Insurance Recovery and Resolution in the UK: the three Rs

At a glance:

• HM Treasury has now published its long-awaited consultation proposing the introduction of an insurance-specific recovery and resolution regime (IRR) in the UK. The proposed framework tasks the Bank of England as the Resolution Authority (RA) with carrying out resolution planning and resolvability assessments and equips it with new insurance recovery and resolution powers.
• While the scope of the proposed regime is broad in that the RA’s new powers can be applied to the vast majority of UK insurers, the most onerous requirements, including RA-led resolution planning and resolvability assessments, would only apply to those insurers the RA deems “systemically important” - these firms are likely to be similar to those identified by the International Association of Insurance Supervisors (IAIS) as Internationally Active Insurance Groups (IAIGs).
• Recognising the role that the PRA already plays in conducting recovery and ease of exit planning, HMT’s proposals leave this work within the PRA’s remit. We expect more details around this to be announced over the course of 2023. Given this work touches the whole UK insurance market, not only the largest and most complex firms, all insurers should monitor developments in this area and engage with the PRA when the time comes.

Relevant to: Board members and senior executives working across UK insurance markets, in particular those in finance, operations, risk and strategy teams.

Context

In January, HMT published an extensive consultation on introducing an IRR. While this is a significant development, the most onerous requirements of the new regime will only apply to a small number of insurers judged to be “systemically important”.

This blog is an update to our three-part blog series on insurance recovery and resolution published last year. The first outlined why 2022 was a turning point in insurance recovery and resolution across multiple jurisdictions. The second explored the direction of travel for reforms in both the EU and UK, and the third offered some lessons insurers can learn from banks’ experience of implementing recovery and resolution planning.

In this fourth blog, we contextualise and examine the potential implications of HMT’s proposals for insurers – focusing on the “three Rs” of the new regime: Resolution, Resolvability and Recovery. We start by explaining what the current regime is, and why HMT is proposing a new one.

What is the current regime, and why is HMT proposing a new one?

Today, insurers usually exit the market by way of solvent or insolvent run-off, through the PRA’s longstanding run-off regime. This process begins either on a voluntary or involuntary basis (when the PRA removes a firm’s legal permissions to underwrite new business). The firm must then submit a run-off plan to the PRA (including a scheme of operations and an explanation of how all liabilities will be met in full as they fall due). The run-off firm is then supervised according to the PRA’s expectations of firms in run-off, with a particular focus on ensuring the firm has sufficient capital to continue to meet its policyholder obligations as they fall due throughout the run-off. The PRA has facilitated the orderly and solvent exit of 45 insurers over the past eight years in this manner, and has argued that the fact that these exits have taken place without impairing financial stability is a sign of “success” and “a healthy functioning market”.

If the current process is effective, why is HMT proposing an insurance-specific recovery and resolution framework? HMT states in its consultation that the introduction of an IRR will “ensure the UK remains at the forefront of international standards”. International best practice, as set out by the FSB[1], envisages that the largest insurers will be subject to specific recovery and resolution rules and guidance. The EU and other jurisdictions have announced their own insurance-specific regimes over the last two years, increasing the pressure for the UK to follow suit. It is also possible that recent market events, such as last year’s Liability-Driven Investment (LDI) spiral, could have strengthened the case for giving the UK authorities more powers to deal with the risk of a “fast burn” collapse of an insurer, particularly where “recovery or run-off may not be appropriate to secure the UK’s financial stability”.

R1: Resolution

There are two elements to Resolution in HMT’s consultation: RA-led resolution planning; and new powers in the shape of stabilisation options and additional resolution tools for the RA.

Resolution planning

RA-led resolution planning, and resolvability assessments (see next section), are the most significant and potentially onerous part of HMT’s proposal, although these two requirements will only be relevant to “systemically important firms”. These are likely to be similar to the list of IAIGs defined by the IAIS but could include a few others, such as those that are domestically systemically important. Importantly, this means that only a few UK insurers will be subject to the full scope of resolution planning requirements and resolvability assessments. The RA-led resolution plans (which would be updated at least annually, provided circumstances do not materially change) would set out the proposed resolution strategy for a firm and an operational plan for its implementation. HMT notes that relevant firms may need to carry out some additional work to support the creation of these by the RA.

RA’s new powers

The RA is also set to receive a number of new powers to facilitate the orderly resolution of insurers. These could be applied to almost all insurers in a stress situation. HMT’s rationale for drawing the regime so broadly is that “[w]hile larger institutions may traditionally be expected to pose greater systemic risk, this may not always be the case for insurers”, and in some cases “an insurer’s failure may have systemic consequences if it provides insurance products with no readily available substitutes, or where there are multiple concurrent insurer failures”. In effect, the regime would cover all UK-authorised insurers (and relevant holding companies and entities within insurance groups), save for Lloyd’s of London, non-Directive firms and friendly societies.

• The new powers granted to the RA could be applied once a number of resolution conditions (RCs) are met. Once these RCs are triggered, a third-party has valued the firm’s assets and liabilities and the firm is placed into resolution, the firm will be unable to write new business. This valuation assessment will then determine the RA’s approach in applying one or more of the following “stabilisation options”, which provide the RA with additional means to resolve a failing insurer outside of the well-established run-off process. Although similar to the banking recovery and resolution regime, the new IRR is, however, tailored to the insurance industry in several ways. Under the bank regime, some banks are required to hold a “Minimum Requirement for Own Funds and Eligible Liabilities” (MREL) to ensure sufficient resources to re-capitalise the bank in resolution. HMT states that introducing an additional MREL-like requirement “is not appropriate in the proposed IRR”. Instead, HMT is proposing that unsecured creditors’ claims, tapped via use of the bail-in tool, will re-capitalise firms.

Resolution Conditions and Stabilisation Options

R2: Resolvability

As mentioned above, HMT also proposes that the RA undertakes regular resolvability assessments for systemically important insurers. Similar to the resolution planning requirements for banks, these are only applicable to the largest insurers. HMT wants to avoid duplication of effort and expects much of the content for the RA’s resolvability assessment to be available from existing or planned PRA work.

The RA-led resolvability assessments would first involve identification of any impediments within the insurer to implementing the stabilisation options. HMT then proposes to empower the RA to be able to compel the insurer to change its business model to remove these impediments. According to HMT, such impediments may arise from corporate structure, contractual features (e.g. reinsurance and intra-group arrangements), outsourcing, operational processes, and IT systems. The new regime also includes provisions to enable the RA to take enforcement action where firms do not comply.

R3: Recovery

The IRR consultation does not introduce RA-led recovery planning. Instead, this is left to the PRA. HMT refers to the PRA’s current activity as “recovery and exit planning”, and the RA’s activity as resolution planning. We understand that the PRA is planning to do more work to enhance recovery and exit planning for insurers. In particular, the PRA will look to develop its approach to wind-down and run-off planning, building this into BAU supervisory activity and tools.

Firms should wait for further details from the PRA about its approach to insurance exit and recovery planning. In our view, any further guidance or expectations from the PRA would involve a wider population of firms compared to the RA-led resolvability assessments. As such, it is important all firms monitor and engage with the PRA on exit and recovery planning in future.

Implications for firms and next steps

If instituted as proposed, these reforms would ensure the UK is aligned with other key jurisdictions such as the EU on IRR and compliant with international standards as set out by the FSB and the IAIS. The reforms would, in effect, provide the BoE with resolution tools that could complement the existing run-off regime, to be used in extreme circumstances.

Altogether, the most onerous requirements under the new IRR (resolution planning and resolvability assessments) would only apply to larger insurers whom will have already developed recovery and resolution plans. As such, the implications for the rest of the market are limited at this time.

However, the PRA have stated they wish to ensure all “insurers can exit the market without causing disruption to policyholders or excessive calls on the FSCS” and have pointed to a consultation paper slated for later this year that will detail a new approach to exit planning. The PRA recommends that firms engage with this process – the IRR “is an important priority for the PRA”, and the recent events linked to Silicon Valley Bank and Credit Suisse will only have increased its salience in policymakers’ plans.

We do not expect the new regime to be finalised for some time, with HMT’s consultation closing on 20 April 2023. However, it will be important for all insurers, not just those subject to resolution planning and resolvability assessments, to stay in the loop of any developments, particularly around the PRA’s work on the ease of exit.

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Reference:

¹ in its Key Attributes and the IAIS’ Common Framework for the Supervision of Internationally Active Insurance Groups (IAIGs) - ComFrame