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FSA puts pressure on providers to improve stress-testing

The FSA says firms need to improve and regularly review their stress-tests to avoid future vulnerability, as proven by the state of overall financial climate of the last nine months.

Speaking today at The Institute of Economic Affairs’ Future of Life Assurance conference, FSA director and insurance sector leader Sarah Wilson looked at risk management in the context of the recent credit crunch and market volatility, Solvency 2, Treating Customers Fairly and with-profits governance.

She said product providers had to consider whether their models for stress testing against market and credit risk were up to scratch.

She said: “We have seen a fundamental repricing of risk, and the simultaneous fall, for example, of equity prices and bond yields. The last nine months has taught us all that the unlikely can become reality and that a whole sector of financial services can be affected by exactly the same issue. And the downside risks have increased making the financial sector as a whole more vulnerable to future shocks. All this means that if firms’ ICAS modelling is to stay up to date and as useful as it should be, firms need to review their assumptions and, in particular, their stress and scenario tests.

“On stress testing, insurers should now be considering whether there is a need to recalibrate their models. Most obviously, recent events might cause life companies to re-examine and strengthen stress tests for market and credit risk and for changes in correlation assumptions.”

Wilson also encouraged firms to reconsider if they needed a more extensive range of scenario analyses, especially noting the ripple effect where in stressed conditions the knock on effect could be even more prominent.

But on individual capital adequacy requirements, Wilson said the FSA was not expecting firms to meet an ICAS standard higher than that already incorporated – a 99.5 per cent probability of survival within one year.

She also said life offices had to improve their TCF requirements in particular relation to the quality of consumer information and with-profits governance.

She said: “I wrote to insurers on this issue last September, and I am pleased to say that we have since seen some improvements in governance arrangements. Nevertheless it is clear that further improvements are needed and, alongside scrutiny of other aspects of firms’ implementation of the new with-profits regime, we will continue to challenge firms on the effectiveness of their governance arrangements.”


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