creating an assessment which is consistent across all participating firms, and therefore only aggregate results will be published.

The stress test for all three scenarios is to be applied to YE2024 positions.

What are the scenarios for the 2025 stress test?

Core scenario

The core scenario is a three-stage evolving financial market stress scenario, which builds on (but will not be the same as) the core scenario from LIST 2022. The evolution of the three stages can be seen in the below graphic from the PRA:

The two exploratory scenarios take the core scenario as a base, and add in one further stress in Stage 3. These may require some more model developments for firms to be able to respond.

Asset type concentration stress

The PRA’s published approach to LIST 2025 indicates that, as the BPA market expands and insurers invest in a wider range of asset types, future stress tests may specify stresses at individual asset level. As a starting point, this scenario will ask firms to assess the impact of an additional downgrade to the asset type which is most material to their Matching Adjustment portfolio.

FundedRe recapture stress

This scenario will ask firms to show the impact of recapture under stress of all FundedRe arrangements with their most material counterparty.  Firms with a single FundedRe counterparty may therefore find themselves harder hit under this scenario than those with more than one counterparty. As with the asset type concentration stress scenario, the PRA has indicated that it sees this exploratory scenario as a first step towards more regular stress testing on FundedRe, with individual firm-level publication in the future.

Details about the exact scenario calibrations will be finalised and published in January 2025. In the meantime, the PRA have described these scenarios as representing plausible, severe shocks. They have indicated that the core scenario will target a 1-in-100 year severity, with no such specific target for the two exploratory scenarios.

When will this be happening?

In July, the PRA published their intended approach, and wrote to firms in scope, asking for feedback. The deadline for that feedback is 6 September. The launch of the exercise, with publication of the final instructions and scenario details, will be in January 2025. Firms’ submissions will then be due by the end of Q2 2025, with the PRA’s publication of findings coming in Q4.

Readers may note that timescales for this exercise have some significant overlap with busy periods of year end reporting, business planning and ORSA preparation. As planning for H1 2025 ramps up, please do get in touch to discuss how we can help!

Reference:

Life Insurance Stress Test (LIST) 2025 | Bank of England

Michael Scanlon

August 2024