By DB and KD
Our friends Tony Jeffery and Andrew Smith have some wise advice that the PRA should consider in their new insurance stress tests. Our advice was not to bother, but assuming the PRA chooses for once not to follow our advice, they might look at the following passage from Andrew and Tony’s recent Society of Actuaries in Ireland (SoAI) report on NNEG valuation:
In 1995 a SoAI paper (Demographic Margins for Prudence – Jeffery & Quinn, 1995) suggested that a valid approach to setting margins was to consider how it would look to a public with the benefit of hindsight if it has gone wrong, noting that with the clarity that hindsight brings can be harsh.
The paper went on to enunciate 3 common sense principles that it believed should be applied:-
- If something has happened before, it can happen again
- If it has happened elsewhere, it can happen here
- If it happens, when it happens it will happen faster than last time.
For these reasons we would strongly recommend that the stress test should be as least as strong as what has been experienced here since 2007. To put this in number terms we suggest that, in Ireland, a suitable test could be an instant fall of at least 55% which lasts for 5 years and then recovers at the rate of 5% per annum after that. The second principle implies that not just the Irish should be thinking about this. (Smith and Jeffery, 2019, p. 47)
Remember that house prices in Dublin fell by 60+%. See the chart at the top from Andrew and Tony’s report, where the y-axis refers to the pre-crisis maximum.
Surely the PRA doesn’t believe that what happened in Ireland couldn’t happen over here? But in that case, why is it proposing a stress of 40% in commercial and real estate and only 30% in residential property?
The Irish experience also tells us that if we did experience a major house price collapse, other things can go wrong too.