The Financial Services Authority has urged companies to improve the stress testing of their businesses after its financial risk report highlighted the greater impact a shock could have were it to happen in the next 18 months.
The FSA's Financial Risk Outlook (FRO) 2007 is designed to raise awareness of the priority risks which the FSA believes it, along with providers and users of financial services, should consider.
While the FSA's overall outlook for the global economy continues to be benign, the FRO identifies an increasing risk that it will become more unsettled. Key factors include the increasing geopolitical risks, which escalate the probability of an 'event risk' materialising; increasingly complex financial markets and the combination of low volatility of asset prices, a low market pricing of risk and stronger correlations between the prices of different classes of asset.
Commenting on the findings of the FRO, Alex Hindson, associate director of Aon Global Risk Consulting said: "The FRO findings reinforce the argument for enterprise risk management (ERM). It enables financial services institutions to evaluate the financial impact of significant unexpected events which could have serious implications on the health of their business. In effect, ERM is supporting the solvency objectives of Individual Capital Adequacy Standards (ICAS) by identifying possible operational and market risks. This is a good discipline for ensuring the organisation is prepared to respond both in terms of capital allocation but also risk mitigation strategies.
"Identifying a pandemic as a 'plausible alternative scenario' drives the logical next step of understanding just how damaging the impact can be - especially for life insurers - through financial modelling. Such financial modelling this enables companies to plan an effective business continuity process. Companies now need to go back to their business continuity plans and ensure they take account of the challenges of a pandemic scenario, with the consequences on staff and employee relations."