APRA stress test assessment finds room for improvement
9 August 2021
The prudential regulator has called on the general insurance industry to improve its internal stress testing capabilities, following an assessment last year to identify ways insurers can enhance their capital management practices and improve adversity resilience.
The Australian Prudential Regulation Authority (APRA) says its assessment of the 18 largest insurers includes 15 direct insurers and three reinsurers which account for 80% of the sector’s gross written premium.
The assessment focused on areas of governance, scenario design and usage of stress testing in capital management.
“Throughout APRA’s assessment of [general insurers’] stress testing capabilities, several insurers were observed to develop and use internal stress test scenarios that were severe enough for them to respond to the stress via management actions, but were not sufficiently severe to test the limits of their capital adequacy,” the regulator said.
In relation to recovery plans, APRA says for several general insurers, the effective testing of key recovery options on the emergence of stress was limited by a lack of severe enough stress scenarios.
“APRA expects stress testing to form an integral part of insurers’ approach to capital, crisis and risk management,” the regulator said.
The regulator says last year it also conducted several stress tests with four active lenders’ mortgage insurers (LMIs) and 21 of the largest life insurers.
The tests featured two separate severe downturn scenarios designed by APRA, both including continued COVID-19 outbreaks within Australia leading to recurring stage three and four restrictions, ongoing international border closures, and sharp contractions in economic activity over a three-year period.
APRA says the results indicate they are well-positioned to withstand a very severe economic downturn.
“Specifically, the results indicate that despite significant losses of capital under a severe economic downturn, both the LMI and LI industries as a whole remained above their minimum capital requirements, while still meeting their commitments to policyholders,” APRA said.
In relation to recovery plans, APRA say several LMIs had not undergone a process of regular review, challenge and updating to ensure their ongoing robustness and credibility as their key risks evolve.
“The stress tests have also reinforced APRA’s view that there remains room to improve stress testing capabilities across the insurance industry, with regular stress testing of a range of sufficiently severe but plausible downturns forming a key part of insurers’ capital management decisions,” the regulator said.
“APRA expects insurers to continually self-assess their own internal stress testing frameworks in light of these findings in order to improve their capabilities.”
Going forward, APRA says it will continue its program of targeted stress testing activities on regulated institutions, subject to macroeconomic and emerging risks.
“Building on lessons learned from recent industry stress tests, APRA intends to consult in the future on new guidance for entities on stress testing,” the regulator said.
“In doing so, APRA aims to enhance the insurance industry’s stress-testing capabilities, as well as APRA’s own ability to promote the stability of Australia’s financial system.”
