Insurance Regulatory eBulletin - Prudential regulation

Feedback from recent PRA review work on the market conditions facing specialist general insurers
On 31 May 2018, Anna Sweeney, Director of Insurance Supervision at the PRA, issued a Dear CEO Letter to firms about the market conditions facing specialist general insurers and included feedback from recent PRA review work.

The letter notes the signs that some of the longer-term prudential risks associated with a soft market, about which the PRA has been warning for a number of years, are now feeding through more demonstrably into firms’ reported results. The PRA believe boards of many firms will benefit from reassessing whether their business models remain sustainable absent further action, and whether controls over underwriting and reserving in specialist lines are adequate. The PRA’s recent supervisory work has demonstrated, inter alia, that:

  • Some firms are now reporting underwriting performance consistently below the levels required to achieve sustained profitability, even in years of low natural catastrophe activity.
  • Some firms are formulating business plans based on loss ratio and reserving assumptions which are optimistic given current market conditions and firms’ historical performance.
  • As well as over-optimism in business planning, some firms appear optimistic in the level of assumed future profitability used when calculating their regulatory solvency position.
  • Insufficient use is being made by underwriters of technical pricing models, even for lines of business where such models are generally considered to be more developed and reliable.
  • Some firms have reacted slowly to emerging loss development and are too reliant on managing by business plan loss ratios.
  • Many firms have diversified from areas of traditional underwriting expertise into new lines of business but in some cases there was insufficient oversight leading to underwriting losses on these new portfolios.
  • Some firms were not able to produce high-level estimates of aggregate exposures within reasonable time periods following the 2017 hurricanes for important geographical areas and other firms appeared to have risk appetites that were set too high to influence exposure management with no clear linkage to underlying underwriting limits.
  • Some firms appear to lack management information to allow them to monitor effectively the use or performance of material delegated underwriting arrangements.
The PRA has requested all Category 1, 2 and 3 firms to respond to the PRA on the issues raised by Friday 27 July 2018.

Solvency II Risk Margin: Letter from the PRA
On 6 June, the PRA published a letter from Sam Woods, Deputy Governor and CEO of the PRA, to the Rt Hon. Nicky Morgan MP, at the House of Commons Treasury Committee, with an update on the risk margin work that the PRA is currently conducting.

Mr Woods states that the current design of the risk margin is too sensitive to interest rates, which means that at current low levels of interest rates, it is too high particularly, for long-dated insurance contracts such as annuities. For new annuity business, firms have responded to the level of risk margin by reinsuring a substantial proportion of the longevity risk offshore. The build-up of this stock of offshore reinsurance is an unintended consequence which if left unconstrained would become a significant prudential concern.

He notes that Solvency II does not appear to be having a detrimental impact on policyholders through annuity prices, the drivers of which continue to be dominated by risk-free interest rates and corporate bond spreads.

However, due to the uncertainty surrounding the UK’s future relationship with the EU, Mr Woods cannot currently identify a certain way to implement any change in relation to future risk mitigation and transfer mechanisms, including the calculation of the risk margin. He will keep the Treasury Committee updated as soon as the PRA identify a clear way forward.

PRA Annual Report 2018
On 14 June, the PRA published its latest Annual Report for the year to 28 February 2018. The report takes a close look at several topics, including the work the PRA has completed to pursue its business aims, how it complies with the Financial Services and Markets Act (FSMA), and the PRA's financial review of 2017-18. The report completes the PRA’s reporting obligations for the year ending 28 February 2018, following the publication of the PRA Business Plan 2018/19 in April.

The consultation on the report closes on 28 September 2018. Comments are requested on how the PRA has or has not fulfilled its responsibilities and the extent to which it has advanced its objectives and the regulatory principles to which it must adhere to when carrying out certain functions, including the way in which the PRA has enabled effective competition in the markets.