Investment risk is arguably at its most volatile for decades. For institutional investors such as insurers, 2020 has only accentuated the long-term investment challenges they face, namely: earning a competitive return on a large investment portfolio whilst remaining within a Board-approved investment risk appetite; and aligning investment strategy with the wider business model.

The PRA’s recent supervisory statement, Solvency II: Prudent Person Principle (‘PPP’), aims to directly addresses investment risk management and clarify regulatory expectations around prudent investment. In this blog we unwrap the statement, and analyse how strengthened regulatory requirements can assist insurers in driving profitability.

Background

Market volatility was always predicted in 2020. Alongside long-term trends like low interest rates, an escalating trade war between the US and China, and the continued uncertainty of Brexit negotiations, US presidential election years generally see a “volatility kink” as investors brace for increased macro-uncertainty. Whilst most markets have rallied sharply from their virus lows, the addition of a “once in a generation” risk event like the COVID-19 global pandemic added additional volatility and uncertainty to the investment landscape.

For insurers, the PRA’s publication of SS1/20 in May 2020 could not come at a more appropriate time. The PPP is the leading regulatory principle governing insurers’ investment strategies; requiring insurers to demonstrate that investment decisions align with the qualitative benchmark of a prudent person. Below, Deloitte’s team of insurance regulatory experts detail how many firms should see its requirements as helpful guidance, rather than a burden, as they navigate future market turbulence.

An overview of the PPP

The PPP is a key element of the Solvency II framework, however, until now, it has been relatively undefined and highly subjective. As a result, the PRA has observed inconsistencies in the way it is interpreted and applied by different firms. Therefore, for the first time, the regulator has addressed the PPP directly, detailing how it expects insurers to demonstrate they are being ‘prudent’, and addressing a number of broader concerns about the asset-side of insurers’ balance sheets, which have fundamentally changed the solvency and liquidity risk drivers of firms. SS1/20 identifies seven explicit areas it expects Boards and Senior Managers to consider in meeting the PRA’s benchmark of a ‘prudent person’.

What this means for the industry

 Below, we summarise the supervisory statement and provide our assessment of what this means for insurers.

Across the industry, as lower fixed income yields and volatile equity markets have driven firms up the yield curve, insurers have already begun the process of reviewing the appropriateness of investment strategies, processes and risk appetites. The PRA’s supervisory statement is therefore extremely timely, and firms can expect to be challenged by supervisors using these newly articulated expectations as they respond to continued market volatility driven by both COVID-19, and the upcoming US presidential election.

As the investment landscape evolves, insurers must continue to develop their investment risk management frameworks and ensure they clearly articulate and monitor their management of risk. Given the extent of underwriting losses the industry is predicted to suffer as a result of COVID-19, it is more important than ever that prudent investing continues to represent a reliable source of income to support insurers’ underwriting activities. As a result, most insurers need to afford increasing strategic importance to the asset side of their balance sheets, giving it a more prominent role in their business plans and risk management frameworks, in particular by defining how they anticipate it should contribute to earnings.

You can find out more about how Deloitte can strengthen your investment risk management framework by contacting any of the authors of this blog.