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Insurance: PRA focus on recovery planning

Shane Smith Shane Smith

Insurance recovery and resolution planning is moving up the regulatory agenda. Shane Smith looks at what this new focus means for insurance firms.

Momentum has been building in recovery and resolution for the wider insurance sector for some time. The Central Bank of Ireland (CBI) has led the way and rules came into effect in March 2022 that require insurance firms to maintain pre-emptive recovery plans. The EU insurance recovery and resolution directive (IRRD) has also published proposals for harmonised recovery and resolution planning across the bloc.  

In May 2021, HM Treasury consulted on amendments to the current insurer insolvency arrangements, outlining plans to introduce a specific resolution regime for insurers aligned with international agreed standards and best practice. Then in September 2021, Sam Woods, CEO of the Prudential Regulation Authority (PRA) said the regulator intends to do more “to increase our confidence that firms can exit the market without disturbing it, in an orderly way and without having to rely on the backstop of an insolvency or resolution process.”

In November 2021, the regulatory initiatives grid included the intention that "in scope insurance firms will be expected to develop recovery plans" – although expected timings were not mentioned.

The direction of travel by the PRA is clear. Although we do not know the final rules for the UK, we have a good sense from looking at the CBI and IRRD proposals what the key content will be. We expect that the PRA will require a wider range of insurance firms to prepare and maintain recovery plans.  

Difference between recovery and resolution

Recovery planning is a comprehensive document that the insurer will need to produce which identifies options to restore financial strength when the company comes under stress. It is expected to be a live document, subject to ongoing regulator scrutiny. Timing is unclear, but more guidance from the PRA is expected during the second half of 2022.

Resolution refers to the situation when an insurer is no longer viable or is likely to become no longer viable. Importantly, it is the regulator who prepares the resolution plan (or advisers on behalf of the regulator), albeit with input from the insurer. It outlines the steps that can be taken to unwind a firm, protect customer interests and restrict the spread of system risk. We expect an additional consultation from the PRA on this later in 2022.

Key elements of a recovery plan

Governance – how will the recovery plan be integrated with wider frameworks and processes? The board will need to demonstrate it has overseen both the planning and subsequent monitoring and reporting of the recovery plan.

Scenario testing – using a range of different types and sufficiently severe stresses, testing how elements of the plan would interact in these stresses. Firms should explain which recovery options would be used in each scenario.

Recovery options – a broad range should be included, including factors that could reduce the likelihood of restoring the firm’s financial position. The PRA expects firms to ensure they have sufficient credible options to restore their capital and liquidity positions to appropriate levels in, or following, a stress.

Indicators – an effective indicator framework can maximise chances of recovery. Firms will need to explain and justify the calibration of the indicators in their recovery plan.

Communication plan – to both internal and external stakeholders. Firms should consider how they will manage any negative market reaction to recovery options.

Existing regulatory requirements for insurers around operational resilience, financial resilience and third-party risk management also feed into recovery plan content. 

What makes a good recovery plan?

Insurers can also learn a lot from looking at the banking sector or at their insurance intermediary counterparts, where rules on recovery and wind-down planning are more developed.

Setting the appropriate parameters is key. Management will need to make judgements around the level of granularity required, the level of support from key stakeholders and the complexity of scenarios considered in any recovery plan.

Regulators can often challenge the stress scenarios provided in a recovery plan, which should be sufficiently severe. Similarly, the trigger framework needs to be set at appropriate levels, including the amount of time that would transpire between a warning sign appearing and the need to execute the recovery plan.

In recent reviews of wind-down plans in the banking and insurance intermediary sector, the FCA found that liquidity and cashflow modelling, intra-group dependencies and trigger calibration were often not meeting expectations. These will also need to be key areas of focus for insurers.

Engage early, prepare now

There are those in the insurance industry who question the need for more formal recovery planning. Over the past eight years, the PRA has overseen the orderly and solvent exits of 45 insurers – none of which impacted financial stability and largely went under the radar. However, against a backdrop of the high inflationary environment, climate change, war and the effects of the pandemic, the emphasis on recovery and resolution planning seems more relevant and necessary than ever.

Pre-emptive recovery planning requires input from, and will have an impact on, risk management frameworks, solvency and liquidity planning, governance structures and management responsibilities and accountabilities. Lessons from the banking side show us that early engagement is essential. Insurers should start preparing now.

For more information, contact Shane Smith.

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Financial services restructuring and insolvency Mitigating the impact of internal and external stresses on your business

120x120-bradley-chadwick.png"In response to questions from their regulators and in preparation for the Central Bank of Ireland we have had a number of our clients ask us to share insights and best practices into recovery and resolution planning. The number one mistake we see firms make is thinking this is a regulatory exercise that can be done by the CRO’s team, without engagement from the whole firm. Unfortunately, that will not cut it.”

Bradley Chadwick, Partner, Financial Services Restructuring and Insolvency

120x120-simon-sheaf.png“Insurers need to robustly model a range of scenarios of severe macroeconomic and financial distress against which they test the impact and feasibility of their recovery plans. Credible options to restore long-term viability - while under severe stress conditions - then need to be developed.”

Simon Sheaf, Partner, Head of General Insurance