John Tiner, managing director of the FSA, said: "The new test will assist life insurance firms in planning their asset allocations across a broader range of market conditions, while at the same time maintaining prudent levels of capital.
"We have in the past temporarily suspended aspects of the resilience test at times of extreme market turbulence and uncertainty, in order to alleviate the possibility of forced selling by insurers leading to a downward market spiral. We see no need to take such a step at present. But it has become apparent that the existing resilience test is insufficiently sensitive to the effect of past changes in equity market prices and can in certain circumstances cause perverse asset allocation. We believe that the test should take some account of past price changes while still requiring insurance firms to ensure that their asset holdings are resilient to market developments
"The resilience test requires insurers to be able to meet regulatory solvency requirements even if equity market prices were to fall by up to 25 per cent. In practice, insurers actively consider at all times their resilience to various types of market conditions.
"In the new guidance issued today, the FSA has introduced an additional element to the resilience test, to take some account of past equity price changes, subject always to testing against the minimum of a 10 per cent fall. In future, insurers should calculate the percentage change in the FTSE Actuaries All Share Index between the current level and the average daily closing level over the previous three months. If the change is negative – i.e. if the market is currently lower than its recent average – then the percentage change should be deducted from the 25 per cent maximum to determine the percentage at which the stress test would be performed.
"So, for example, if prices were 10 per cent below their 3-month average, insurers would test their portfolios against falls of a further 15 per cent - i.e. 25 per cent minus 10 per cent. Insurance firms should continue to calculate the stress test percentage on the existing basis which compares the price-earnings ratio of equities to the yield on government bonds, and utilise the lower number -but no lower than 10 per cent - in their tests."
