Information current as at 20 March 2020
COVID-19 presents a severe, ongoing and rapidly-evolving supply and demand shock to financial markets, business and broader society, and is prompting a fast and imaginative response from financial regulators and policymakers.
With a focus specifically on the insurance industry, this blog draws together the announcements and policy measures of various key regulators and supervisors in recent days, and considers their implications for UK insurers. It also discusses how the market movements and central bank monetary policy measures (principally reductions in interest rates) may affect the insurance industry and influence the regulatory response.
This blog accompanies other blogs by Deloitte’s EMEA Centre for Regulatory Strategy which consider implications for the banking and asset management sectors.
This blog principally covers regulatory announcements and guidance issued by the UK’s FCA and Bank of England/PRA, and the European Insurance and Occupational Pensions Authority (EIOPA). Each of these are summarised, as they apply to the insurance industry, in the annex to this blog.
The regulatory response to COVID-19 – key implications for the insurance industry
Capital, solvency and business model risks
- The dramatic falls in financial markets and reductions in central bank interest rates will hit many insurers’ solvency ratios through a substantial simultaneous impact on risk free rates; credit spreads and associated credit default risk; and falls in asset values. That said, as a result of Solvency II the European insurance industry is positioned to display substantial financial resilience in the face of this shock, with insurers capitalised by the regime to withstand at least a one in two hundred year equivalent event within a one year time horizon. Specifically:
- Insurance SCR requirements are likely to increase through credit default and downgrade risk, particularly if COVID-19 presents a prolonged shock to the broader economy. Increasing credit spreads will be smoothed by the matching adjustment (MA) for annuity portfolios, though MA portfolio composition will also be affected by any downgrades. Outside of MA portfolios, increases in corporate bond spreads will materially affect both asset values and capital requirements for many insurers.
- For insurers writing long term business, the risk margin – already a substantial burden on capital resources – will increase still further as a proportion of capital. Recalculating the transitional measure on technical provisions (TMTP) (as invited by the PRA, for example) should provide some mitigation for firms that apply the measure. However, these apply only to pre-2016 business and are in the fourth year of a sixteen year amortisation process. Despite interest rate hedging by many insurers, the interest-rate sensitivity of the risk margin will now be still more of a burden.
- Insurers will also suffer significant losses in asset values given market falls. This is likely to affect unit linked portfolios particularly (where asset and liabilities, though held on the insurers’ balance sheets, are essentially matched), presenting losses to both policyholders, who bear the investment risk, but also insurers, which are likely to see a reduction in fee income corresponding to the reduced asset value. General reductions in liquidity for more illiquid assets will also pose difficulties, especially for insurers with asset management businesses in-group.
- Implications for insurers’ claims, and consequently liabilities, are likely to vary by individual insurer, for example according to whether they write affected classes of business such as travel or business interruption, the terms of those policies, and how they respond to COVID-19 policy announcements (for example, requiring business closure). Supervisors are, needless to say, likely to be focused on firms with most liability exposure to COVID-19. Insurers may also be exposed to reputational risks relating to COVID-19, for example relating to public perceptions of their scope of coverage and response to claims.
- EIOPA has not at this stage declared an “exceptional adverse situation” that would be required to extend the period within which insurers may operate below their SCR, with a suitable recovery plan. However, EIOPA has given some indication that it may be prepared to contemplate such a step.
- In the meantime, close supervisory work with any insurers suffering and recovering from COVID-19-related financial and solvency difficulties is likely to be a critical priority for regulators. Solvency II provides some flexibility for supervisory judgment and discretion that can be applied without any announcement from EIOPA, for example around the timing of recovery when an insurer falls below its SCR.
- Insurers are also likely to see increasing expectations from regulators to preserve capital during this period, for example by restricting dividends.
Conduct and protection of vulnerable customers
The FCA has issued guidance to firms on its response to COVID-19. For the insurance sector, these are predominantly focused on general insurance:
The FCA expects insurers to take the steps necessary to safeguard their operations during any period of operational disruption, and to show flexibility in how they treat their customers, considering specific needs that may arise in the context of COVID-19.
General insurers are required to have a Senior Manager responsible for business continuity and for managing the impact of coronavirus.
The FCA has highlighted that “many consumers are currently in a vulnerable position because of the coronavirus pandemic”, and has warned insurers that it would not expect customers’ ability to claim to be affected by “circumstances over which they have little control”.
The FCA’s expectations focus particularly on how insurers treat policy exclusions and changes in terms and conditions or product availability at renewal. The FCA has set out clear expectations that policyholders should not be disadvantaged in their ability to make a claim due to COVID-19-related changes to life and working patterns (for example, working from home or vehicle use), and that customers relying on policy cover be treated fairly at renewal, for example by continuing to offer renewals on products that are otherwise suspended.
The regulatory agenda and timeline
- Several regulators and supervisory bodies have announced delays to a swathe of regulatory and regulatory development activities, for example information requests, regulatory reviews and consultations.
- Insurers may see delays to broader regulatory activity in the following key areas:
- Delays to information requests and stress testing (including the 2021 Bank Exploratory Scenario for UK insurers), where these are not related to COVID-19.
- Changes to processes and timelines for supervisory review and approvals. Firms may find it more challenging to secure supervisory time for routine supervisory review work that is not time-critical.
- Extensions to supervisory deadlines, for example supervisory reporting, in order to reduce the compliance burden on firms in the short term.
- COVID-19 adds to the likelihood of delays to the Solvency II review, in particular as EIOPA has announced a two month extension to its Holistic Impact Assessment for the review.
Insurers, along with other financial services firms, have seen rapid changes in regulatory policy and supervisory activities in response to COVID-19, as well as profound changes in markets and their operating environment. Needless to say, it appears likely that this pace of change will continue for some time.
Insurers will see a close regulatory focus on immediate risks relating to COVID-19 and their responses, both internally and from the perspective of consumers. They are also likely to face increasing scrutiny from the regulators as to whether they are sufficiently focussed both on consumer outcomes in the current exceptional circumstances, particularly outcomes for those left vulnerable by COVID-19, and on the spirit as well as the letter of their obligations from a treating customers fairly perspective. The regulators can also be expected to take a very dim view of any perceived attempts in any sector to exploit profit opportunities created by the crisis. However, this heightened prudential and conduct regulatory focus is likely to be offset by a general slowdown in other, more routine and hence less urgent regulatory and supervisory activities that insurers will need to factor into broader planning, for example if undertaking wider business change activities such as internal model approval.
Annex – summary of key regulatory and policy announcements
Bank of England (BoE)/Prudential Regulation Authority (PRA)
The BoE/PRA have released a package of supervisory measures in response to COVID-19. The most relevant measures for insurers include:
Potential delay of Bank Exploratory Scenario (BES): “The Bank published a discussion paper on the 2021 BES on the financial risks from climate change on 18 December 2019. The Bank will take stock of the responses as well as the evolving situation with a view to announcing the way forward for this exercise in the summer.” The BES is relevant for the largest insurers in the UK.
Review of approach to Senior Manager Function (SMF) applications: “The PRA will review its approach for considering and processing applications with a view to reducing the burdens involved during current events.”
Review of programme of regulatory change: “The Bank and PRA will also review its programme of regulatory change. Where appropriate, we will postpone non-critical work at the current time to allow firms and FMIs to focus on their safety and soundness, the protection of policyholders and delivering their functions.” This includes for example postponing the deadline for responses to the Operational Resilience CP.
Postponement of non-critical supervisory work: “Bank and PRA supervisors will review their work plans so that non-critical data requests, on-site visits and deadlines can be postponed, where appropriate.”
The PRA also published a brief statement on the Transitional Measure on Technical Provisions (TMTP) for insurers. The statement invites insurers to apply to recalculate the TMTP as at 31 March 2020, due to movements in risk free rates and the risks posed by COVID-19. However, the PRA expects firms to demonstrate that a material change in their risk profile has, in fact, occurred.
Financial Conduct Authority (FCA)
The FCA has set out its expectations of insurers in relation to operational resilience and the treatment of customers. Some key aspects of the FCA’s guidance to insurers include:
Operational resilience and business continuity: the FCA states that it is “essential” all general insurance firms have plans in place to manage and mitigate the operational impact of coronavirus. It expects firms to have robust systems and controls to continue to operate effectively and to have a Senior Manager responsible for business continuity and for managing the impact of coronavirus.
The FCA further expects firms to consider how staff absences or inability to use business premises can be sufficiently mitigated to ensure critical services are provided to customers, and to notify their supervisors of any gaps identified.
Product suspensions: whilst acknowledging that firms are trying to manage their exposure to risks, the FCA sets out clear expectations regarding product suspensions. Firms must consider the needs of their customers carefully. In particular, where a customer was relying on a renewal for continuity of cover and taking account of any vulnerabilities. In such circumstances, the FCA warns that it may not be treating customers fairly if a firm were not to renew an otherwise suspended product.
Renewals: If firms are changing their policies to exclude coronavirus, in addition to following appropriate processes for making these changes, the FCA expects firms to make it very clear to those consumers whose policy is due to renew, that their policy has changed, and of the exclusion - both before renewal. The FCA further expects firms to consider the needs and circumstances of individual consumers (taking into account any vulnerabilities) when considering what may be an appropriate change to make.
Mid-term adjustments: If firms intend to make mid-term adjustments to their policies, the FCA expects them to consider, inter alia, whether there are terms in the contract allowing them to make those changes; whether those terms are fair and transparent and whether they are applying the term correctly; and whether due regard has been given to the interests of their customers and treating customers fairly.
The FCA’s guidance sets out specific expectations regarding the following products:
Travel insurance: Firms must clearly communicate to existing policyholders any policy exclusions that result from coronavirus. If a claim arises after a policy renewal date, the FCA says it expects insurers to treat customers fairly, which may include considering claims under the terms of the original policy, particularly if the customer was given a reasonable expectation that cover would continue.
Motor and home insurance: the FCA expects motor and home insurers not to reject claims because of a consumer’s “understandable” temporary change in how they use their vehicle and their home address.
Private medical insurance: the FCA expects that most privately insured treatment is likely to fall under non-urgent care and may need to be delayed due to coronavirus. Insurers need to communicate effectively, timely and compassionately with customers.
European Insurance and Occupational Pensions Authority
EIOPA has issued a statement on actions to mitigate the impact of COVID-19 on the insurance sector. EIOPA calls for:
- Flexibility on timing of supervisory reporting and public disclosure.
- An extension of two months to the holistic impact assessment for the Solvency II review (to 1 June), and more general for limits to its request for information and consultations. It is reasonable to suppose that the delay to the holistic impact assessment will delay EIOPA’s Solvency II review opinion.
- Insurers to take measures to preserve their capital, for example “prudent dividend and other distribution policies, including variable remuneration”. EIOPA draws attention to the flexibility and tools that NCAs have under Solvency II, including when an insurer is in between SCR and MCR.
- EIOPA has not declared an “exceptional adverse situation” to extend the SCR recovery period. However, it says that it “will take or propose to EU institutions any measure necessary in order to mitigate the impact of market volatility to the stability of the insurance sector in Europe and safeguard the protection of policyholders.” This may indicate that EIOPA considers the current situation one in which it may need to contemplate such a step.