In March, the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) hosted the first meeting of the jointly established Climate Financial Risk Forum (CFRF). The CFRF was established to build capacity and share best practice across financial regulators and the industry to advance financial sector responses to the financial risks from climate change.
The CFRF produced a guide to help firms understand the risks that arise from climate change and to provide support on how to integrate these risks into strategy and decision-making processes. The CFRF emphasises the importance of greater transparency and consistency regarding firms’ disclosures of climate-related financial risks, the benefits of effective risk management and scenario analysis and the opportunities for innovation in the interest of consumers.
The forum set up four working groups to explore the risks that climate change poses in each of these areas and developed practical guidance. In this paper, Milliman’s Amy Nicholson and Sophie Smyth summarise the key guidance from each of these four working groups.
In June, the Prudential Regulation Authority (PRA) published its feedback to general and life insurers following their participation in the Insurance Stress Test (IST) 2019 exercise and the more recent stress test exercise specific to COVID-19.
IST 2019 was the third IST conducted by the PRA since the introduction of Solvency II. However, IST 2019 was the first in which UK life insurers participated (the first two tests being restricted to general insurers) and only life insurers with significant annuity exposures were invited to participate.
This paper by Milliman professionals summarises the key feedback from the PRA and discusses the expected implications for life insurers in the United Kingdom over the course of 2020 and beyond.
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.
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.
Equity release mortgages (ERMs) have been sold for many years in the United Kingdom and in their early days were subject to controversy around customer fairness. However, ERMs are now a growing component of UK life insurers’ balance sheets, and are mired in a new controversy, this time around their prudential and capital treatment when used to match annuity liabilities.
Milliman consultants have drafted a briefing note that brings together the recent developments affecting the valuation and capital treatment of ERMs in the UK, particularly those brought about by the evolving prudential regulatory regime being put in place by the Prudential Regulation Authority (PRA) and the debates around the most appropriate technique for valuing the no-negative-equity-guarantee.
This paper by Milliman’s Robert Bugg and Paul Fulcher is relevant to life insurers with annuity liabilities who invest in, or are considering investing in, ERMs.
Recently, the European Insurance and Occupational Pensions Authority (EIOPA) announced results from the 2018 Stress Test. EIOPA published its third annual analysis on the use and impact of long-term guarantees (LTG) measures and measures on equity risk. The Prudential Regulation Authority (PRA) also published its ‘Solvency II- Equity release mortgages- PS31/18.’ This briefing summarises these and other regulatory updates as of December 2018.