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Law360, London (June 18, 2020, 2:17 PM BST) -- The Bank of England told the U.K.'s general insurance sector on Thursday to assess their capital holdings in preparation to pay out for business interruption claims arising from the coronavirus pandemic, ahead of the City's watchdog testing the industry's liability in July.
The central bank told insurers that they must monitor the risks presented by COVID-19 and ensure they hold enough capital in case they must cough up to businesses that have been shuttered during the outbreak.
The BoE said that a stress test showed that the sector is robust but general insurers may face an influx of claims depending on the decision of the Financial Conduct Authority's test case on whether insurers are liable to pay out for business interruption policies during the U.K.-wide lockdown.
"Our analysis showed that the sector was robust to downside stresses, with the highest uncertainty centered on certain general insurers' liabilities — particularly those arising from business interruption claims," Anna Sweeney and Charlotte Gerken, executive directors for insurance at the BoE, said in a joint letter to chief executives of insurance firms dated Thursday.
The FCA filed a claim earlier in June against eight insurance companies: Hiscox, Arch Insurance UK, Argenta Syndicate Management, Ecclesiastical Insurance, MS Amlin Underwriting, QBE UK, RSA and Zurich. The insurers have refused to pay out for business interruption claims.
The City watchdog said it had examined more than 500 policies from 40 insurers and narrowed its selection to just 17 policy wordings it felt were the most contentious and also most representative. The result of the test case, set to play out from July 20, will provide certainty to insurers and their business customers.
"We support this initiative and will work with the FCA and firms to understand the potential financial impact of the court case," Sweeney and Gerken said in their letter.
The Bank of England conducted its biennial stress test based on information submitted by insurers for 2019. But the central bank said that it further tested the sector's resilience during April, in response to the stresses caused by the COVID-19 pandemic.
The 2019 test, the third that the BoE has done, also looked at whether insurers could weather the impact of climate change on their business for the first time. The scenario revealed that the industry has "gaps in capabilities, data and tools" to cope with the harm caused by global warming.
Extreme weather such as floods and fires swept across the world with increasing frequency in 2019, hitting profits at insurers.
The central bank plans to further test how well Britain's banks and insurers can withstand the financial shocks that could come with a warming climate in 2021 under its so-called Biennial Exploratory Scenario, or BES. This will include catastrophic weather events and damage to businesses' property, as well as disruption to supply chains and damage to agricultural products.
The BoE said that it will push back its next insurance stress test by one year, completing this in 2022 to allow firms to focus on their response to the pandemic.
--Editing by Rebecca Flanagan.
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