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:

  • As regulators work to finalise their recovery and resolution policies and frameworks in 2022, now is the time for insurers to revisit lessons learnt from the banking experience and take “no-regrets” actions that will place them ahead of the curve.
  • These include for example incorporating recovery and resolution considerations into work currently being done to meet new operational resilience requirements and updating recovery plans with results from stress and scenario testing of emerging perils.
  • The large number of regulatory initiatives underway in the EU/UK insurance sector, including work on climate change, operational resilience and cyber, as well as reforms to the capital frameworks, also make it imperative that insurers plan ahead and consider the concurrent reforms in the round. This will not only ensure consistency across the various change programmes, but also scope for efficiency gains.

Reading time: 7 minutes


Introduction

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. In the second blog, we turned our focus to the direction of travel of reforms in both the EU and the UK, concluding that these appear to be very similar to those we have seen on the banking side.

In this third and last blog, we outline what we think are some of the most important lessons learnt from banks’ experience of recovery and resolution reform in the last decade, and in that context, what practical steps insurers can take now to get ahead of the curve.


Lessons learnt from the banking side

Insurers can learn several lessons from banks’ experience of implementing the EU-wide Banking Recovery and Resolution Directive (BRRD). Four aspects of the BRRD that have proved particularly onerous are: valuations in resolution; requirements around operational continuity in resolution (OCIR); banks’ ability to demonstrate recovery capability in an extreme scenario; and making their legal entity structures compatible with resolution. Insurers which invest time early on to understand these issues, and the extent they apply to them, will be at an advantage compared to peers as they will be able to identify and address challenges that are likely to arise later in the process.


OCIR: the OCIR requirements, which are aimed at minimising operational disruption in the event of a resolution scenario and involve banks cataloguing all supplier agreements for “critical services”, have proved time-consuming and expensive for banks. While there are synergies in terms of work being done in relation to the new operational resilience frameworks in the EU and the UK, the effort involved should not be underestimated, especially in a post-COVID operational environment. As UK insurers embark on their three-year implementation period of the PRA’s new operational resilience framework, they should bear potential OCIR requirements, which might even extend to the insurance sector, in mind. This could include, for example, expanding the work they do to identify their “important business services” and related impact tolerances to include “critical services” and “core business lines” in order to demonstrate effective operational arrangements to facilitate recovery and resolution. In the EU, meanwhile, insurers that will be subject to the EU’s Digital Operational Resilience Act should assess whether their recovery strategies and plans respond appropriately to the expanded ICT rules.


Valuations in resolution (ViR): the ViR requirements for insurers under the proposed EU framework are very similar to those for banks under the BRRD, which require three separate resolution valuations to be performed. These include valuations to 1) support the authorities’ decision on resolution; 2) to determine resolution action; and 3) to confirm that no creditor is worse off compared to an insolvency. Global banks have had to invest heavily in enhancing and developing data and modelling capabilities to produce the required valuations; a time-consuming, expensive and difficult process for complex bank balance sheets.

While in some respects insurers generally have more straight-forward balance sheets than banks, they should still explore what potential challenges could arise when revaluing their balance sheets in resolution. Some insurers, for example those which have moved into more illiquid investments in search for yield, may find it more challenging than others to produce a timely and accurate valuation. On the liability side, insurers will need to assess the availability of data. This includes for example in relation to producing updated estimates of Incurred But Not Reported (IBNR) losses, and updating assumptions to recognise any changes to, amongst other factors, persistency behaviour, which will need to be readily accessible and delivered within shorter time frames and outside of normal reporting cycles, during a time of extreme stress.

An added complexity here may be the implementation of IFRS17 in January 2023, which fundamentally changes the accounting for insurance contracts. This, coupled with other major regulatory change programmes including Solvency II reform, will likely put a strain on insurers’ resources, in particular on actuarial and finance teams, which are expected to invest time developing ViR capabilities.


Recovery planning: while banks have found it relatively straightforward to develop escalation and governance processes to identify recovery actions in extreme scenarios, they have faced challenges in terms of establishing and demonstrating operational capability to recover. Here, good practices that insurers can learn from include developing practical tools to support recovery, including playbooks and template documents, regular engagement with senior management in simulation exercises and integration of recovery measures within ERM frameworks. Insurers should also re-visit existing regulatory guidance and initiatives where there is potential crossover in terms of recovery planning. For example, UK insurers could usefully review their recovery plans in the context of the PRA’s existing liquidity contingency planning requirements as well as third party risk management, including e.g. firm or group-wide concentration risk.

Another important consideration for insurers here will be the changing nature of extreme scenarios, given an evolving risk landscape and increasing regulatory focus on both man-made and natural perils such as climate, cyber and pandemic risks. As insurers enhance their exposure management practices and stress and scenario testing for these emerging risks, they should use these insights to update their recovery plans and associated management actions. In particular, the COVID-19 experience has put the issue of unintended or “silent” exposures in the spotlight. Here, insurers should actively assess whether e.g. current reinsurance arrangements cover all assumed perils or events in an extreme scenario to enable timely recovery. In this context, life insurers may also want to assess to what extent they are protected against mass lapse risk in crisis situations should confidence in the insurer’s solvency be damaged.


Legal entity restructuring: lastly, insurers should consider whether their legal entity structure is compatible with future recovery and resolution planning requirements. Insurers with particularly complex legal entity structures will be perceived by regulators as being harder to resolve. This could include for example having multiple layers of intermediate holding companies that could compromise access to fresh capital. Equally, having numerous intra-group service companies will require greater clarity on service-level agreements between entities as well as funding arrangements that may be needed to support an insurer’s critical functions and core business lines. If insurers are undertaking any legal entity restructuring in the near term, they should look for opportunities to simplify their structures while doing so.


For more details, please read our other blogs in this series:

Insurance recovery and resolution Part I: A moment of truth

Insurance recovery and resolution Part II: Similar direction of travel in the EU and the UK