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Freshfields Risk & Compliance

| 5 minutes read

PRA insurance supervisory priorities for 2023

Earlier this week, the PRA published a Dear CEO letter to all insurers, including third-party branches supervised by the PRA setting out its supervisory priorities for 2023.

The PRA’s areas of focus include, amongst other things:

  • financial resilience;
  • risk management;
  • implementing financial reform;
  • reinsurance risk;
  • operational resilience; and
  • ease of exit for insurers.

Financial resilience

for insurers has been high on the PRA agenda for some time now – more so now in light of the latest downbeat projections by the Bank of England’s Monetary Policy Committee which describe a “very challenging outlook for the UK economy, which is expected to be in recession for a prolonged period with CPI inflation remaining elevated in the near term”. 

The Financial Policy Committee (FPC) also identified that prices have continued to rise rapidly, in considerable part reflecting steep increases in energy and food prices. In response to these price rises, central banks around the world, including the Bank of England, have increased interest rates. These rate rises, and the expectation that they will rise further, have subsequently caused the cost of borrowing to rise for households and businesses. The large and rapid moves in financial market asset prices and the fall in price of certain assets, such as risky corporate bonds are due to a combination of the worsening global economic outlook and the potential for further adverse geopolitical developments, including from Russia’s invasion of Ukraine.

This has increased uncertainty and, unsurprisingly, financial resilience remains at the top of the PRA’s priorities for this year. For life insurers, stress testing against prolonged adverse credit scenarios remains key and for general insurers it is expected that they factor general and social inflation risk drivers into their underlying pricing, reserving, business planning, and capital modelling.

Firms are also asked to focus their attention on the adequacy of their risk management and control frameworks to enable them to respond to market and credit risk conditions that differ to the risks that have affected them in recent years. The PRA has stated that it will focus on how well insurers’ capital models operate in conditions that differ substantially from those that prevailed when much of current modelling was developed. The growth in bulk purchase annuity deals and the gaps in insurers’ liquidity frameworks highlighted by the LDI crisis also drive the need for insurers to have sound risk management processes in place.

Solvency II reform 

is also a key supervisory priority this year and over the course of 2023 the PRA will seek to engage constructively with firms affected by the reforms. There is still plenty of work to be done in respect of the proposed reforms and HM Treasury and the PRA are expected to continue to work together to legislate on the package of reforms and on the necessary Rulebook and other changes. The Financial Services and Markets Bill is currently passing through the legislative process and will enable reforms to the Solvency II regime.

Later this year, the PRA will publish a detailed technical consultation on proposals for reform of its Solvency II rules and supervisory expectations, including in relation to:

  • reducing the level of the risk margin for long-term life insurance liabilities, making it less sensitive to interest rates;
  • supporting sustainable investment by adjusting the design and strengthening calibration of the matching adjustment to better reflect actual risks retained by insurers;
  • expanding the eligibility criteria for matching adjustment portfolios;
  • simplifying processes for the approval of internal models, and of matching adjustment eligibility for less complex assets; and
  • facilitating effective competition by raising the threshold for the application of the Solvency II regime, introducing a mobilisation process for new insurers, and reducing capital and reporting requirements for incoming branches.

The PRA is also paying close attention to whether the “continued high level of longevity reinsurance and the emergence of the more complex ‘funded reinsurance’ in the UK life market reduce the protection UK policyholders should have, beyond the risk tolerance”. The PRA is concerned that offshored counterparty concentration risk may arise from rapidly growing levels of reinsurance. At present, the PRA expects firms, among other things, to continue monitoring the level of annual cessions as a proportion of their gross premiums and the quantity of reinsurance recoverables compared to their available capital resources, and take appropriate actions to manage risks arising. Additionally, firms should consider aspects relating to the prudent person principle as well as to what extent reinsurance concentrations may impede effective resolution. The PRA’s expectations of risk management increase in proportion to the size of the concentration and the risk it poses to a firm.

The PRA notes again in its letter that it expects UK authorised firms to consider their compliance with the prudent person principle for the risks associated with their reinsurance activities. It adds that insurers need to consider the reinsurer’s resilience over the whole duration of the exposures, as well as the potential impact from a mass recapture event where large concentrations to a small number of counterparties exist. Compliance with the prudent person principle is assessed on an objective basis, from the standpoint of the hypothetical prudent person in similar circumstances (taking into account all relevant factors case-by-case), rather than a firm’s subjective view about the prudence of its investment standards.

The PRA also maintains its focus on operational resilience which has been high on the agenda in recent years. Following the introduction last year of the new policy framework to strengthen the resilience of financial institutions and financial market infrastructures (FMIs) and protect the wider financial sector and UK economy from the impact of operational disruptions, the PRA expects insurers to have identified and mapped their important business services and set impact tolerances. It will also continue to assess firms against its operational resilience rules. The three-year transitional period for firms to comply with rules requiring them to remain within their impact tolerance for each important business service in the event of a severe but plausible disruption ends on 31 March 2025. Between now and then, firms should continue developing more sophisticated mapping processes and scenario testing. Insurers must also ensure that their important business services can remain within impact tolerances even when relying upon third party providers.

Resolution planningkey attributes of effective resolution regimes for financial institutions. Broadly, this means establishing crisis management groups, developing recovery and resolution plans, and assessing the insurer's resolvability.

also remains crucial for firms. At present, there is no detailed framework for the resolution of insurers in the UK, however the PRA has, over the course of the last couple of years, noted the need to develop a targeted resolution framework for the UK insurance sector beyond the PRA’s Fundamental Rule 8. HM Treasury is actively engaging with the PRA to develop a proposal for the introduction of a specific resolution regime for insurers and will publish further details in due course. Systemically important insurers are expected to have resolution arrangements in place that meet the Financial Stability Board's (FSB)

In the meantime, the PRA notes that it expects firms to begin considering how they might exit the market if the need arose, what the obstacles might be, and how they might be overcome. These plans should be executable on a timely basis and appropriately prudent. In particular, firms considering transferring run-off books of business to other firms should ensure that, before disposal, they are fully cognisant of the risks contained in those books, and that those risks are fully understood by the acquiring firm.

The PRA also highlights its focus on non-natural catastrophe risk, financial risks arising from climate change and diversity and inclusion. All in all, it will be another busy year ahead for the industry at a time when the changing economic and market climate will mean that firms have plenty already to confront even without the weight of proposed changes in regulatory standards and expectations.