APRA reviews insurer stress testing

The Australian Prudential Regulation Authority (APRA) conducted a series of stress tests on life and general insurers during 2020, finding insurers are well-equipped to withstand serious economic downturns, while still meeting their obligations to policyholders.

APRA’s 2020 stress testing offered some insights into how insurance companies use stress testing to inform capital and risk management frameworks, alongside broader business decision-making.

2020 stress testing

APRA conducted stress testing on 21 of the largest life insurers, including 14 direct insurers and seven reinsurers, plus four active lenders mortgage insurers. The scenarios used were significantly worse outcomes than the RBA’s August 2020 Downside Scenario to asess resilience, and see what actions they would take.

Findings

APRA found that insurers were well-positioned to withstand a very severe economic downturn, with even despite significant losses of capital, the industry as a whole remained above minimum capital requirements, while still meeting obligations to policyholders. Some individual insurers, however, fell below their minimum capital requirements.

The main reasons for this fall in capital requirements were large investment losses emerging in insurance companies with exposure to lower-rated investments, as credit spreads over Australian Government Securities rose sharply, and serious deterioration of disability income insurance claims and credit quality of underlying mortgages insured as economic conditions worsened, leading to much higher claims costs.

However, once benefits insurers would derive from management actions in response to the stress were implemented, this situation changed and the capital levels return to pre-stress levels.

Business model, portfolio composition and levels of reinsurance coverage all made a difference in these scenarios. Some of those strategies include capital injections by parent companies, capital raisings, repricing and reductions in new business. Few insurers considered the feasibility of these actions in context, particularly when other market peers were doing similar things. Recovery plans must be credible.

Stress testing insurers during COVID-19: results and key learnings