On 11 January the Prudential Regulation Authority (PRA) set out its 2024 supervisory priorities for UK insurers.
Each year, in early January, the PRA publishes its supervisory priorities for the year ahead, for each of its supervision directorates (UK deposit takers, international banks and insurance). The priorities complement a firm’s individual supervisory strategy that will have been communicated following the firm’s Periodic Summary Meeting.
The priorities cover a broad range of matters, but at a high level are: i) PRA expectations for managing risks arising from the current economic environment and changes in the insurance market; ii) implementing new regulatory policies (including Solvency II reform); iii) PRA expectations for firms’ risk management capabilities; and iv) managing financial risks from climate change.
In general, banks can expect the PRA’s normal supervisory engagement process to consider how these matters are being dealt with, and to seek assurance that their overall governance, risk management and control frameworks are evolving in line with the changing environment, and the PRA’s priorities.
In early December the International Association of Insurance Supervisors published its 2023 Global Insurance Market Report (GIMR), which highlights key risks and trends facing the global insurance sector, many of which affect the UK insurance market. While the report reflects data up to the end of 2022, the trends have substantially continued. Sections 3 and 4 of the GIMR are particularly relevant to the first, third and fourth PRA priority themes, as they explore in more detail the credit, interest rate and liquidity risks from the macroeconomic environment, structural shifts in the life insurance sector, and climate related risks.
Financial markets and the economic environment
The PRA’s objective is that insurers are financially resilient and can manage their credit and liquidity risk exposures.
The PRA does not highlight any general concerns with firms’ credit risk management. Rather it highlights that the current state of the economy (subdued growth, inflation) and the potential for economic relationships to change creates risks, and that firms’ credit risk management capabilities need to be capable of managing these risks. The PRA will focus on firms’ capabilities in 2024, including that internal credit assessments reflect a firm’s risk profile.
The PRA highlights that recent events (the Dash for Cash in March 2020, the Liability Driven Investment shock in 2022) revealed weaknesses in insurers’ liquidity risk frameworks. The current economic environment also increases the potential for lapse risk. In response the PRA proposes to work with key stakeholders to new develop liquidity reporting requirements during 2024. Some insurers will also be involved with the Bank’s 2024 exploratory wide stress test, while the Bank has also indicated it will look to develop a new lending tool, that would be available to insurers.
Business and operating environment
The PRA’s objective is that insurers are operationally resilient. It is just over a year (by March 2025), until the PRA’s supervisory statement 1/21 (Operational resilience: Impact tolerances for important business services), comes into effect. The PRA expects “Boards and senior management to actively oversee the delivery of their firm’s operational resilience programme”. It also indicates it expects insurers to conduct cyber stress tests to assess their reliance to a cyber related incident.
The PRA indicates a key objective is “to increase confidence that insurers can exit the market in an orderly way”, and that it will consult in 2024 on requirements for insurers to develop plans for an orderly solvent exit. The consultation was launched 23 January 2024 (CP 2/24), with a response date of 26 April.
The PRA is considering the feedback to the various Solvency II reform consultations in 2023. While it doesn’t indicate when it might publish its final policy statements, it does say that they will be published to ensure the changes can be completed by the end of the year, and in its most recent Solvency II consultation it indicated final policy would be published in Q2 2024. The PRA also notes it may provide more clarity during the year to facilitate efficient and proportionate implementation.
Expansion of the life insurance sector
Life firms invest in a wide range of credit risky assets. The PRA expects expansion in the rage of investments in response to the proposed Solvency II UK reforms and the expected growth in the bulk purchase annuity (BPA) market. The PRA expects insurers’ strategic choices and investment decisions are made within their risk tolerance limits, and that their supporting risk management, asset origination, and operational capabilities develop accordingly.
The PRA considers that funded reinsurance has the potential to introduce significant risks to its objectives, as they are complex transactions which give rise to contingent exposure via recapture risk. Moreover, the PRA has found weaknesses in life assurers using funded reinsurance. The PRA has indicated it sees “only a limited role for funded reinsurance”, and expects firms limit their activity. The PRA issued a consultation paper in November 2023 with its proposed expectations for risk management: the deadline for responses is 16 February 2024. The FPC will also keep the issue under review, and further policy will be developed.
The next life insurance stress test is planned for 2025. In the meantime, the PRA will engage with the industry on the technical, operational and communication aspects of the exercise, and will look to publish an approach document.
General insurance sector reserving risk and model drift
Cyber insurance has continued to grow in significance to the UK insurance sector, while cyber threats have evolved. The PRA plans to focus on ensuring that insurers’ capital and exposure management capabilities are commensurate to the growth in risk exposure.
Claims inflation continues to be a significant risk for general insurers. The PRA has a concern that there is the potential for excessive optimism to impact reserving, pricing and reinsurance planning. It will continue to monitor the risk and reflect whether further work may be required.
Following a 2023 review, the PRA found issues with model drift – ie, internal models not reflecting or capturing the changing risk environment (eg, limited allowance for inflation uncertainty). The PRA will continue to monitor the ongoing appropriateness of internal models with an emphasis on improving the effectiveness of internal model validation.
The PRA will run the first dynamic stress test in 2025 (ie, simulating a sequential set of adverse events over a short period of time). The PRA will provide more details of this exercise during the first half of 2024.
Financial risks arising from climate change
While the PRA considers that there have been positive steps to embed supervisory expectations, it notes that further progress is required by all firms. In particular there is a need for integration of scenario analysis and risk management into insurers’ strategic, risk appetite and decision-making processes. The PRA will continue to assess insurers’ progress and commence work to update its expectations set out in supervisory statement 3/19 (including providing examples of effective practice).
Summary
The PRA’s priorities are substantially unchanged from 2023, mainly reflecting the ongoing fragility in the macroeconomic environment and the multi-year implementation of new regulatory policies (such as Solvency II). But there is also an element of continuing weaknesses in firms’ own risk management, and these affected firms may find PRA takes a more interventionist approach.
