Supervisory Information Circular – Stress Testing for Insurers

Stress testing is an essential risk management tool used to assess how changes in various risk factors may impact an insurer's financial position under extreme but plausible scenarios. This process can involve either scenario testing, which evaluates hypothetical future events, or sensitivity testing, which measures the impact of incremental changes in key risk factors, such as interest rates, inflation, or mortality rates. Global regulatory bodies, including the International Association of Insurance Supervisors (IAIS), require insurers to carry out stress testing to gauge their ability to withstand macroeconomic stresses and other external shocks.

Scope and Applicability

The Cayman Monetary Regulatory Authority International (the “Authority”) mandates that all insurers under its regulation conduct stress testing as per the Rule on Risk Management for Insurers. Section 5.3.2 of the Rule specifies that each insurer, based on its size, complexity, and risk exposures, must conduct both quantitative and qualitative stress tests and scenario analyses.

This Supervisory Circular applies to all categories of insurers licensed by the Authority and provides guidelines to follow in the design and execution of stress testing. However, insurers are encouraged to conduct additional stress tests, as deemed necessary, to enhance their risk management practices.

General Instructions

• Insurers must design their stress testing frameworks in alignment with their specific risk profiles and business operations. The insurer’s board of directors and senior management must oversee the process, approving the scenarios and assumptions used.
• In conducting stress tests, insurers should examine multiple risk areas, including solvency, market positioning, investment strategies, and reinsurance policies.
• Stress tests should evaluate individual risk categories (e.g., insurance risk, market risk, credit risk) and consider collective impacts in multi-factor scenarios, such as economic downturns or natural catastrophes.
• A baseline scenario, representing the insurer’s book of business with no stress applied, should be used as a comparison point for evaluating the effects of various stress scenarios.
• Stress testing should be carried out regularly (annually or biennially) and any time there are significant changes to an insurer’s business.
• Year-end data from the insurer’s Annual Return Filings must be used for conducting stress tests.

The Authority’s Review and Assessment Process

The Authority will periodically review and assess insurers' stress testing frameworks. This assessment includes evaluating the chosen scenarios, assumptions, and the overall rigor of the stress testing process. The Authority reserves the right to challenge insurers on their methods and may require corrective actions if deficiencies are found.

Based on the results of the stress tests, the Authority may require insurers to submit more frequent updates or take other remedial actions to address any identified risks.

Appendix A: Effect of Shocks in Stress Testing Scenarios

Table 1 below outlines various shocks and their direct impact on income statement and balance sheet items. These include changes in interest rates, real estate values, equity markets, and claims experiences.

Table 1: Effect of Shocks in Stress Testing Scenarios

Stress factors	Income Statement Items Affected	Balance Sheet Items Affected
Change in interest rate	Impact on investment income and life insurance liabilities due to interest rate shifts.	Changes in fixed-income asset values and life insurance liabilities.
Losses on mortgages	Impact on investment income from mortgage losses.	Changes in mortgage asset values.
Change in real estate market values	Impact on investment income due to real estate devaluation.	Changes in real estate investments.
Change in equity market values	Impact on investment income due to equity market decline.	Changes in equity asset values.
Change in claims experience	Gross incurred claims or changes in future benefits due to impact of shock.	Reduction in equity values due to changes in claims experience.
Property claims shock	Incurred claims change by percentage of premiums in Property class of business.	Catastrophe provision changes based on incurred claims for Property class.
Change in technical reserves	Changes in technical reserves by impact of shock.	Changes in reserves due to shock.
Failure of reinsurance asset	Impact on investment income from shock to reinsurance asset value.	Reduction in reinsurance asset value.
Government securities fall in value	Impact on investment income from reduction in government securities' value.	Reduction in government securities value.

Appendix B: Scenarios for Class A Insurers

Class A insurers are expected to consider various scenarios such as economic downturns, natural catastrophes, and extended pandemics. Each scenario should assess the insurer's resilience to severe but plausible shocks. For example:

Economic Downturn

An economic downturn scenario examines the effects of external shocks like unemployment and market declines on the insurer's operations, impacting investments and claims. Key shocks include a -250 basis point shift in the yield curve and a 20% fall in real estate values.

Economic Downturn	Shocks
Yield curve shifts down	-250 bps
Real estate values fall	-20%
Equity market values fall	-40%
Losses on mortgages	-20%

Catastrophes

This scenario considers the occurrence of natural disasters like hurricanes and earthquakes and their impact on insurers. Key shocks include:

Description	Shocks Hurricane/Windstorm	Shocks Earthquake	Shocks Earthquake and Tsunami
Yield curve shifts down	-250 bps	-250 bps	-250 bps
Real estate values fall	-20%	-20%	-20%
Equity market values fall	-20%	-20%	-20%
Increase in claims	100%	200%	300%

Extended Pandemic

This scenario explores the possibility of an extended pandemic. Key shocks include:

Description	Shocks Extended Pandemic	Shocks Extended Pandemic and Economic Downturn
Yield curve shifts down	-250 bps	-300 bps
Real estate values fall	-10%	-20%
Equity market values fall	-20%	-30%
Losses on mortgages	-20%	-30%

Appendix C: Scenarios for Class B(iii) and D Reinsurers

This section outlines scenarios specific to reinsurers, including economic downturns and catastrophic events. For example:

Economic Downturn

Economic Downturn	Shocks
Yield curve shifts down	-250 bps
Real estate values fall	-20%
Equity market values fall	-40%
Losses on mortgages	-20%

Insurance Asset Shock and Longevity Event

Description	Shocks
Yield curve shifts down	-250 bps
Real estate values fall	-30%
Equity market values fall	-40%
Mortality rate	-15%