Insurers have displayed good resilience in a stress test conducted by the Bermuda Monetary Authority (BMA) and the UK’s Prudential Regulatory Authority (PRA).
Reinsurance coverage enabled insurers to maintain relatively healthy capitalisation levels in the face of stress scenarios that the regulators described as “severe but plausible.”
The stress test assessed the likely impact of five different scenarios, four of them involving natural catastrophes, on property and casualty insurers. It was conducted before the outbreak of the COVID-19 pandemic.
The exercise involved a sample of nine large Bermuda commercial insurers with material natural catastrophe business both in the UK and on a global basis, holding approximately $35 billion of capital and surplus (C&S) between them, as of 31 December 2018.
Each scenario envisaged an asset shock in which the risk free interest rate fell by 100 bps, with a widening of corporate bond spreads according to credit rating of 150bps for AAA rated assets down to 400bps for BB rated and lower or unrated paper. It also saw a fall in other asset values, including a 30 percent fall for equities, a 40 percent fall for commercial property and a 30 percent fall for residential property.
Four catastrophe scenarios were envisaged as occurring in conjunction with this insurance asset shock (IAS). One envisaged a cluster of three US hurricanes making landfall in continental US, leading to $181bn of industry loss in aggregate. Another US scenario entailed a severe earthquake of magnitude ~8.0 along the San Andreas fault, followed by an aftershock of magnitude ~7, leading to $103bn of industry loss in aggregate and disruption to supply chains.
Two catastrophe scenarios were envisaged outside of the US. One involved a severe earthquake of magnitude ~ 8.0 with its epicentre close to Tokyo, followed by a tsunami, generating circa $60bn of industry loss in aggregate. The other saw a large UK windstorm and a large UK flood leading to some £22bn of losses in aggregate to the UK insurance sector.
The two US scenarios generated the most substantial gross losses, with the California earthquake being slightly more severe than the US hurricane. However, the greatest overall net loss came from the IAS, as the catastrophe scenarios benefited from material reinsurance recoveries.
In both US cases more than 70 percent of the losses were ceded out, with the earthquake scenario seeing 81 percent of exposure ceded out to the reinsurance market.
Participating insurers showed resilience to all the scenarios envisaged by the regulators, demonstrating healthy capitalisation levels. No insurer would breach the Enhanced Capital Requirement (ECR) under any individual scenario, the regulators said - a single catastrophe scenario without the IAS.
The net loss from the hurricane event would be equivalent to roughly 22 percent of the C&S as at year-end 2019, while the three hurricane scenario would be equivalent to approximately 8 percent of C&S, adding to a combined impact of approximately 30 percent.
The combination of the IAS with the three hurricane scenario saw three insurers’ ECR drop below 100 percent, but all maintained an average ECR ratio of 86 percent.
Insurers identified a number of management actions to improve their post-stress solvency levels, including recapitalisation from the parent, retention of future dividends, purchase of additional reinsurance, loss portfolio transfer and de-risking of asset and underwriting portfolios.
Bermuda is the region with the most significant share of reinsurance recoverables, with 58 percent of exposure ceded to Bermuda in the three hurricane scenario. No significant concentration to any single reinsurer or reinsurance group was identified, with the largest concentration to any one third-party reinsurance group being less than 5 percent of the total recoveries.
The biggest reinsurance contribution came from fully collateralised structures funded by the capital markets and regulated under the BMA’s prudential regime.
For the participating insurers, approximately one-third of the US stress losses are retained in Bermuda by traditional insurance vehicles, with the balance ceded either overseas or to the capital markets.
The majority of the collateralised recoveries are backed by cash or cash equivalent types of assets, showing that liquidity risk is low, the regulators said.
The results highlight the critical role fully collateralised vehicles have in offering reinsurance capacity, which minimises the credit risk that is typically observed in traditional reinsurance arrangements, the regulators added.
However, they admitted the availability of alternative capital following adverse catastrophe experience could show different behaviour patterns than traditional reinsurance capital, the regulators said.
Bermuda Monetary Authority, BMA, Prudential Regulatory Authority, PRA