On 11 December 2023, the PRA published a Letter to general insurers’ chief risk officers (CROs) outlining the findings of its 2023 thematic review of expected underwriting profit allowed for in firms’ internal models (IMs).
The PRA’s key findings included:
- The expected underwriting profit is a core assumption in the firms’ IMs. The PRA noticed discrepancies in the extent of independent verification regarding this projection. While some firms made efforts to detect and mitigate any perceived over-optimism in their projections, only a limited number conducted thorough sensitivity or scenario analysis to gauge the potential impact on metrics such as the Solvency Capital Requirement (SCR) arising form potentially optimistic assumptions about underwriting profit. Some firms directly relied on figures from their business plans without making any adjustment.
- The PRA noted that certain firms’ risk function recognised a level of optimism within the firms’ business plans. Nevertheless, there was minimal indication that this insight had been factored into the model validation. Many firms failed to distinguish between aspirational business planning and the underwriting profit assumed for the IM. The former could be ambitious, but the latter must be realistic and justified, representing a best estimate.
- The PRA has identified certain possible shortcomings. These encompass insufficient actual versus expected analysis against the business plan to inform subsequent business planning cycles, considering past weather and other extreme events as isolated incidents without proper justification, and a deficiency in strong, rigorous challenge procedures.
Further to these findings, the PRA’s analysis modelling using using data derived from internal model outputs revealed that overestimating the anticipated underwriting profit can significantly impact the Solvency Capital Requirement (SCR). This may have a greater impact on for firms with limited reinsurance cover or where reinsurance programmes start to exhaust in the tail. The PRA emphasises the necessity for all firms using IMs to conduct thorough validation validation and update model assumptions.
The PRA states that these review findings will shape its ongoing assurance work and the development of the supervisory review process for IM ongoing review. It calls upon CROs to be prepared for discussions regarding how they’ve taken into account these findings and any subsequent actions they have taken.