This blog was published on 04 April 2022.
Who this blog is for:
Board members and senior executives working across the EU and UK insurance industries, in particular those in finance, operations, risk and strategy teams.
At a glance:
- The European Commission’s recent proposal on an EU-wide insurance recovery and resolution framework, whilst not without controversies, gives insurers a clear idea of the direction of travel of future reforms in the EU. This appears almost identical to those that European banks have experienced in the last decade.
- In the UK, the picture is less clear, but we expect more clarity on future reforms in 2022. In particular, the PRA is planning to do more work on pre-emptive planning for dealing with firms in financial distress, while HMT is planning to introduce a specific resolution regime for insurers.
- International insurance groups with operations in both the UK and the EU should spend time understanding the scope and nature of proposed and potential reforms, in particular exploring the implications of potential differences between the two frameworks.
Reading time: 7 minutes
In the first of our three-part blog series, we established that 2022 will mark a real turning point for insurance recovery and resolution, with a number of recent important regulatory developments launched or about to be launched.
Now, we turn our focus to the direction of travel of reforms in both the EU and the UK. Most importantly, all of these appear to be moving in the same direction as those we have seen on the banking side. This gives us an important starting point in terms of determining what insurers can do now to anticipate regulatory change and get ahead of the curve (this is the focus of our third and last blog).
A banking-style resolution framework in the EU
The EU’s proposed framework, which follows EIOPA’s previous advice in its consultation and Opinion on the Review of Solvency II, is akin to a fully-fledged banking-style recovery and resolution framework. Aiming to harmonise the rules and processes for the recovery and resolution of insurers, the proposal requires EU Member States to set up insurance resolution authorities equipped with enhanced resolution tools and powers that are triggered by a set of common parameters. The resolution authorities are required to prepare resolution plans setting out the resolution actions, with 70% of undertakings in each Member State (based on gross written premiums for general insurers, and gross technical provisions for life insurers) to be subject to potentially onerous resolution planning requirements and resolvability capabilities, with low risk undertakings excluded on an individual basis. The new rules would also require the vast majority of insurance groups (at least 80% of each Member State’s market) to draw up and submit pre-emptive recovery plans, which will be assessed by the relevant supervisory authority.
The proposed framework will not come into force any time soon. The recovery and resolution proposals are controversial, with a number of areas to watch in forthcoming negotiations (see below). After that, once it does come into force, it will be a further 18 months before it is transposed and applies for practical purposes in individual Member States. This does not mean, however, that insurers should do nothing in the meantime. In fact, lessons from the banking side teach us that starting preparations early is necessary given the breadth of reforms and the complexity of issues that may arise as a result. In particular, banks have faced challenges around Valuations in Resolution (ViR) – insurers should explore to what extent they may face similar challenges when revaluing their balance sheets in resolution. Similarly, banks have also found it time-consuming and expensive to implement the Operational Continuity in Resolution (OCIR) requirements – as these may well be applicable to insurers in the future, insurers should bear them in mind as they implement the EU’s new Digital Operational Resilience Act (DORA).
Given the significance of the various elements of the proposed framework, EU insurance groups which already have recovery and resolution plans should revisit them and perform a gap analysis to see where they have to build capacity ahead of implementation. Some small- to medium sized insurers will have to produce their plans from scratch. Importantly, UK‑based insurers that have operations or parents in the EU should also assess to what extent these new rules may affect them, as the EU’s incoming regulations also apply on a group basis. Any early planning and strategy setting should also consider the potential impact of concurrent changes to the Solvency II framework overall.
On top of the EU-wide package, there have also been some national developments in individual EU Member States. The Dutch National Bank (DNB) was among the first countries in Europe to introduce a national insurance recovery and resolution framework already in 2019, while the Central Bank of Ireland (CBI) has also been proactive in introducing new requirements over the last year, both jurisdictions taking action ahead of the anticipated EU-wide regime. The fundamentals of the finalised Irish recovery planning framework, and proposed resolution framework, closely align with those on the banking side and, more likely than not, those of the future EU regime. In-scope firms in Ireland are required to draft and finalise (or update existing) recovery plans by March 2022 prior to submission to the CBI. We expect more clarity on the CBI’s proposed resolution framework in the coming year, with the consultation having closed in November 2021. Towards the end of 2021, the French prudential regulator (the ACPR) also released a framework outlining various resolution tools available for insurers, building on its existing insurance recovery and resolution regime.
Areas to watch
As noted above, aspects of the EU’s proposal are controversial; in particular, it has raised a number of questions around policyholder protection.
Some industry groups are concerned that the proposal introduces write-down or conversion tools that “convert to equity or reduce the principal amount of claims, including insurance claims”. This means that, in effect, policyholders would bear some of the cost in extreme situations.
This is exacerbated by the fact that, contrary to EIOPA’s recommendation, the EU’s proposal does not introduce a harmonised framework for insurance guarantee schemes across the EU “given the economic uncertainties created by the COVID-19 pandemic, as well as the need to focus on economic recovery”. While the European Commission has committed to reassess the appropriateness and timing of harmonisation in the future, EIOPA “deeply regrets” that this has not been considered in the Commission’s current proposal. EIOPA stresses that “as a result of the current fragmentation [in the field of Insurance Guarantee Schemes], policyholders receive different levels of protection in the event of [a failure], depending on the country from where the insurance policy originates”.
As the Commission’s legislative proposal is negotiated throughout 2022, the relationship between the resolution and policyholder protection regimes will be central to the debate, particularly as the harmonisation of deposit protection in the EU proved key in establishing a resolution framework for the banking sector.
The UK: what we know, and what we don’t know
In the UK, orderly exit is currently undertaken through solvent or insolvent run-off; a regime that has operated successfully for many years. In the words of Sam Woods, the PRA has over the past eight years facilitated the orderly and solvent exits of 45 insurers – the fact that “these firms (…) exiting has gone largely under the radar and without impacting financial stability is a sign of success, and of a healthy functioning market”. Over the next year and beyond, we expect the PRA to build on this and do more work in relation to pre-emptive planning for dealing with firms in financial distress, without necessarily having to rely on formal resolution powers, while separately, HMT is planning to introduce a resolution regime for insurers.
Sam Woods explained in his speech that the PRA “intends to do more in the coming years to increase [its] 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 particular, the PRA will “develop its approach to wind-down and run-off planning”, “building this in a proportionate way into BAU supervisory activity and tools” (using skilled person reports where needed) and look at whether there is “scope to reform any aspects of the protection framework of the Financial Services Compensation Scheme (FSCS)”.
Meanwhile, HMT is planning to introduce a specific resolution regime for insurers. While we don’t know exactly what it will look like, we do expect it to be aligned with internationally agreed standards and best practice, such as the FSB’s Key Attributes. HMT is currently consulting on targeted amendments to the UK’s insurance insolvency arrangements, with a proposal to enhance the court’s existing power to order a reduction or write-down of the value of an insurer’s contracts. In essence, this would provide for a banking-style write-down resolution tool, similar to what the EU has proposed. But, unlike in the EU, the UK’s proposal also includes a new provision to change the operation of the FSCS in the event of any such write-down to ensure protected policyholders are not financially worse off. This demonstrates that while the UK is looking at similar reforms, there will probably be nuances as to how they will be applied in the UK.
We expect more clarity in terms of UK recovery and resolution reforms in 2022. UK insurers should continue to monitor developments and engage with consultations as they are published. Insurers should also revisit existing regulatory guidance and initiatives where there is potential crossover in terms of recovery and resolution planning – for example, UK insurers could review their recovery plans in the context of the PRA’s existing regulatory considerations around liquidity, operational resilience and third party risk management. International insurance groups with operations in both the UK and the EU should take time to understand the implications of any potential nuances or divergence between these two recovery and resolution frameworks.
For more details, please read our other blogs in this series: