16 November 2020

CRE: UK regulator says insurers have ignored warning on reserves

The UK’s Prudential Regulation Authority (PRA) has told financial lines insurers to correct any weaknesses in reserving and warned it will “sharpen” its focus on firms with significant exposures to the risk.

In a letter to CROs following a reserving review in the general insurance sector, the PRA said concerns raised last year about reserving and exposure have not been fully addressed by players in the market.

Since then, Covid-19 has added to uncertainty over reserves and the regulator said “a number of firms’ estimates for Covid losses on casualty classes may be optimistic”.

The PRA told insurers there is too much focus on favourable claims development potential, even though there is evidence of deteriorating incurred claims and a weakening in reserve estimates. The regulator added that CROs should be able to demonstrate where they have challenged reserving teams’ assumptions and informed the board about uncertainty in reserving for financial lines business.

It said these trends apply across general liability, but are most noticeable in financial lines. Some firms have reviewed reserving assumptions and strengthened reserves since the regulator highlighted its concerns a year ago. But the PRA has called out those that have yet to take action.

 “Others have either not done so or made insufficient allowance for uncertainty. In some cases, these same firms have then experienced continued reserve deterioration, particularly on financial lines. You can expect us to sharpen our focus on those firms that have material exposure to financial lines of business,” said Lisa Leaman, the PRA’s head of London market insurance supervision, and Vishal Desai, acting head of general insurance risk specialists, in a letter on Friday.

 “We encourage the board to satisfy itself that the key assumptions related to the rate of future claims development remain appropriate, that case reserving has not weakened over time, and that there is no unjustified anchoring to optimistic business plan loss ratios,” the PRA said.

The regulator added that Covid-19 has created further uncertainty and will present new problems for reserving at year-end. It said some firms have not pinned down Covid-19 exposures or potential losses.

Some Covid-19 claims may be delayed and the claims trends that have emerged in 2020 may not be a true picture of future claims experience, the PRA warned. It added that firms should make sufficient reserves to cover the direct impact of Covid losses and the indirect losses from a downturn in the economy.

It also said insurers should review their reinsurance coverage to mitigate further uncertainty in reserves. “Our review work highlights that Covid has given rise to situations where coverage may not respond as envisaged, be it from an insurer or reinsurer perspective,” the PRA said. Insurers should stress test assumptions for reinsurance recoveries and “understand the impact of reinsurance not responding as expected” before reserving for any uncertainty, it added.

Insurers also risk being caught out by contract policy wordings or unintended exposures from the Covid-19 pandemic, the regulator said. It urged insurers to stress and scenario test key assumptions, including reinsurance, to calculate potential Covid-19 exposures. The FCA’s test case on business interruption policies and Covid-19 claims is due to be heard at appeal this week.

CRE

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