The results of the latest stress tests of London insurance and reinsurance market participants showed that a $200 billion extreme loss scenario could seriously erode the market’s capital base, but that it would be unlikely to deal the market a fatal blow.
The industry with the help of the Prudential Regulation Authority (PRA) of the UK’s Bank of England has tested the London insurance and reinsurance market like never before, with the results showing its ability to be resilient.
This year’s stress test saw a combined scenario of a $200 billion market loss, which would be the biggest ever faced by re/insurers, involving a major cyber attack striking the U.S. causing widespread power loss, financial market contagion and a major Florida hurricane all occurring within a short period of time.
The stress test was led by Hiscox and facilitated by McKinsey & Company, with the PRA providing oversight of the process.
The loss events chosen reflect the changing nature of risk, the participants said, with a highly destructive hurricane striking the U.S., an unprecedented cyber event, one of the largest stock market declines ever seen, and a major re/insurer default with consequent delays in reinsurance payments all coinciding and resulting in huge global insurance losses of approximately US$200 billion.
This scenario tests the ability of the market’s insurance and reinsurance players to respond to such an extreme scenario, the ability to pay claims and the ability to recapitalise to carry on providing continuity to clients.
Interestingly, the scenario testing found that within the confines of the specific loss scenario and the test, companies believed they would have the ability to cope, both in terms of resource and financial liquidity.
Re/insurers said they would be able to “serve clients and pay claims fairly at the same time as ensuring continuity of cover to further enhance its pre-eminent global position.”
The test found no serious lack of liquidity, although it was acknowledged that there could be more difficulty in securing liquidity than normal. The ability of re/insurers to recapitalise was particularly highlighted in the test.
Participants said that key to the ability to respond to such events is the “deep underwriting expertise and a surefooted regulatory response that will differentiate the London insurance market in, and after, a major loss event.”
However recapitalisation is key and questions do emerge over where capital would flow to after such a major loss event. Would it be to London market re/insurers, the global reinsurance players, or even to capital market alternatives?
The results of the test show that access to capital is not such a differentiator for London’s insurance and reinsurance market as it used to be. The report recommends that “clear plans for raising additional capital” are key to the London market’s ability to respond and maintain continuity after such large and catastrophic insurance loss events.
Robert Childs, Chairman of Hiscox Group commented on the results of the test; “We have not had a market-turning event since 9/11 and it is important we understand how one might play out in today’s trading environment. Exercises such as these are often imposed by a regulator, but our industry-led approach is what makes the London Market so special. As a market, we have tested our robustness and resilience and stand ready to support our clients, trade forward, and ensure financial and economic stability during turbulent times. I would like to thank my colleagues from across the sector for their hard work and support in this project, including insurers, brokers, Lloyd’s, rating agencies, regulators and Her Majesty’s Treasury.”
Karl Hennessy, President, Aon Broking, who led one of the project’s two working groups, added; “This dry run is a demonstration of the London Market’s unique value proposition; namely the ability to bring together specialist underwriters, brokers, claims and other professionals to serve our clients at the time of their greatest need and beyond. In an increasingly competitive global (re)insurance market, such exercises, alongside the Market modernisation work (London Market Target Operating Model), are essential for London to continue to maintain and evolve its position as the pre-eminent centre of insurance expertise serving clients from across the globe.”
Commenting on the White Paper, the Economic Secretary to the Treasury, Simon Kirby MP, also said; “As the global hub for insurance and reinsurance, the London Market plays an important role in supporting economic activity in the UK and across the world. Thanks to the efforts of government, regulators and industry, the UK’s financial system is fundamentally strong and pro-active industry-led exercises like this one enhance our ability to identify and manage the risks of the future.”
The full report can be downloaded from Hiscox’s website here.