Solvency II unit matching is no longer just a theoretical concept, but rather a common strategy used by UK insurers with material blocks of unit-linked business to help improve liquidity and balance sheet stability, and better manage market risks. This paper by Milliman’s Emma Hutchinson, Fred Vosvenieks, and Paul Fulcher highlights lessons learned from implementations in the UK market and the practical challenges to implementation in other countries.
In March, the European Insurance and Occupational Pensions Authority (EIOPA) published its recommendations on the implications of COVID-19 for supervisory reporting and financial disclosure. EIOPA recommended that insurers consider the pandemic as a “major development” and publish appropriate information in their Solvency and Financial Condition Reports (SFCRs) on the effect of COVID-19 on their business.
However, EIOPA did not prescribe the possible format or extent of such disclosure. As a result, different approaches were taken by insurers to meet the disclosure requirements. They ranged from having dedicated sections for the impact of COVID-19 to having a few lines giving a brief description of the potential impact at much higher levels.
In this paper, Milliman’s Paul Fulcher, Sihong Zhu, and Samuel Burgess review the SFCRs recently published by major life insurers in the United Kingdom to examine the disclosures made on the impact of COVID-19 and what can be learnt about the impact the epidemic has had.
Life insurance companies face multiple risks that evolve over time and they must hold capital as a buffer against these risks. Capital management is an increasingly important topic for insurers as they look to find ways to manage their risks and the related capital requirements and to optimise their solvency balance sheets.
Given the traditionally long-term nature of the insurer’s liabilities, effective capital management can be complex. Insurers may face capital pressure due to their solvency coverage level, shareholder demands, regulatory concerns, etc. Reinsurance is one of the key capital management tools available to insurers. Several reinsurance structures are available, each with its own advantages and disadvantages and requiring experience and expertise to make optimal decisions.
In this paper, Milliman professionals explore a range of reinsurance strategies that could be used by life insurers for capital management purposes. They investigate more common reinsurance strategies along with new developments and innovative strategies that could be implemented by companies.
In May, the Prudential Regulation Authority (PRA) published Supervisory Statement (SS) 1/20 on its latest expectations of the application of the Solvency II (SII) Prudent Person Principle (PPP) rules to insurers’ investment strategy, risk management and governance.
The SII PPP requires insurers to conduct investment activities in an appropriate manner, and to only invest in asset risks which they can properly identify, measure, monitor, control and report, and which are in the best interest of policyholders. The importance of this has been highlighted by the increased trend towards investment in less liquid and more complex assets as well as recent economic volatility.
This paper by Milliman’s Paul Fulcher and Sihong Zhu summarises the key PPP expectations from the updated text in the SS and their potential implications for insurers.
The economy after COVID-19 may look very different from before the crisis and may involve the use of hitherto unfamiliar fiscal and monetary tools. These tools have the potential to fundamentally change conventional economic relationships and market conditions. The insurance industry is going to have to adapt to this new environment. Milliman consultants Thomas Bulpitt, Paul Fulcher, and Russell Ward offer more perspective in their paper “Economic responses to COVID-19: ‘Extraordinary times call for extraordinary measures.’”
On 24 September 2019, the Prudential Regulation Authority (PRA) released Policy Statement (PS) 18/19, ‘Liquidity risk management for insurers.’ In this paper the PRA publishes the responses it received to Consultation Paper (CP) 4/19 and outlines the subsequent changes it has made to its draft policy on liquidity risk management for insurers. The final Supervisory Statement (SS) 5/19 ‘Liquidity risk management for insurers’ is contained within the appendix.
This paper is relevant to all UK Solvency II firms.
- Liquidity risk management framework: Clarity was requested on the establishment of risk tolerance limits for liquidity risk, and on the way in which groups should implement the provisions of the SS.
- Sources of liquidity risk: Responses requested additional guidance on intraday risk, suggesting that it is typically not material for insurers.
- Stress testing: Clarity was requested on the stress horizons listed, while additional guidance on the treatment of individual funds within a life insurer’s portfolio was also requested.
- Liquidity buffers: Responses requested clarification on the purpose of the liquidity buffer and the PRA’s classification of assets of primary and secondary liquidity.
- Risk monitoring and reporting: Some responses raised concerns over the required level of board involvement with liquidity risk management.
- Liquidity contingency planning: Responses highlighted that contingency planning requirements have been set across different jurisdictions.
- General comments.
The most significant changes to the policy are as follows:
- Definition of risk limits: There were concerns that establishing risk tolerance limits would be needlessly complex as they would interact with existing risk limits and would be unlikely to materialise from a single source. The PRA now expects an insurer’s senior management to decide what liquidity risk limits need to be set, in accordance with the nature, scale and complexity of the firm’s activities, rather than for each material risk to which the insurer may be exposed.
- Documentation: There were concerns over the duplication of existing documentation in order to comply with the PRA’s expectations. The PRA has confirmed that existing documentation does not need to be duplicated, and only needs to be accessible from one location.
- Liquidity buffer: The PRA has clarified the characteristics of the liquidity buffer, stating that the purpose is to cover any mismatch between cash outflows and cash inflows. Where liquidating assets could conflict with business or risk management strategies, including such assets in the liquidity buffer goes against the objectives of the SS. They also clarified the definitions of assets of primary and secondary liquidity, but retained the list of example assets for each, while noting that they were not necessarily definitive classifications. The PRA also added additional requirements to consider the suitability of pooled money market funds for inclusion in the liquidity buffer, including a fund’s ability to limit or stop withdrawals.
- Role of the board: The PRA has clarified that oversight of liquidity management may be conducted by any risk committee of the board. However, if the insurer approaches or breaches its liquidity risk appetite then the issue must be escalated to the board and the PRA should be informed.
The PRA states that it does not believe that these
amendments alter the substance of its expectations.
The expectations set out in SS 5/19 have immediate effect. To discuss this topic further, contact Milliman consultants Russell Ward, Paul Fulcher, or Claire Booth.