A regulatory shift: implications of the PRA’s 2025 life insurance stress test

This article was written by Sheikh Yasir, 4most’s Head of Insurance Capital Solutions, and originally published in COVER Magazine.

The Prudential Regulation Authority’s (PRA) decision to publish the results of its 2025 life insurance stress test (LIST) at the individual company level marks a significant departure from the typical practice of reporting outcomes at the aggregate sector level. Historically, individual firms could benchmark their performance against competitors without the risks associated with public exposure. However, while firms are being challenged, the onus is also on the PRA to ensure clear communication that avoids misinterpretation of the results and prevents undue market influence. With the PRA planning to launch LIST 2025 and publish the final scenario design and calibrations in January 2025, now is the time to get to grips with the full scope and implications of next year’s big regulatory shift.

Shifting to individual company disclosure

The 2025 LIST will assess the financial resilience of 11 bulk purchase annuity (BPA) providers across three different scenarios. This includes a ‘core scenario’ which is designed to evaluate stress in financial markets and build on the previous PRA life insurance stress test conducted in 2022. This will be supplemented by two ‘exploratory’ scenarios that examine and evaluate emerging risks to support the industry’s development of modelling capabilities. While only the results from the core scenario will be publicly disclosed, firms are facing heightened scrutiny during the PRA’s quality assurance phase.

The aim of public disclosure is to give market players a clearer understanding of firms’ resilience, thereby promoting greater industry discipline and accountability. To meet these expectations, firms may need to revise their governance and control frameworks to effectively manage the pressures associated with stress testing and public disclosure. Public disclosure goes beyond regulatory compliance- it is an opportunity to demonstrate resilience and robust risk management practices.

However, with increased transparency comes the risk of greater market pressures, particularly if stakeholders misinterpret the results. Perceived negative outcomes could adversely affect an insurer’s creditworthiness and jeopardise future BPA deal opportunities. The pressure is on, and it is up to insurers to identify the areas of their business most vulnerable to the consequences of these disclosures.

Additionally, firms will need to implement strategies to manage and shape the narrative around results, safeguarding against potential negative market implications and reputational damage. As the first instance of public disclosure applied to this type of test for the life insurance sector in the UK, some initial challenges are to be expected. However, firms are acutely aware of the risks and a proactive approach is the best way to prepare for a new regulatory landscape.

The need for transparent communication

The success of the public disclosure aspect of the stress test relies not only on firms themselves but also on the PRA’s ability to provide clear and transparent messaging alongside the published results. A situation where interested parties categorise firms based on pass or fail outcomes would be a severe oversimplification, underscoring the need for preventive measures to mitigate any risk of misunderstanding.

One of the key concerns is that the stress test might not give a comprehensive view of a firm’s resilience. The stress test will only encapsulate a solo entity view and limits set on management actions, meaning some risk management tools available to firms will not be factored into the results.

The PRA needs to strike a delicate balance between providing meaningful insights into insurer resilience while steering clear of creating unnecessary panic. Firms can also help with clarity surrounding perceived negative results by highlighting the risk management tools that they are able to call on which are not captured in the stress test. Ultimately, fostering open dialogue between the PRA, firms, and market participants will ensure a nuanced understanding of the results and their implications.

Testing funded recapture scenarios: An added layer of complexity

However, the challenges facing firms extend beyond public disclosure. As mentioned, two exploratory scenarios will be tested, with one focusing on funded reinsurance recapture. While the PRA has opted to publicly disclose the results at the aggregate level rather than at the individual firm level for these scenarios, industry experts have made it clear that these tests will place an additional layer of responsibility on insurers.

Many firms have honed their ability to model various stresses, using past exercises as a base. However, the intricacies surrounding funded reinsurance recapture scenarios, along with the new regulatory framework, may require firms to develop new methodologies and systems to comply with the PRA’s expectations. The importance of proactive planning and investment is again critical to ensure that firms aren’t caught cold and are aligned with the current regulatory landscape.

The shift to individual company disclosure in the 2025 LIST represents a significant change from previous exercises and could have a significant impact on the insurance industry. This regulatory evolution increases scrutiny on firms, challenging them to demonstrate their resilience and risk management capabilities like never before. Both firms and the PRA must manage the risks of public results to prevent undue market influence. At the same time, insurers need to prepare for the complexities of funded reinsurance recapture scenarios to navigate this new regulatory landscape effectively.