In November 2017 the PRA issued Consultation Paper CP23/17 "Financial Management and Planning by Insurers". The purpose of this paper was to publish a draft Supervisory Statement ("SS") on this topic which the PRA plans to issue to complement its other supervisory statements.
The overview of the paper says that "This draft SS is intended to complement existing policy material, rather than to set any new expectations on governance or risk management for insurers" and this seems to be generally true. The purpose of this article is to summarise the contents of the draft SS and suggest what firms may need to do to ensure they are meeting the PRA’s expectations.
There are four sections to the draft SS:"Overview", "Risk Appetite Statement", "Business and Financial Plans" and "Dividend Suitability and Sustainability". Each section is considered below.
This gives the scope of the SS. It applies to all UK insurance firms and groups that are within the scope of Solvency II and to the Society of Lloyds and its managing agents. Firms outside the scope of Solvency II are not affected by this SS. It also gives the context for the SS and lists the other relevant PRA publications which should be read alongside it.
Risk Appetite Statement
The PRA expects firms to have a clear Risk Appetite Statement, including the rationale for how the risk appetite is expressed and how it has been determined. The statement also needs to identify the reasonably foreseeable circumstances under which it might be reviewed and changed.
The statement should include the risk appetite for the levels of capital that are to be maintained in reasonably foreseeable market conditions, for example, a probability statement for the likelihood that the SCR will fall below 100%.
The section includes a list of the particular factors that firms may have to take into account.
For companies, the statement should also include the appetite for the level and volatility of future dividend payments.
The PRA requires firms to ensure that the statement covers all relevant material risks, including those in Conditions Governing Business 3.1(2)(c). These are the standard insurance risks and are listed in the Appendix for ease of reference. The statement needs to set out the risk tolerance limits for the different types of risk.
The PRA makes it quite clear that the risk appetite should only be changed following an overall discussion by the Board on the risks and capital requirements of the business. The risk appetite should not be changed just to allow for the assumption of a new risk, a change in investment policy, or a dividend payment.
The PRA expects the risk appetite statement to be communicated appropriately within the business so that all key individuals understand their responsibility for the management and reporting or relevant risks.
The level of detail should be proportionate to the scale and complexity of the business.
Business and Financial Plans
The PRA expects firms to have business plans that are consistent with their risk appetite. The plans need to reflect achievable capital generation and (where appropriate) capacity for dividend payouts. Firms need to understand the drivers of their profitability and the volatility of those drivers. They must understand the risks relating to their plans and the impact of reasonably foreseeable adverse scenarios.
The PRA expects firms to produce regular management information ("MI") which shows how the firm is performing against its plans. The MI should include information about whether any deviation from the plans is likely to be outside the risk appetite.
General insurance firms are required to consider the possible effects of a Market Turning Event on their business and the steps they might reasonably take to ensure they could respond appropriately.
The SS reminds firms that the ORSA is the tool which should ensure there are effective links between the firm’s business planning and its risk appetite.
The PRA expects firms to develop planned management actions in response to stress scenarios which are "realistic, credible, consistent with regulatory expectations, and achievable". These actions need to be approved by their Boards. Firms also need to consider trigger points for management actions and what precautionary measures they might take.
Firms also need to understand any dependencies for the implementation of planned management actions on third parties or external conditions and monitor those dependencies.
If an insurance firm is relying on support from its group it needs to be sure that support would be readily available in the stressed conditions.
Dividend Suitability and Sustainability
This section only applies to companies that pay dividends.
Firms need to be able to demonstrate that planned dividend payments are appropriate in relation to business performance as well as the capital position of the firm allowing for its risk appetite. This means the dividend policy must take account of the firm's earnings and their sustainability.
Firms have to consider where the capital to generate dividends comes from and ensure that future dividends are supported by future capital generation. Pre-approval of dividends is not normally required (except for firms in run-off) provided the firm is within its risk appetite and the SCR coverage is in excess of 100%.
Firms are cautioned that frequent breaches of the SCR may result in a review by the PRA concerning whether firms are meeting the requirements to have in place "an effective system of governance which provides for sound and prudent management of its business".
What is there for firms to do?
OAC considers there is nothing alarming in this SS for well-run firms. The SS clarifies and gives substance to the PRA’s expectations of how insurers should manage their business. While OAC does not believe there will be no cost implications, those implications should be relatively slight if firms are complying with the requirements of the PRA Rulebook for Solvency II firms.
It is suggested that firms should use the SS as a checklist to ensure that their Risk Appetite Statement does meet the PRA’s expectations. Similarly, the SS can be used to check that the business planning process and dividend policy meets regulatory expectations.
Responses to the Consultation Paper are required by 9 February 2018. OAC does not think there is much that firms should object to in this paper. Whether or not any objections are raised, it is likely that the proposed SS will remain virtually unchanged.
If you need further guidance in understanding the proposals in this Consultation Paper and how they apply to your firm, then our experts are ready to help. To be notified about future articles by OAC you can subscribe to our newsletters.
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