Insurance regulation: themes for the year ahead

For many insurers the UK’s exit from the European Union coupled with the ongoing economic uncertainty arising from the pandemic has resulted in continued pressure on premium income.

The UK’s GDP contracted by 9.8% during 2020 and given the link between GDP and demand for insurance, this pressure is likely to continue throughout 2021. It comes as no surprise then that the Prudential Regulation Authority’s (PRA) focus for the short to medium-term for insurers remains fixed on ensuring robust prudential standards and its supervision of firms, financial and operational resilience and recovery and resolution planning, amongst others. The financial risks arising from climate change also remain a central regulatory focus. 

Prudential standards and supervision

One of the PRA’s strategic goals is to ensure that it has in place robust prudential standards, and that regulated firms, and those who run them, are held accountable for meeting these standards. Work on the Solvency II review which commenced last year remains ongoing with the intention of tailoring certain provisions of the UK regime to properly reflect the unique features of the UK insurance market. The review is not intended to be a wholesale review, but rather to focus on certain features of the UK Solvency II regime including:

• the risk margin;
• the matching adjustment
• the solvency capital requirement (SCR) and the consolidated group SCR calculation;
• transitional measure on technical provisions calculation;
• reporting requirements;
• foreign branch prudential requirements;
• Solvency II application threshold;
• the mobilisation of new insurers; and
• the transition from LIBOR to OIS rates.

Any proposed changes are likely to require amendments to legislation or to the PRA Rulebook so later this year we can expect to see consultation papers published in respect of the proposed amendments. Hopefully the revised UK Solvency II rules will come into effect towards the end of 2021 or early next year.

HM Treasury is simultaneously conducting the Future Regulatory Framework (FRF) review to determine how the overall UK financial services regulatory framework needs to adapt to the UK’s position outside the EU. The FRF review involves HM Treasury assessing the allocation of regulatory responsibilities between Parliament, the government and the financial services regulators, with HM Treasury emphasising the need for appropriate and effective arrangements for accountability, scrutiny and public engagement in respect of the policy-making process. HM Treasury is also reviewing the  framework for how firms based overseas, including overseas long-term insurers, access the UK to ensure that the UK legislative and regulatory regimes for overseas access achieve HM Treasury’s goal of attracting liquidity and activity to the UK while supporting financial stability and openness in financial markets. The outcome from these two reviews are crucial to the reforms made to the UK Solvency II regime.

The International Association of Insurance Supervisors (IAIS) has developed a series of standards, known as the insurance core principles (ICPs). These are recognised as the globally accepted standards for supervising the insurance sector and the PRA is continuing its work with the IAIS, including development of the insurance capital standard (ICS) and the Holistic Framework Implementation Assessment, as well as contributing to the Financial Sector Assessment Programme’s assessment of compliance with ICPs.

The holistic framework itself has moved away from the previous set of pre-determined policy measures applied only to a small group of global systemically important institutions towards a proportionate application of an enhanced set of policy measures to a broader portion of the insurance sector.

As the holistic framework recognises and operates on the basis that systemic risk can arise both from sector-wide trends with regard to specific activities and exposures, as well as from a concentration of these activities and exposures in individual insurers, firms can expect to see enhanced supervisory measures come into effect. These are designed to increase overall resilience of the insurance sector and to help prevent vulnerabilities and exposures in the sector from developing into systemic risk. The proposed annual IAIS global monitoring exercise is designed to assess global insurance market trends and developments to detect the possible build-up of systemic risk in the global insurance sector.

Climate change

Climate-related policy, ensuring delivery of the Bank of England’s climate biennial exploratory scenario and acting on the 2019 insurance stress test climate scenario outcomes remain a focus for the PRA and the Prudential Regulation Committee (PRC) – this is something the PRA wants firms to take seriously. Going-forward insurers are expected to consider the financial risks arising from climate change as a priority and indeed the PRA is planning to embed supervision of these risks into its routine supervision of firms.

From a governance perspective, boards should understand the financial risks from climate change, and since 2019, boards and management have been required to identify a senior manager with responsibility for managing the financial risks arising from climate change. Senior managers should be considering the different ways that climate risks are likely to have an impact, whether this is credit risk, operational risk, market risk, or otherwise. Firms should continue to address the financial risks from climate change through their existing risk management frameworks and insurers should continue to consider the possible accumulation of risk in the investment portfolio. Scenario analysis and stress testing to examine the impact of financial risks from climate change on business strategy (both short and long-term) remain key and the PRA continues to be interested in climate-change related disclosures.

Financial and operational resilience

The PRA has a strategic goal of ensuring that firms are adequately capitalised, and have sufficient liquidity, for the risks they are running or planning to take. To meet this goal, after a pandemic related pause, the PRA will resume a regular stress testing regime to examine how firms cope with stress scenarios. The PRA will also assess the potential impact of any moves toward greater consolidation in the insurance sector, with a view to safeguarding financial and operational resilience, and introducing target risk scores into firms’ risk models.

Earlier this year, the PRA published a policy statement on operational resilience which included new Operational Resilience Parts of the PRA Rulebook; amendments to the Group Supervision Part of the PRA Rulebook; a new Supervisory Statement (SS) 1/21 ‘Operational resilience: Impact tolerances for important business services’; and a new Statement of Policy (SoP) ‘Operational resilience’. The new proposals are designed to improve the operational resilience of firms and protect the wider financial sector and UK economy from the impact of operational disruptions. Insurers are required to identify important business services considering the risk their disruption poses to financial stability (where applicable), the firm’s safety and soundness and policyholder protection, and for these important business services, firms will be required to set impact tolerances.

An impact tolerance is defined as the maximum tolerable level of disruption to an important business service as measured by a length of time in addition to any other relevant metrics. The Operational Resilience Parts require firms to set their impact tolerances at the point at which any further disruption to the important business service would pose a risk to the firm’s safety and soundness and policyholder protection, and, if a firm meets certain criteria as set out in the Operational Resilience Parts, the financial stability of the UK. By the time the provisions come into force on 31 March 2022, firms should be mapping and testing the delivery of important business services to establish whether and how they can remain within impact tolerances and firms should have commenced a programme of scenario testing to achieve this and to identify any vulnerabilities.

There is work to do for boards too, boards are specifically required to approve the important business services identified for their firm and the impact tolerances that have been set for each of these. While individual board members are not required to be technical experts on operational resilience, the PRA expects boards to ensure that they have the appropriate management information. Boards should also collectively possess adequate knowledge, skills, and experience to provide constructive challenge to senior management and inform decisions that have consequences for operational resilience.

Recovery and resolution planning

Ensuring that firms have credible plans in place to enable them to recover from stress events, and that firms work to remove barriers to their resolvability to support the management of failure (proportionate to the firm’s size and systemic importance) in an orderly manner remains a central regulatory focus, more so now in light of the impact of the pandemic than ever.

The PRA is working with the FSB and IAIS so that UK internationally active insurance groups contribute to the implementation of the holistic framework (as noted above) for the assessment and mitigation of systemic risk in the insurance sector, a key component of which is a set of crisis management and planning tools including resolution planning.

The PRA will contribute to the continuing development of the IAIS draft Application Paper on Resolution Powers and Planning. The paper aims to provide guidance on supervisory practices related to resolution, which is defined as “actions taken by a resolution authority towards an insurer that is no longer viable, or is likely to be no longer viable, and has no reasonable prospect of returning to viability.” In particular, it provides guidance for the application of ICP 12 (Exit from the market and resolution) and ICP 25 (Supervisory cooperation and coordination), including the relevant ComFrame standards integrated therein. The IAIS is currently considering feedback that it has received to this draft paper and we can expect to see further guidance in this area in due course.