Bank of England warns insurers over ability to sell down assets in a crisis

Life insurers could be overly optimistic about their ability to sell down assets in a crisis, the Bank of England has warned.

The BoE’s Prudential Regulation Authority, which supervises the sector, put 16 life insurers through a stress test of credit downgrades and increased longevity. In results published on Monday, it found them resilient, but said their assumptions ran the risk of overconfidence.

Several companies relied on their ability to sell bonds that had been downgraded to junk, with £8bn to £9bn of such assets expected to be offloaded, the report found. Most assumed this could be done within six to 12 months of the event.

“In light of the aggregate finding, this could be optimistic, especially as other investors would also be taking similar actions,” said Charlotte Gerken, the PRA’s executive director for insurance supervision.

“It is important that, when firms plan for the management actions that they could take in stress, they allow for market liquidity and potential stress amplification arising from actions taken by other investors.”

An example of institutional investors rushing for the exit was provided in the UK’s gilts market crisis last year, triggered by former prime minister Liz Truss’s ill-fated “mini” Budget, when pension funds struggled to offload government debt quickly enough to meet collateral calls and the BoE was forced to intervene.

For general insurers, including those within the Lloyd’s of London market, the regulator identified areas for improvement in how they quantify losses from so-called secondary perils — events such as floods that have historically been less costly, but are growing in frequency.

For cyber risks, it found that insurers’ assessment of the likelihood of tail risks were “highly variable” and that there were “challenges and sensitivities” in the use of exclusions for state-sponsored attacks. These holes in the policies have sparked fierce debate in the sector and a flurry of legal cases.

“Indeed, some entities reported that they have a specific governance approach to invoking this language and have considered potential costs that may be incurred,” said Gerken. Participants highlighted efforts to create new policy language to address the challenges.

The Financial Times revealed last week that insurers were in discussions with the Treasury about whether Pool Re, the UK’s terrorism reinsurance scheme, could be expanded to back state-sponsored cyber attacks.

The insurers in the stress test were not named, though there are plans to do so in the future as part of an overhaul to the insurance regulatory regime.