PA Draft Standard and Guidance Note Liquidity risk management for insurers

Insurers are accustomed to modeling long-term cash flows, but managing short-term cash flow obligations during market stress remains challenging. The recent UK pension fund crisis illustrates how liquidity stress can quickly escalate, leaving little time for unplanned remedies.

The International Association of Insurance Supervisors (IAIS) monitors liquidity risk through its Global Monitoring Exercise (GME) and has developed tools to address gaps in insurers' practices. Locally, the Prudential Authority (PA) has released an updated draft Prudential Standard FSI 6 and draft Guidance Notice for comment. These documents incorporate IAIS principles and propose an Insurance Liquidity Ratio (ILR) to better manage liquidity risk.

A key theme from the IAIS and PA is the need to distinguish between solvency and liquidity risk. Insufficient liquidity can lead to failure even in solvent insurers. While tools for monitoring solvency are well-established, they may not adequately address liquidity risk. The proposed standards emphasize holding sufficient liquid assets and contingent funding sources, especially in stress scenarios that differ from those related to solvency.

This paper provides an overview of the proposed changes to FSI 6, detailing governance, risk management, and reporting requirements.