New year’s resolutions (and pre-emptive recovery plans) for insurers

Recovery and resolution (R&R) planning appears to have arrived in insurance, following multiple false dawns.

Governments and regulators introduced a number of important changes to regulation following the financial crisis, including more stringent capital rules, but also new recovery and resolution regimes for banks and insurers. These regimes aimed to ensure firms can recover from stress, while protecting consumers, businesses and taxpayers.

While such regimes have been in place for a number of years, rules are more advanced in banking than insurance. However, recent moves by the International Association of Insurance Supervisors (IAIS) to introduce guidance for supervisors, and The European Insurance and Occupational Pensions Authority’s (EIOPA) ongoing development of pre-emptive recovery rules show a shift is happening in insurance.

New decade, new momentum

The insurance industry has long argued against detailed R&R rules given the different systemic profile of the sector. However, authorities have little tolerance for systemic risk and are willing to intervene to avoid taxpayer-funded bailouts. Momentum on this picked up in the second half of 2019 with EIOPA including specific proposals for pre-emptive recovery plans within the 2020 Solvency II review process.

The IAIS also finalised the long-awaited Holistic Framework in November 2019, which includes tools and policy options for supervisors on a range of macroprudential issues, including recovery planning. It followed this with the final version of an application paper on recovery planning which provides key indicators of what good practice looks like.

A significant body of policy thinking is now available to authorities to ensure firms - particularly internationally active insurance groups - are prepared for the worst. As a leading regulator internationally - and irrespective of Brexit - we expect the Prudential Regulation Authority (PRA) to continue developing and adopting best practice regulatory policy in this area.

What does R&R look like for insurers?

While closely related, there are important differences between recovery and resolution and the clues are in the names:

  • Recovery planning refers to the steps a firm can take if it becomes stressed and breaches solvency requirements to try to restore its financial position.
  • Resolution refers to the steps that can be taken to unwind a firm, protect customer interests and restrict the spread of systemic risk.

Under Solvency II, recovery plans are required from firms on a reactive basis when the Solvency Capital Requirement is breached. The major development we are seeing is the need - at least for larger or internationally active firms - to prepare preemptive recovery plans. This mirrors requirements in place in the UK for banks, which the PRA set out in 2017 (supervisory statement SS9/17). While requirements differ for insurers, the underlying principles are likely to be similar to banking rules.

Proposals on resolution planning are less developed. Today, pre-emptive resolution plans are only required for global systemically important insurers, but EIOPA’s proposals would likely extend this to other large firms. The PRA already accounts for resolvability within its supervisory assessment framework and can direct firms to address impediments to resolvability. The development of pre-emptive plans is a key part of a emerging macroprudential tools intended to address systemic risk and protect policyholders and tax payers from disorderly failures.

What should firms be doing?

R&R is quickly rising up regulators’ agendas. Firms should be monitoring developments and anticipating where they may face challenges from new rules. However, beyond this, there are good reasons to bring new R&R thinking into firms’ plans. Sound risk management practices should not only assess the risks a firm is exposed to, but also anticipate the steps needed to overcome problems.

When thinking about significant changes to group structure or other major strategic decisions - such as Brexit-related restructuring - firms should consider whether there are inherent barriers to their ability to recover from stresses or be resolved. Firms can utilise the insight that emerges when looking at their business through a R&R lens to support a wider view of risk management practices and respond to vulnerabilities.

Peter Thomas | Director, PwC United Kingdom
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