U.K. general insurers should improve how they tackle shortfalls in the catastrophe risk models they use, the country's Prudential Regulation Authority has said following its biennial stress test of the sector.
The recommendation was one of four areas in which the PRA felt insurers could improve. Others were identifying the accumulation of exposures, post-loss planning for major events and accounting for how large events affect their capital position for Solvency II — Europe's capital regime for insurance companies.
The PRA's 2017 stress test covered the U.K.'s 26 largest general insurers, the 16 largest Lloyd's of London syndicates and the Society of Lloyd's as a whole. The participants together accounted for total gross written premium of £80 billion — 82% of the U.K. general insurance sector.
The test examines how insurers would cope with four natural catastrophe scenarios — European windstorms and U.K. floods; U.S. Pacific Northwest earthquake; California earthquake; and U.S. hurricanes — plus an economic downturn scenario.
In a letter to the CEOs of the participating firms dated Dec. 7, PRA insurance director Anna Sweeney said few firms go beyond adding a simple loading to account for known weaknesses in catastrophe models, such as the ability to model floods and earthquakes accurately.
"Firms are encouraged to improve their ability to reflect these risks as their models evolve," she wrote. "Boards are encouraged to understand what the limitations are with the catastrophe modeling, and their inherent uncertainty when applicable, especially for their key perils."
The stress test also showed need for improvement in how companies capture, monitor and report accumulations of exposures to risk.
"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 modeled loss output," the letter stated.
In addition, the PRA said many firms would benefit from being more detailed in planning the management actions they would take in if a large loss hit, including reinstating exhausted reinsurance cover.
The regulator also noted that a number of firms "struggled" to forecast how the stress-test scenarios would affect their Solvency II basic own funds, which it said highlighted the time needed for large regulatory changes to bed in.
The stress test found that the Pacific Northwest earthquake scenario would trigger the biggest gross loss to the U.K. general insurance market of £43.5 billion. But the biggest net loss, which factors in reinsurance cover, was from the economic downturn scenario, which produced a market-wide loss of £21.9 billion.