​​AM Best: Stress testing essential amid rising secondary peril risk

By Mia MacGregor

April 24 - (The Insurer) - ​​Stress testing is becoming increasingly essential as geographic risk profiles shift and secondary perils emerge as a greater threat to the insurance industry, according to a new report from AM Best.

The rating agency said 2024 brought significant insured catastrophe losses, and recent wildfires in California have further strained both insurance and reinsurance markets. AM Best described the situation as a “crisis of sorts,” with many insurers now hesitant to underwrite wildfire risks.

As weather-related losses grow in frequency and severity, AM Best emphasised that regular stress testing is a vital part of insurers’ ERM frameworks.

The report also noted that in 22 U.S. states, the 10-year maximum property catastrophe loss ratio exceeded the 10-year median by more than 20 percentage points, with many of these classified as “highly impacted cat states”.

However, secondary perils, often harder to predict than primary perils, are increasingly affecting less traditionally exposed areas, including states like Tennessee and Kentucky. This trend has prompted insurers to reassess pricing models, underwriting strategies, and overall risk management practices, according to AM Best.

The report noted that “highly-impacted cat states,” have been hit more frequently by the growing number of billion-dollar weather events affecting the U.S.

“Regardless of a company’s size or complexity, they need to properly identify and report risks, set risk appetite levels and tolerances, and stress-test modelled and non-modelled risks while having adequate risk management controls, which ultimately are wrapped in the company’s governance and risk culture. With shifting geographic risk profiles, ERM has become more critical,” the report stated.

National insurers remain dominant in the U.S. property catastrophe market, accounting for nearly 87% of direct losses paid in 2023.

But AM Best noted that in some states, such as Kentucky, Tennessee, Wyoming, and Louisiana, regional and single-state carriers hold a larger share of claims relative to their premium volumes, pointing to heightened concentration risk.

AM Best recommended that, at a minimum, stress tests should reflect historical worst-case scenario severities and correlations, as well as performing back testing and reverse stress testing.

The impact of these tests should be quantified in terms of balance sheet strength, income, and business plans.

Larger insurers tend to have more embedded ERM frameworks, but the report noted that most companies, regardless of size, have developed such frameworks.

Stress testing, AM Best said, should also consider risk appetite, net exposure, reinsurance structure and dependence, and liquidity to fully assess a company’s ability to withstand shocks.