## _cr16158 ## Source details **Canonical URL:** [_cr16158](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16158.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16158.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16158.pdf.json) --- ### Executive summary — Market overview and key statistics - The U.K. has one of the deepest, most developed insurance markets in the world. - The U.K.’s life insurance premium accounts for almost 9 percent of the world’s life insurance premium and 5.5 percent of the world nonlife premium. - Insurance penetration is 50 percent higher than in the European Union (EU) or other advanced markets. - Expenditure per capita in insurance amounts to USD 5,429 as compared with USD 3,815 in the advanced markets. - The U.K. insurance industry is the third largest in the world and the largest in Europe with around 600 insurers operating in the U.K. - The U.K. is the home supervisor of two of the nine designated Global Systemically Important Insurers (G-SII). ### Supervisory framework and approach - Supervision is shared between the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) under robust cooperation and coordination arrangements. - The PRA and the FCA supervisory approaches are forward-looking and risk-based. - Supervision focuses on companies that present the highest risk to consumer outcomes or the integrity of the U.K. financial system; the smallest PRA-regulated firms and most FCA-regulated firms are supervised on a reactive approach, based on thematic methodologies and outlier analyses. - The forward-looking approach is supported by comprehensive stress testing requirements that follow international best practices. - PRA supervisory design: - Risk Assessment Framework captures (i) potential impact of firm stress/failure on the financial system; (ii) macroeconomic and business risk context; (iii) mitigating facts; (iv) resolvability. - Firms divided into five categories of potential impact; Category 1 firms receive the most intensive supervision. - Proactive Intervention Framework (PIF) assigns stages triggering supervisory actions and continuous reporting up to board level. - FCA supervisory design: - Forward-looking, judgment-based approach focused on business models, culture, causes of problems, and accountable individuals. - Sectoral focus under a new supervisory model; development of House Views expected to align cross-FCA sectoral risk assessment (first iteration by Q2 2016). ### Data, enforcement, and market conduct challenges - Improved data availability and an enhanced risk appetite statement are required. - Sufficient data provided with the necessary frequency and in the required level of granularity are not always available. - The FCA’s data needs will not be met by the Solvency II reporting regime; the FCA is working on addressing the gaps. - Some firms use the U.K. “brand” to operate mainly offshore (e.g., exclusive reinsurers’ branches and brokers) but are not captured under the current supervisory risk appetite because they are not considered large in U.K. market terms; these firms could still represent reputational risk for the U.K. insurance market and the supervisors. - The FCA’s thematic work is commendable but policy revisions can be slow; enforcement action can take up to a few years. The FCA should accelerate timetables while ensuring due process and fair treatment. - Disruptive technological change in digital sales increases outreach but creates new conduct supervision challenges (e.g., comparison price web pages disaggregating benefits). ### Group supervision and cross-border cooperation - Progress made: Memoranda of Understanding (MoUs) and formation/functioning of colleges through EIOPA guidelines; PRA-led colleges largely complying with EIOPA requirements. - Areas for improvement beyond direct U.K. authority: - PRA direct powers over holding companies apply only to qualifying parent undertakings; these powers should be exercised with regard to relationships of U.K. entities with others outside the U.K., including measures to protect U.K. policyholders. - For insurers with significant business outside the EEA, similar arrangements to the EIOPA requirements for colleges in the EEA should be introduced for non-EEA jurisdictions—this requires cooperation of international supervisors. - Need clear responsibilities around joint decisions on group internal model applications and group model changes; ensure transferability of surplus capital across jurisdictions; establish appropriate cooperation, information-sharing and engagement within colleges, including consistent guarantee schemes and cross-border resolution powers. - Conduct risk has had little mention on colleges’ agendas; the U.K. is well-placed to promote further harmonisation. ### Solvency II implementation, risk sensitivity, and potential arbitrage - Solvency II came into force on January 1, 2016; transposition into national law carried out without significant exceptions. - PRA focus: implementation, internal model approvals, and supervisory statements aligned with EIOPA guidelines. - Scope and exemptions: - About 20 percent of insurers are out of scope of Solvency II (majority mutuals; includes approximately 60 partnership pension friendly societies, 24 other friendly societies, and about 20 other small (re)insurers). - Third-country pure reinsurance branches are out of scope; PRA expects Article 174 compliance and EIOPA Branch Guidelines. - Risks: - Maximum harmonization, complexity and onerous requirements could motivate use of freedom of service to seek jurisdictions with lighter Pillar Two and Three supervision—monitoring and prevention at EU level important. - One-year SCR horizon may be insufficient for long-tail latent liabilities in the London market. - Pillar One specifics: - Standard Formula (SF) has limitations; where SF inappropriate, firms may need internal models or capital add-ons. - Internal model approvals: initially ~120 intended applicants; 19 internal models approved to date. - Recommendation: PRA should maintain strong focus on internal model supervision and develop an analytical toolkit to monitor model drift. ### Matching Adjustment (MA) and Volatility Adjustment (VA) - MA: - Provides relief for matching long-term liabilities with assets; over 20 U.K. life insurers have applied or indicated intent to apply for MA approval. - Estimated benefit: substantial increase in own funds for U.K. life insurance market; precise impact contingent on portfolio decisions and to be disclosed in annual reports. - VA: - Expected to have a much smaller impact than MA due to lower calibration and uptake. - Key calibration differences: VA uses 65 percent of risk-adjusted spread (vs 100 percent for MA) and a currency-specific reference portfolio excluding MA assets. - PRA has not permitted firms to assume change in the VA under stressed conditions; MA can increase reducing SCR. - Supervisory concern: - VA simplifications could distort market-consistent capital determination and, if applied indiscriminately, could allow insurers to operate beyond recovery point. - Recommendation: PRA should introduce well-defined actions to monitor impact of MA and VA on insurers’ solvency positions. ### Financial stability, stress testing, and vulnerabilities - Interest rate scenarios: - A sharp increase in interest rates would generally benefit insurers’ business models. - If accompanied by rising default risk, substantial increases in corporate bond credit spreads could adversely affect insurers—annuity writers particularly exposed. - Life insurers generally well cash-flow matched and relatively insensitive to upward shifts of the risk-free yield curve; exception: annuities with large corporate bond portfolios. - Nonlife firms generally less vulnerable to interest rate risk. - Stress test outcomes: - In the 2014 EIOPA stress test, U.K. insurers were most impacted by mass lapse, longevity, and provision deficiency stresses. - Low-yield test results for U.K.-regulated solo insurance entities were relatively positive, reflecting sound asset-liability matching. - Vulnerabilities requiring monitoring: - Diminishing attractiveness of some life products prompting new business search and potential contagion/reputational effects. - Growing longevity swaps activity and annuity block transactions require close monitoring for counterparty risk—particularly when ultimate risk carrier is in a jurisdiction with light regulatory requirements or where insufficient risk transfer occurred. - Profitability in nonlife and reinsurance has been artificially inflated by a below-average level of natural hazard losses over the last five years; further softening in terms could increase future losses, leading to reserve deterioration and capital impacts. - Geographic diversification protects against a U.K. downturn but increases vulnerability to global shocks. ### Supervisory measures, stress testing enhancements, and policy suggestions - Steps authorities should consider to mitigate Solvency II-related risks: - Multi-year stress testing to allow PRA to take preventive measures to offset effects of no longer having matching and volatility adjustments. - Close monitoring of Solvency II transitional measures and development of a framework of actions for non-compliance by firms. - Additional consideration to address long-tail nature of certain lines for firms using internal models and standard formula, e.g., through PRA stress testing exercises. - Work with EIOPA and member states to propose revision of risk margin definition to incorporate prevailing economic conditions. - Use macroprudential tools to manage macroeconomic risks instead of relying on Solvency II adjustment measures for cyclical conditions. ### Systemic risk supervision and recovery/resolution - U.K. supervision of systemic risk in insurance is strong. - G-SIIs (two in U.K.) required to monitor group-wide liquidity continuously and provide monthly reports; G-SIIs have developed SRMP and RCP that PRA is reviewing. - Resolution plans for the two U.K. G-SIIs are under development; PRA timetable for BCR and HLA follows FSB timetable (confidential reporting as part of IAIS field testing 2015–2018; BCR and HLA applied to G-SIIs designated in November 2017 and future years—January 2019 implementation dependency noted). - PRA resolution powers strengthened but remain indirect and need court approval for restructuring; the ability to write down policyholder liabilities is exercised through the courts. - Recommendations: - U.K. authorities should work with international partners to develop an integrated regime of resolution powers for insurance, with due regard to the insurance business model. - U.K., with EU authorities, should consider whether current cross-border failure arrangements ensure adequate coordination and flexibility between resolution tools and authorities. - Delegated supervision to the home supervisor requires increased cooperation, information sharing, and engagement within colleges, including consistent guarantee schemes and cross-border resolution powers. ### Recommendations (summarized, including timing and authority as provided) - PRA to consider introducing complex business scenarios in internal model approval process to cover long-term latent losses; Timing: Immediately; Authority: PRA. - PRA to specify supervisory measures for insurers meeting technical provision transitional milestones in case of delay; Timing: Immediately; Authority: PRA. - Authorities to introduce supervisory tools for entities with strong international focus independent of their U.K. size; Timing: Immediately; Authority: FCA. - Consideration to raise with EU Commission the merits of a non-objection rather than approval of the model; Timing: Immediately; Authority: U.K. through the EU. - PRA to maintain strong focus on internal model supervision and develop an analytical toolkit to monitor model drift; Timing: Immediately; Authority: PRA. - Longevity swaps activity and annuity block transactions need monitoring for counterparty risk; Timing: Immediately; Authority: PRA. - Authorities to develop tools to exploit data to enhance supervision on thematic and outlier approach; Timing: Near Term; Authority: PRA, FCA. - Authorities to maintain oversight and, if required, take action regarding relationships of U.K. firms with others beyond the U.K.; Timing: Near Term; Authority: PRA, FCA. - For insurers with significant business outside the EEA, introduce similar agreements to EIOPA colleges for non-EEA jurisdictions; Timing: Near Term; Authority: PRA, FCA. - U.K. authorities to work with international partners to develop an integrated regime of resolution powers for insurance; Timing: Near Term; Authority: U.K. with partners. - PRA stress testing strategy should consider: - Multi-year stress testing to offset loss of matching and volatility adjustments. - Stress testing using the matching adjustment under spreads widening shocks in persistent low interest rate environment beyond one-year horizon. - Stress testing to assess resilience to overseas economic shocks. - Timing: Near Term; Authority: PRA. - PRA to work with EIOPA and European bodies to consider macroprudential tools for cyclical issues in Solvency II and revise risk margin definition to incorporate economic conditions; Timing: Near term; Authority: PRA. ### Market structure, financials, and key statistics - Current annual premium amounts to GBP 233 billion (GBP 140 billion life and GBP 83 billion nonlife). - Total assets held by the sector: GBP 2,161 trillion, of which GBP 1,882 billion correspond to life insurance and GBP 279 billion to nonlife business. - The estimated occupational pension fund sector is GBP 1.4 trillion. - The top 10 individual U.K. authorized insurers account for 60 percent of the life market but only 37 percent of the nonlife market. - Life gross premiums by year (GBP millions): 2010: 144,703; 2011: 140,895; 2012: 161,635; 2013: 149,371; 2014: 139,785. - Life total assets by year (GBP millions): 2010: 1,716,853; 2011: 1,635,956; 2012: 1,714,351; 2013: 1,784,213; 2014: 1,882,131. - Nonlife gross premiums by year (GBP millions): 2010: 76,393; 2011: 78,220; 2012: 81,287; 2013: 84,561; 2014: 82,951. - Nonlife total assets by year (GBP millions): 2010: 252,548; 2011: 280,343; 2012: 286,169; 2013: 281,332; 2014: 278,874. - Life insurance — top firms Total Assets and % of industry (GBP millions and percent): - Legal & General (Pensions Management) 260,944.76 — 16.0 - Standard Life Assurance 137,119.82 — 8.4 - Prudential 127,149.63 — 7.8 - BlackRock Life 102,411.11 — 6.3 - Aviva Life & Pensions UK 98,848.54 — 6.0 - Royal London Mutual Insurance Society 62,191.79 — 3.8 - Friends Life 62,014.51 — 3.8 - Scottish Equitable 57,221.50 — 3.5 - Legal & General Assurance Society 46,203.29 — 2.8 - Managed Pension Funds 38,440.92 — 2.4 - Nonlife insurance — top individual firms Total Premiums and % of industry (GBP millions and percent): - AIG Europe 4,835.63 — 6.0 - Aviva Ins 4,708.35 — 5.9 - Royal&SA Ins 3,896.44 — 4.9 - AXA Ins UK 3,292.92 — 4.1 - UK Ins 3,099.01 — 3.9 - ACE European Grp 2,322.94 — 2.9 - BUPA Ins 2,217.13 — 2.8 - Allianz Ins 2,088.14 — 2.6 - Great Lakes UK 1,949.96 — 2.4 - QBE Ins Europe 1,400.07 — 1.7 ### Insurance product trends and investments - Life product trends: - Total gross premiums written (Life) 2011: 140,895.23; 2012: 161,634.58; 2013: 149,370.74; 2014: 139,785.2. - Unit-linked (Domestic risks) 2011: 105,387.1; 2012: 118,060.35; 2013: 110,701.33; 2014: 101,439.99. - Annuities (Domestic risks) 2011: 16,704.52; 2012: 24,163.3; 2013: 20,838.33; 2014: 22,473.76. - Main driver of life premium volatility: changes in occupational pensions now make up approximately 60 percent of the entire U.K. life business excluding unit link products (up from 50 percent in 2011). - Fewer participating and nonparticipating policies sold; premium reduction of 15 percent since 2011. - Nonlife product trends: - Total gross premiums written (Nonlife) 2011: 78,219.88; 2012: 81,287.18; 2013: 84,561.27; 2014: 82,951.3. - Property 2014: 20,145.49; Motor 2014: 12,594.93; Liabilities 2014: 13,665.11; Reinsurance 2014: 13,657.2. - Nonlife insurers view the U.K. as saturated and expect future growth mainly from overseas business. - Investments (2014): - Total investments in 2014: GBP 1.7 trillion or 92 percent of GDP. - 71 percent of investments correspond to assets that support unit linked business (up from 60 percent in 2010). - Of the 29 percent of other investments belonging to insurers, 72 percent is invested in bonds. - Percentage of investments in derivatives remains around one percent. - Life investments (GBP millions): 2010: 1,388,628; 2011: 1,383,219; 2012: 1,442,940; 2013: 1,501,008; 2014: 1,559,076. - Credit quality trends: - BBB rated sterling corporate bonds increased from 21 percent to 32 percent (2010 to 2014). - Life investments in BBB corporate bonds increased from 27 percent to 35 percent (2010 to 2014). - Longevity swaps and annuity block transactions grew from GBP 5.5 billion in 2010 to GBP 38.1 billion in 2014. *Source: Based on information provided by the authorities from PRA regulatory returns and the IMF staff report content.* ### EXECUTIVE SUMMARY ___________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### Market overview and key statistics - The U.K. has one of the deepest, most developed insurance markets in the world. - The U.K.’s life insurance premium accounts for almost 9 percent of the world’s life insurance premium and 5.5 percent of the world nonlife premium. - Insurance penetration is 50 percent higher than in the European Union (EU) or other advanced markets. - Expenditure per capita in insurance amounts to USD 5,429 as compared with USD 3,815 in the advanced markets. - The U.K. insurance industry is the third largest in the world and the largest in Europe with around 600 insurers operating in the U.K. - The U.K. is the home supervisor of two of the nine designated Global Systemically Important Insurers (G-SII). ### Supervisory framework and approach - Supervision is shared between the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) under robust cooperation and coordination arrangements. - The PRA and the FCA supervisory approaches are forward-looking and risk-based. - Supervision has a strong focus on companies that present the highest risk to the achievement of better outcomes for consumers or the integrity of the U.K. financial system. - The smallest PRA-regulated firms and most FCA-regulated firms are supervised on a reactive approach, based on thematic methodologies and outlier analyses. - The forward-looking supervisory approach is supported by comprehensive stress testing requirements that follow international best practices. ### Data, enforcement, and market conduct challenges - Improved data availability and an enhanced risk appetite statement are required. - Sufficient data provided with the necessary frequency and in the required level of granularity are not always available. - The FCA’s data needs will not be met by the Solvency II reporting regime; the FCA is working on addressing the gaps. - Some firms use the U.K. “brand” to operate mainly offshore (e.g., exclusive reinsurers’ branches and brokers) but are not captured under the current supervisory risk appetite because they are not considered large in U.K. market terms; these firms could still represent reputational risk for the U.K. insurance market and the supervisors. - The FCA has started commendable thematic work, but policy revisions can be slow; enforcement action can take up to a few years. The FCA should accelerate timetables while ensuring due process and fair treatment. - Disruptive technological change in the digital sales of insurance increases outreach but creates new challenges for market conduct supervision that have not yet been fully addressed. ### Group supervision and cross-border cooperation - Progress made in group supervision, including Memoranda of Understanding (MoUs) and the formation/functioning of colleges through EIOPA guidelines. - Room for improvement remains in areas beyond direct U.K. supervisory authority: - The direct PRA powers over holding companies apply only to qualifying parent undertakings; given complexity and size of groups, these powers should be exercised with regard to relationships of U.K. entities with others outside the U.K., including appropriate measures to protect U.K. policyholders. - For insurers with significant business outside the EEA, similar arrangements to the EIOPA requirements for colleges in the EEA should be introduced for non-EEA jurisdictions—this requires cooperation of international supervisory authorities. - Continued efforts needed to establish clear responsibilities around joint decisions over group internal model applications and group model changes; ensure transferability of surplus capital across jurisdictions; and, given delegated supervision to the home supervisor, establish appropriate cooperation, information-sharing and engagement within colleges of supervisors, including consistent guarantee schemes and consistent cross-border resolution powers. - At this early stage in Solvency II, conduct risk and its supervision have had little or no specific mention on colleges’ agendas; the U.K. is well-placed to promote further harmonisation on this facet. ### Solvency II implementation, risk sensitivity, and potential arbitrage - The PRA maintains a strong focus on implementation of the Solvency II Directive in the U.K. - Maximum harmonization implementation, complexity, and onerous requirements of Solvency II could theoretically motivate use of freedom of service in the EU to search for jurisdictions with lighter supervision on Pillars two and three; monitoring and acting to prevent such potential deterioration in cross-border supervision standards is important. - Supervision of the Solvency Capital Requirement (SCR) (including those from internal models) and of Own Risk and Solvency Assessments (ORSAs) are central to ensuring required resilience. - Specific Solvency II concerns: - The Volatility Adjustment (VA) involves a number of simplifications; applied indiscriminately, the VA has the potential to allow insurers to operate beyond the recovery point and to create systemic risk. - The Matching Adjustment provides a considerable benefit and requires close monitoring. - The one-year horizon of Solvency II may be potentially insufficient for some long-tail risks insured in the London market. ### Financial stability, stress testing, and vulnerabilities - A sharp increase in interest rates could have material immediate and secondary effects: - Overall, rising interest rates would benefit insurers’ business models. - If accompanied by rising default risk, substantial increases in credit spreads for corporate bonds could affect insurers adversely. - Life insurers are generally well cash-flow matched and use a market-consistent based valuation method; they are relatively insensitive to upward shifts to the risk-free yield curve—with the notable exception of annuities written by life firms that generally have large corporate bond portfolios. - Nonlife insurance firms are less vulnerable than life insurers, as their balance sheets are typically less exposed to interest rate risk. - In the 2014 EIOPA stress test, U.K. insurers were most significantly impacted by the mass lapse, longevity, and provision deficiency stresses. - Low-yield test results for U.K.-regulated solo insurance entities were relatively positive, reflecting prevalence of sound asset-liability matching practices. - The U.K. insurance sector has remained resilient amidst the hostile interest rate environment (for life) and intense competition (in nonlife): - Life insurers have largely maintained the rating of their investments with only a gradual, small shift to lower rated bonds from 2005 to Q3 2015. - Regulation led insurers to tighten asset-liability duration matching, lower guarantees offered, and move into unit-linked products where the policyholder carries the return risk. - Nonlife insurers have preferred to forfeit growth to revert underwriting losses by improving results in motor insurance to compensate for diminished investment returns. - Potential vulnerabilities requiring close monitoring: - Diminishing attractiveness of some life products may prompt search for new business; contagion or reputational impact on U.K. insurers is possible given the delicate situation of insurers in the EU. - Growing longevity swaps activity and annuity block transactions require close monitoring for counterparty risk—particularly when the ultimate risk carrier is located in a jurisdiction with light regulatory requirements or where there has been insufficient risk transfer. - Profitability in nonlife and reinsurance has been artificially inflated by a below-average level of losses due to natural hazards over the last five years; any further softening in terms and conditions could increase future losses, leading to reserve deterioration and impacts on capital. - Geographic diversification protects against a U.K. downturn but could make insurers vulnerable to global economic shocks that need to be monitored and stress tested. ### Supervisory measures, stress testing enhancements, and policy suggestions - Steps authorities should consider to mitigate Solvency II-related risks: - Multi-year stress testing as a tool to allow the PRA to take preventative measures to offset the effects of no longer having matching and volatility adjustments. - Close monitoring of the Solvency II transitional measures and development of a framework of actions that could be taken in case of non-compliance by firms. - Additional consideration to address the long-tail nature of certain lines of business for firms using an internal model as well as for those using the standard formula, for example, through the PRA’s stress testing exercises. - Working with EIOPA and other member states to propose revision of the risk margin definition to incorporate prevailing economic conditions. - Using macroprudential tools to manage macroeconomic risks instead of relying on adjustment measures in the Solvency II framework to address cyclical conditions. ### Systemic risk supervision and recovery/resolution - U.K. supervision of systemic risk in insurance is strong. - U.K. G-SIIs are required to monitor their group-wide liquidity position on a continuous basis and provide monthly reports. - G-SIIs have developed a Systemic Risk Management Plan (SRMP) and Recovery Plan (RCP) that the PRA is reviewing. - Resolution plans for the two U.K. G-SIIs are under development. - Market-wide stress tests have been carried out, including the 2014 EIOPA stress test and the 2015 PRA stress test for nonlife companies. - The Financial Policy Committee (FPC) is monitoring the systemic risk that insurers, as investors, could create through reporting and stress tests. ### Recommendations (Table 1: United Kingdom: Recommendations for the Insurance Sector) - The PRA should consider introducing into the internal model approval process, where appropriate, complex business scenarios that cover long-term latent losses—i.e., supplementing the one-year horizon with complementary analysis including explicit stress testing. - Timing: Immediately - Authority: PRA - In case of a delay, the PRA should specify the supervisory measures to be taken by an insurer in meeting the technical provision transitional milestones. - Timing: Immediately - Authority: PRA - The authorities should introduce supervisory tools that include supervisory scrutiny of entities with a strong international focus independent of their size in the U.K. - Timing: Immediately - Authority: FCA - Consideration should be given to raising, along with the EU Commission, the merits of a non-objection rather than approval of the model, in order for the supervisor to avoid taking excessive legal risk. - Timing: Immediately - Authority: U.K. through the EU - The PRA should maintain the strong focus on internal model supervision as it has been doing for the approval phase. In particular, to monitor the model drift risk the PRA should develop an analytical tool kit, with a suite of measures such as ratios based on independent and external measures as well as the internal model SCR. - Timing: Immediately - Authority: PRA - The longevity swaps activity and annuity block transactions need to be monitored for counterparty risk. - Timing: Immediately - Authority: PRA - The authorities are recommended to develop the appropriate tools to exploit the data in a manner that enhances its supervision on the thematic and outlier approach. - Timing: Near Term - Authority: PRA, FCA - Given the complexity and size of the groups active in the U.K., the authorities should maintain oversight and if required take action with regard to relationships of U.K. firms with others beyond the U.K. - Timing: Near Term - Authority: PRA, FCA - For insurers with significant business outside the European Economic Area (EEA), similar agreements to the EIOPA requirements for colleges in the EEA should be introduced for non-EEA jurisdictions. - Timing: Near Term - Authority: PRA, FCA - The U.K. authorities should work with international partners to develop an integrated regime of resolution powers for insurance, with due regard to the insurance business model. - Timing: Near Term - Authority: U.K. with partners - When developing its stress testing strategy, the PRA should consider: - Multi-year stress testing as a tool to allow the PRA to take preventive measures to offset the effects of no longer having matching and volatility adjustments within the limits imposed by Solvency II. - Stress testing using the matching adjustment under spreads widening shocks in a persistent low interest rate environment beyond the one-year horizon on a regular basis. - Stress testing to assess resilience to overseas economic shocks. - Timing: Near Term - Authority: PRA - Working together with EIOPA and other relevant European bodies, the PRA is recommended to consider macroprudential tools to manage issues of a cyclical character in the Solvency II framework. Also the risk margin definition should be revised to incorporate economic conditions. - Timing: Near term - Authority: PRA *EXECUTIVE SUMMARY, UNITED KINGDOM, INTERNATIONAL MONETARY FUND* ### INTRODUCTION ### INTRODUCTION ### Scope and focus - This Technical Note covers the analysis carried out of the insurance sector as part of the 2015 United Kingdom Financial Sector Assessment Program (FSAP). - Analysis based on the regulatory framework, supervisory practices, and other conditions as they existed in November 2015. - The note also refers to the regulations that came into force in January 2016 (Solvency II). - The Technical Note is not a full assessment on the observance of International Association of Insurance Supervisors (IAIS) insurance core principles (ICPs). - Assessment focus determined by findings of the 2011 FSAP, IAIS new supervision requirements, and aspects relevant to the U.K. global center role for insurance. - Key assessment aspects: - Elements supporting effectiveness and efficiency of the supervision of both authorities in the area of insurance supervision and regulation. - Level of implementation of Solvency II, including internal model approval, group supervision and reporting requirements. - An assessment of the resilience of the sector based on the available stress test results. *This technical note was prepared by Rodolfo Wehrhahn, IMF external expert.* ### Institutional, regulatory, and supervisory issues — Institutional framework and arrangements - Financial Services Act 2012 (FSA12) established a new framework for financial regulation in the United Kingdom. - Financial Policy Committee (FPC) of the Bank of England (BoE): - Primary objective: identifying, monitoring, and taking action to remove or reduce systemic risks to protect and enhance the resilience of the U.K. financial system. - Secondary objective: to support the economic policy of the Government. - Must hold an annual dedicated discussion on regulatory perimeter boundaries. - Her Majesty’s Treasury (HMT) is required at least once a year to review the FPC’s remit. - FSA12 established new microprudential supervisors: - Prudential Regulation Authority (PRA) prudentially supervises banks, insurers, and the largest investment firms, a total of around 1,700 entities. - The PRA is a subsidiary of the BoE. - Financial Conduct Authority (FCA) responsible for conduct supervision of all financial services firms and prudential supervision of firms not supervised by the PRA; currently supervises around 56,000 firms. - Since April 2014, the FCA has been responsible for conduct-focused supervision of all consumer credit firms in the U.K. - April 2015: independent Payment Systems Regulator established as a subsidiary of the FCA. - Interaction and coordination mechanisms: - FSA12 requires the FCA, PRA, and BoE to coordinate functions effectively and empowers the PRA to veto certain actions by the FCA if they threaten U.K. financial stability. - MoUs entered to support communication and coordination; several MoUs are public on the BoE web page. - Cooperation and communication observations: - Cooperation and communication between the PRA and the FCA is good. - Frequent practical collaboration, including quarterly meetings between corresponding general insurance leadership and operational sharing of firm assessment findings. - Formal U.K. regulatory colleges exist for dual regulated firms; more frequent informal meetings for the largest firms. - Policyholder protection: - Financial Services Compensation Scheme (FSCS) protects insurance policies and insurance broking (for business conducted on or after January 14, 2005). - For insurance business, there is no upper limit on the amount of protection. - For firms declared in default after July 3, 2015: - Claims for long-term insurance, compulsory insurance, professional indemnity insurance, and certain claims for injury, sickness or infirmity of the policyholder are protected at 100 percent. - Other types of insurance claims are protected at 90 percent. - Before paying compensation for long-term insurance, the FSCS must seek to make arrangements to secure continuity of insurance and maintain benefits falling due. - For general insurance, the FSCS may seek to secure or facilitate transfer of the insurance business and secure issuance of policies by another firm. - Financial Ombudsman Service (FOS): - Established by law as an independent public body to resolve individual disputes between consumers and financial sector businesses. - Depending on complexity, FOS can sort out some complaints within a few weeks and over half of all cases within three months. - FOS involvement has accelerated settlement time and reduced costs for PPI claims and other insurance small claims. ### Institutional, regulatory, and supervisory issues — The supervisor structure - PRA Insurance Directorate: - Comprises two divisions (Life Insurance and General Insurance) and the Executive Director's Office (includes Solvency II project team). - Supported by Prudential Policy, Regulatory Operations, and Legal Directorate. - General Insurance Division: - Two supervisory Departments and General Insurance Risk Specialists (GIRS). - London Markets department supervises an estimated 80 firms operating in the London wholesale insurance market (including Lloyd’s of London and firms writing business through Lloyd’s; subsidiaries of Bermudian and North American insurance groups; and P&I Clubs). - Nonlife and International Composites Department supervises 160 firms offering consumer products and some 150 firms in runoff. - GIRS comprises specialists (predominately actuaries) with deep understanding of prudential risks in nonlife insurance and reinsurance. - Sectoral trends and analysis refreshed every quarter. - Life Insurance Division: - Four departments: Groups, Retail Life (RLD), Life Insurance & Pensions Risk (LIPRD), and Business Model Analysis (BMA). - Groups supervises five of the largest life groups, which together represent more than 70 percent of the U.K. life insurance market. - RLD supervises 40 to 50 firms, comprising Category 1 to Category 4 firms and much of the mutual life insurance sector. - LIPRD comprises specialists (predominately actuaries) with broad and deep understanding of prudential risks posed by life insurers, reinsurers and pension schemes. - BMA is a small group (five to six) of specialists focusing on business models, profit/capital generation, threats, and sustainability. - FCA organization: - Comprises nine divisions with several executive and nonexecutive committees. - Two supervision divisions divided by market participants: - Supervision—Investment, Wholesale, and Specialists (SIWS): - Supervises producers and distributors of financial products including asset managers, life companies, retail distribution platforms, and investment banks. - Contains centers of excellence for Prudential, Client Assets, Financial Crime, and Event Supervision. - Made up of three subdivisions: Wholesale Markets and Investment Management, Life Insurance and Financial Advice, and Specialist Supervision. - Spans five market sectors: Wholesale Banking, Capital Markets, Investment Management, Retail Investments, and Pensions and Retirement Income. - Houses Central Support covering operational and systems support, management information, quality assurance, and data. - Supervision—Retail Banking and Authorizations: - Supervises Retail Banking, Retail Lending, General Insurance and Protection. - Provides Authorizations and Contact Centre services, including authorization of consumer credit firms, and a center of excellence for conduct supervision. - Consists of three sector teams: Retail Banking, Retail Lending, General Insurance and Protection, along with Authorizations and Credit Authorizations. ### Resources - Human resources trends: - PRA resources for insurance supervision have been gradually increasing and turnover is low. - FCA resources have been increasing. - At June of 2015 the full time equivalent (FTE) number at the FCA was two percent higher than at the end of 2014. - The PRA’s Insurance Directorate FTE at the end of June 2015 showed a 7 percent increase in headcount compared to the end of 2014. - Fee and funding arrangements: - Both the PRA and the FCA have authority to levy fees from the industry to finance operations; fees intended to recover all costs of their operations. - The FCA collects fees on its own account and on behalf of the PRA as its collection agent. - Fee is based on the size of regulated business as a proxy for impact risk on statutory objectives. - For some projects like Solvency II implementation, special project fees can be levied. - PRA and FCA can require individual firms to pay for experts’ reports commissioned under Section 166 of FSMA. - Fines imposed by the authorities are transferred to HMT after recovering enforcement costs. - FCA fee increased by 11 percent in the last three years amounting, for 2015/2016, to GBP 66 million. - For 2015/2016, the PRA fee amounted to GBP 227 million, also an increase from the previous year. ### Supervision approach — The PRA - Statutory objectives of the PRA: - General objective: promote the safety and soundness of the firms it regulates. - Insurance-specific objective: contribute to securing an appropriate degree of protection for those who are or may become insurance policyholders. - Secondary objective: facilitate effective competition. - PRA supervisory tools and philosophy: - Advances objectives through regulation (setting standards/policies expected of firms) and supervision (assessing risks firms pose and taking action where necessary). - PRA does not seek a “zero-failure” regime; aims to ensure orderly failure that avoids significant disruption to supply of critical financial services. - Secondary competition objective: - Applies when PRA discharges general functions in a way that advances its primary objectives; came into force on March 1, 2014. - Bank’s Independent Evaluation Office (IEO) will monitor the PRA’s approach to this objective. - Example: influence on Solvency II long-term guarantees package and consultation on transitional measures for insurance technical provisions to avoid market disruption. - Risk-based supervision and Risk Assessment Framework: - Supervision is risk–based with a forward view allowing supervisory judgement within a structured framework. - Risk Assessment Framework captures: - (i) potential impact of firm stress/failure on the financial system; - (ii) how macroeconomic and business risk context affects viability; - (iii) mitigating facts that determine overall safety and soundness; - (iv) extent to which a firm would be resolvable as a going concern (resolvability). - PRA divides each type of firm it supervises into five categories of potential impact. - Resource deployment and categorization: - Intensity of supervisory activity varies across insurers and reflects PRA judgement of insurer’s potential impact on: - (i) policyholders; - (ii) stability of the financial system; - (iii) proximity to failure; - (iv) resolvability; - (v) PRA’s statutory obligations, if any. - Other factors: type of business, complexity of business and organization. - Category 1 firms have the largest number of supervisors; specialist support provided in addition to firm-specific teams. - Supervision of lower-category firms: - Reduced intensity of supervision for lower categories in line with risk-based approach. - Category 5: smaller insurers assessed to have the lowest potential impact; supervised on a portfolio basis using automated tools to analyze regulatory returns; supervision mainly reactive with no named supervisor. - PRA examines individual insurers when a risk crystallizes, in response to authorization requests, conducts peer group analysis, and annual assessments in large peer groups. - Proactive Intervention Framework (PIF): - Complement to baseline supervisory activities; assessment of each firm against seven risks is carried out within each category with varying frequency. - Supervisory judgement assigns a PIF stage to each firm; PIF stages trigger possible supervisory actions (e.g., watch list) that may require continuous reporting up to board level. - PIF stage list updated monthly; all firms up to Category 4 have been assigned a PIF stage. - PRA maintains a watch list of firms posing heightened supervisory concern requiring continuous reporting in some cases up to board level. - Regular reporting and governance: - Supervision supported by regular reporting and an ongoing program of continuous assessment. - Periodic Summary Meeting (PSM) reviews previous year’s work, approves supervisory plan for next 12 months, and assesses longer-term supervisory strategy. - For Category 1, 2, and 3 firms PSMs are firm-specific; for Categories 4 and 5 PSM considers firms in peer groups. - For Category 1 firms, PSM convenes at the Supervisory, Risk, and Policy Committee (SRPC) level and sends outcome to the PRA Board within a maximum period of four weeks for decision on whether to discuss those firms. - PSMs for Category 2 to 5 firms can make decisions for firms considered or escalate decisions to a more senior supervision committee if necessary. *UNITED KINGDOM — INTERNATIONAL MONETARY FUND* ### 22. The supervisory effectiveness and consistency of the actions taken is assessed by the ### 22. The supervisory effectiveness and consistency of the actions taken is assessed by the ### Supervisory Oversight Function (SOF) - The SOF provides independent assurance to the PRA Board and Executive as to the quality and effectiveness of supervision. - The SOF promotes and supports the PRA’s aim to deliver high quality, forward-looking, and judgment-led supervision. - Activities: - Undertakes firm-specific and thematic supervisory effectiveness reviews. - Provides management information and analysis in the application of the supervisory approach. - Facilitates forward-looking recommendations and identification of good practices to further improve supervision. - Areas considered in supervisory assessments include: external context, business risk, governance, risk management, capital, liquidity, and resolution. ### Decision-making at the PRA - The PRA governance framework supports proportionate and practical decision making, ensuring senior management involvement for the largest firms. - Decisions with potential material impact on PRA objectives and/or firm safety and soundness are escalated; committee seniority depends on potential impact and materiality. - The PRA Decision-Making Framework details escalation processes and specifies certain decisions that must always be taken by a particular committee (e.g., placing a firm into resolution). - Different supervisory views and disputes: - Disputes about an individual firm usually decided by the relevant PSM. - If necessary, disputes can be escalated to the SRPC. ### Risk appetite and international reputational considerations - The risk appetite driving supervision should account for the reputational risk of the U.K. as a global financial center. - Entities authorized in the U.K. by the PRA and FCA to carry on insurance business or by the FCA to carry on insurance mediation business are subject to supervision. - Some brokers using the U.K. “brand” operate mainly offshore (e.g., exclusive reinsurance branches and brokers) and are not captured under current risk appetite declarations because they are not considered large in U.K. market terms. - Recommendation: - The authorities should consider a minimum level of supervisory scrutiny of entities with a strong international focus regardless of size. ### The FCA: remit and supervisory approach - The FCA supervises business conduct and prudential aspects where the PRA is not responsible. - FCA risk-based judgments assess whether: - (i) the firm’s business model results in fair treatment for consumers; - (ii) it upholds market integrity; - (iii) for those firms it regulates prudentially, they are financially sound. - The FCA uses a forward-looking, judgment-based approach, focusing on business models, culture, causes of problems, and accountable individuals. - Prudential supervision by the FCA includes establishing financial resource requirements and monitoring compliance. ### FCA restructuring and sectoral focus - The FCA supervises a very large number of entities: 56,000. - The supervisory approach moved from a company focus to a sectoral focus; overall risk appetite replaced by sectoral risk appetite declarations, including cross-sector departments. - In August 2015, the FCA Board approved the new supervisory model. - The new model places less emphasis on firm-specific supervision and allows flexible response to significant risks. - The FCA approach to Prudential, CASS, and FC supervision remains unchanged. ### Continuous supervision processes - Continuous supervision is supported by formal processes to maintain up-to-date views of risks in firms and sectors. - Largest (re)insurers subject to a continuous cycle of proactive supervision. - Firm Evaluation meetings: - Use all available intelligence to form an overall view of a firm and the risk it poses to FCA objectives. - Establish a supervisory strategy to mitigate risks. - Held at intervals of up to three years, depending on firm risk. - Supplemented by interim reviews at least annually to refresh the view and ensure supervisory strategy remains appropriate. ### Sectoral risk identification and House Views - The FCA is developing House Views to provide a unified cross-FCA view of a sector and its risks. - House Views: - Strategic approach to managing sector-wide risk and inform prioritization across the FCA. - First iteration expected to be completed by Q2 2016. - Refreshed quarterly and rewritten annually. - Used to identify priority areas for market studies, thematic work, or discrete investigatory work in firms. - Ongoing oversight includes continual identification and assessment of key and emerging risks to target work mitigating priority risks for (re)insurers. ### Access to centralized resources and potential constraints - The FCA’s sectoral declarations apply to cross-sector departments (e.g., FC, authorization, enforcement). - Access to centralized resources depends not only on supervisory risk appetite but also on priorities set by centralized departments. - Recommendation: - The FCA should consider a mechanism to allow any sector to satisfy urgent needs independently of the risk appetite of centralized resources. - Footnote: In the area of FC a mechanism exists (e.g., FC can apply override in exceptional cases; supervisors can and should take FC cases forward where FC does not). ### Challenges in supervision and enforcement timing - Identified challenges: - Thematic work: commendable but time to action and policy revision is relatively slow. - Enforcement actions: may take a few years to be effective and published if cases cannot be settled; the FCA should accelerate timetables while ensuring due process and fair treatment. - Digital distribution/disruptive technology: increases competition and customer experience but creates new conduct supervision challenges (e.g., comparison price web pages disaggregating benefits without adequate explanation can render protection useless or inadequate). - Recommendation: - Ensuring consumer understanding will require enhanced regulatory requirements when providing web-based comparisons. ### FCA IT and reporting systems - The FCA IT system is not connected with the new reporting system of the PRA. - At its creation the FCA inherited the reporting regime of the FSA; the core insurance return was transferred to the PRA. - The FCA is reviewing the returns they receive to assess data adequacy for its objectives and remit. - Over the next few years the FCA will update reporting requirements and develop new returns for insurers and insurance intermediaries to allow better monitoring of consumer protection and market integrity. ### Enforcement: objectives, powers, and recent outcomes - Enforcement objectives: make powers effective, provide redress to consumers, set expectations on authorized firms’ behavior, and provide credible deterrence. - Enforcement uses criminal, civil, and regulatory powers; final notices are published for transparency and deterrence. - Alerts about unauthorized firms and individuals (overseas and U.K.-based) support credibility of U.K. supervision. - Accountability: authorities enjoy operational independence but are subject to numerous accountability mechanisms. - Enforcement actions have taken forms including fines, prohibitions, and withdrawal of permissions; breaches in risk management and wrong remuneration incentives have been penalized. - Firms can be penalized by both authorities for the same action if rules of both authorities are breached; fines have been applied to firms and individuals. - Timelines: from start to publication of a fine can take several years if contested and referred to courts; supervisory corrective and protective measures may be taken in parallel. - Recent enforcement outcomes: - The FCA imposed fines totaling GBP 425 million. - By October of this year, more than GBP 20 billion had been paid under an FCA redress scheme to consumers mis-sold card and identity insurance and payment protection policies. - In November, the FCA fined five banks GBP 1.1 billion for attempted manipulation of the FX market; potentially criminal misconduct by individuals investigated by the Serious Fraud Office. - HMT published a review of enforcement decision-making at the financial services regulators with recommendations to enhance enforcement processes. ### Group supervision: scope and Solvency II preparation - Publication and listings: - A definitive list of all insurance groups supervised in the U.K. is not published by the PRA; individual legal entities are listed on the Financial Services Register. - For European insurance groups where a college has been established, a list (the Helsinki List) is published by EIOPA. - A similar list of financial conglomerates with head of group in the EU/EEA is published by the Joint Committee of European Supervisors. - Twenty groups were identified in the 2014 listings where the U.K. is the group supervisor. - Preparation for group supervision under Solvency II has been ongoing for several years. - Colleges of supervisors for groups where the PRA is lead supervisor have been created and are in compliance with EIOPA requirements. - Relevant guidance and rules: - EIOPA guidelines on internal model pre-applications applied as of January 1, 2014. - Final draft of EIOPA guidelines on operational functioning of colleges published February 2015 (organization of information exchange, communication with firm management, voluntary sharing/delegation of tasks, templates for coordination arrangements, emergency plans, suggested data lists). - Processes for joint decisions on group internal models under Article 231 found in Title II Chapter II Section 2 of the delegated acts. - Directive requirements transposed by HMT in FSMA—the 2015 Solvency 2 Regulations. - PRA publications: supervisory statements on compliance expectations with EIOPA guidelines; PRA and FCA liaise closely on EIOPA colleges and run their own college meetings for U.K. groups for large (re)insurers and for some small entities by sector/sub-sector. ### PRA powers and college coordination - PRA powers: - PRA has direct powers over authorized companies within a group and indirect power over other group entities. - Obligations to comply with group requirements are placed on authorized entities within a group (U.K. (re)insurers). - Direct PRA powers over holding companies apply only to qualifying parent undertakings under FSMA (2012) definitions (financial holding companies, mixed financial holding companies, insurance holding companies as defined under CRR, Financial Conglomerates Directive, and Solvency II, respectively) provided head office is in the U.K. - PRA powers of direction can be used where a direction to a qualifying parent undertaking would further supervisory objectives (the ‘general condition’) or for meeting consolidated group requirements (the ‘consolidation condition’). - College coordination: - Where PRA supervises an entity within a broader multinational group or is group supervisor, a ‘college of supervisors’ is established. - Prior to full Solvency II implementation, all colleges with at least two EEA members were required to have a coordination arrangement. - Majority of coordination arrangements for PRA-led colleges based on EIOPA template, stating participants, status for Solvency II decisions, contact information, roles/responsibilities, college work plan, specialized teams, and procedures for sharing/delegation of tasks. - FCA’s experience with supervisory colleges limited so far; expects teething problems to be overcome and quality relationships with home supervisors to develop. - Solvency II requirement: - Under Solvency II, all EEA colleges should put in place a “College Coordination Agreement” including an emergency plan to support crisis management, define crisis-handling means, and provide common understanding of division of tasks such as public communication of measures. ### Recent PRA group-level activities (2014–15) - PRA engaged in a range of group-related activities; firms and groups undertook significant restructuring and/or acquisition activity. - Reviews included: change in control, issuance of capital instruments, scope of the group, availability of own funds across the group, and scope of internal models. - Considerable focus on internal model development and progress against delivery plans. - Regular supervisory activity included periodic summary meetings assessing supervisory strategy and key risks, considering compliance with threshold conditions, impact score, and PIF score. - During 2014 and continuing into 2015, commitment panels were introduced to assess group readiness for internal model application: - Panels chaired by senior management with supervisory and specialist representation. - Purpose: challenge/confirm assessment of readiness to proceed to formal application phase. *Source: _cr16158 - 22. The supervisory effectiveness and consistency of the actions taken is assessed by the* ### 43. The FCA has performed a number of on-site assessments (as well as desk-based review ### _cr16158 - 43. The FCA has performed a number of on-site assessments (as well as desk-based review ### Group supervision and on-site assessments - The FCA has performed a number of on-site assessments (as well as desk-based review work) on the U.K. operations of multiple financial conglomerates and insurance groups. Reviews covered entity governance, product design, outsourcing oversight, and sales, and where relevant looked at group operations in relation to U.K. entities. - Examples of supervisory action: - Required a report by a skilled person to review the governance of a major international insurance group where it was concerned that the U.K. firms had an inappropriately low level of control over their operations. - Required an on-site assessment of the centralized policy administration and claims payments operations of a multinational group. - Solvency II is introducing extensive improvements in group supervision requirements that will accelerate progress already made by the authorities. - PRA actions: - The PRA has been creating the supervisory colleges for the most important groups, and has also been participating as a member in other colleges where it is not the group supervisor. - The EIOPA requirements on the conduct of colleges have been implemented for the PRA-led groups. - FCA actions: - The FCA is in the process of structuring its group supervision for market conduct purposes by reallocating responsibilities to sector-specific supervisors. - This sector-specific approach will require strong coordination among the different group of supervisors looking at the group as a whole. - Recommendation: The FCA should ensure a coordinated approach to group supervision when finalizing the new supervisory approach for groups. - Further improvements the PRA should consider (text preserved): - A large number of groups are supervised by the PRA, but its current IT system does not allow the supervisors to map comprehensively individual legal entities to a group structure. - The monitoring of contagion risk could benefit from a IT tool that maps the group structure together with all important intragroup transactions—like loans, reinsurance and guarantees. The tool should allow for stressing the different transactions to gain an overview of the contagion risk within the group and the transmission channels. - Effective cooperation establishing a clear definition of responsibilities around joint decisions over group internal model applications and group model changes, in particular where the group internal model determines the solo SCR of more than one (re)insurance undertaking. - Capital transferability across jurisdictions when diversification benefits are granted. - Given that the possibility to designate the lead supervisor independently of the domicile of the insurer is not always given for insurers with significant business outside the EEA, similar agreements as those existing under the EIOPA requirements for colleges in the EEA should be introduced. ### Market entry, licensing, and exit - Licensing and entry controls: - The licensing process, including fit and proper assessments, is strong. Good practices from the last FSAP (including the approved person regime and corresponding fit and proper assessments) continue to be in effect. - The PRA is responsible for licensing firms supervised by both authorities; however the license can only be approved after the FCA has provided its consent. - The PRA’s Central Supervisory Support (CSS) covers routine authorizations, firm enquiries, PRA communications and maintenance of the supervisory model. - EU freedom of services and data gaps: - The EU’s freedom of services rules allow insurers established anywhere in the EU to operate in the U.K. without an additional license. - The FCA has a limited market conduct responsibility for branches of EEA-domiciled insurers; prudential supervision and key elements of conduct supervision of such branches are the sole responsibility of the home supervisor. - Currently, information on the prudential condition of these insurers is delayed and the level of granularity of the data does not allow for timely preventive market conduct actions. - These deficiencies are expected to be removed with the strong reporting requirements that Solvency II is imposing. However, for market conduct supervision, the FCA’s data needs are likely to not be entirely met by the Solvency II reporting regime, and it is working on addressing the gaps. - Market exit: insolvency regimes and transfer tools - Two main options for dealing with insolvent insurers established in legislation are administration and liquidation: - Modified administration regime: based on corporate U.K. administration process; administrator has a duty to carry out the insurer’s contracts of life insurance with a view to business transfer as a going concern; administrator required to cooperate with the FSCS; administrator appointed by the court and may be suggested by directors, creditors, or regulatory authorities. - Modified liquidation regime: based on U.K. corporate liquidation process; primary purpose is to allow assets to be realized and thereafter claims to be agreed and settled after payment of the cost of proceedings. - Winding-up of insurers is usually a long process to protect policyholders by enabling more accurate calculation of long-tail claims liabilities. Insurers generally cannot cancel their authorization and liquidate promptly because they might still receive claims and need to ensure all policyholders are paid what is due them (or an equitable percentage). - Case example: the last major insurer in the U.K. to go insolvent was in 2001; it entered a court-approved scheme under which claims were processed and agreed (but not paid). In 2015 (having received non-objection from both the PRA and FCA), it gained court sanction to amend this to an arrangement whereby all known and projected future liabilities are calculated and creditors, including claimants, are to be paid a fixed percentage of the amounts due to them. This is currently ongoing. The company is expected to liquidate in 2016, following the court-agreed date for the amended scheme. Since the firm became insolvent, the FSCS has ensured that protected claims have been paid, and it will continue to pay any new protected claims going forward (including after the liquidation of the insurance company). - Part VII of FSMA (2000) provides the legal framework for transfers of insurance business of U.K. authorized insurers, allowing an (re)insurer to transfer insurance business to another (re)insurer without policyholder consent. Requirements include: report by independent expert, policyholder notification, court approval, and non-objection by the PRA and the FCA or other regulators and interested parties. - Both PRA and FCA must be independently satisfied that the independent expert is appropriate and that the report covers the right issues; the court participates at the directions hearing (leave to proceed) and at the final hearing (sanction). - FCA focus in transfers: impact on policyholders’ rights, fair treatment, and effectiveness of the firm’s policyholder communications strategy; factors include transferee’s ability to handle claims and the sophistication of policyholders. - PRA focus in transfers: prudential aspects such as impact on business models, capital position and fungibility, reinsurance arrangements, intragroup arrangements, and ongoing ability to meet threshold conditions; capital injections may be required; transfers may raise Solvency II jurisdictional issues. - Part VII transfers are routinely used in winding up or restructuring; their volume has risen markedly as firms prepare for Solvency II implementation. - Insurance Guarantee Schemes (IGS) and cross-border considerations: - Protection afforded to insurance policyholders under EU member states’ various IGS is uneven; some member states have no such scheme. - The Insurers’ Winding-up Directive (incorporated into Solvency II) ensures mutual recognition of reorganization measures and winding-up legislation of member states for insurance undertakings. - For cross-border insurers with branches operating in the EEA, reorganization measures and modified insolvency proceedings are determined by the home state regulator and are effective throughout the community. - The U.K. FSCS covers protected insurance policies sold by both U.K. authorized insurers and U.K. branches of EEA insurers (whether the risk is a U.K. or EEA risk), and covers U.K. risks insured with firms based in EEA countries and sold via freedom of services in the U.K. - The FCA requires all covered insurers to pay the corresponding levy to the FSCS independently of their domicile. - The European Commission is considering whether to make a legislative proposal for a harmonized Insurance Guarantee Schemes Directive. - Recovery and resolution: - The PRA is preparing resolution plans for the two G-SIIs headquartered in the U.K. in the context of FSB work on recovery and resolution planning for G-SIIs. - G-SIIs are required to prepare recovery plans; no requirements exist for insurers that are not G-SIIs to prepare recovery plans. Under Solvency II, all insurers must submit a recovery plan within two months where the solvency capital requirement has been breached. - Resolution powers of the PRA have been strengthened but remain indirect, needing court approval for any restructuring. The PRA does not operate as a single resolution authority for insurers; final enforcement of restructuring relies on the courts. - The ability to write down policyholder liabilities is exercised through the courts—not an administrative power available to the resolution authority, as is the case for banks. - Recommendation: U.K. authorities should work with international partners to develop an integrated regime of resolution powers for insurance, with due regard to the insurance business model. - Recommendation: The U.K., in conjunction with EU authorities, should consider whether current arrangements in the case of a cross-border failure ensure adequate coordination and flexibility between various resolution tools and authorities. - Delegated supervision to the home supervisor requires an increased level of cooperation, information sharing, and engagement within colleges of supervisors; this should include consistent guarantee schemes for failing insurers, and consistent cross-border resolution powers. ### Solvency II implementation: preparations, scope, costs, and vulnerabilities - Implementation status and PRA preparation: - Solvency II came into force on January 1, 2016. - Over 30 percent of Executive Directors’ time in recent years was dedicated to Solvency II implementation; the PRA prepared by securing and maintaining skilled human resources (supplemented with external specialists), developing IT systems for intense data reporting requirements and exploiting data granularity for supervision and systemic risk monitoring, and preparing approvals firms need prior to the commencement of Solvency II (notably approvals for internal models). - Firms must obtain approval should they wish to calculate capital requirements using an internal model. - Transposition and scope: - The transposition of the Solvency II Directive into national law was carried out without significant exceptions. All EIOPA guidelines have been incorporated into PRA rules as set out in various supervisory statements. - The Directive has been fully transposed into national law, using an intelligent copy-out approach; deviations were exceptional and intended to preserve the meaning of the directive requirement. - The FCA has amended its handbook to make appropriate changes as a consequence of Solvency II implementation. - Only a small part of the market is out of the Solvency II scope: About 20 percent of the insurers are out of scope of Solvency II. The majority of these firms are mutuals. - This figure also includes approximately 60 partnership pension friendly societies (not required to submit regulatory returns and for whom detailed data is not available), 24 other friendly societies, and 20 or so other small (re)insurers (including branches of EEA firms that passport into the U.K.). The majority of these are in the life business, but there are a few writing GI. - Life firms at end-2013 collectively had total assets of approximately GBP 232 million and gross written premium of approximately GBP 89 million. - The 13 (re)insurance companies writing a variety of GI business at end-2013 had total assets of approximately GPP 5.26 billion, and gross written premium was GBP 310 million. - Third-country pure reinsurance branches are also out of scope of Solvency II requirements. The PRA has reviewed rules for third-country pure reinsurance branches and published a Supervisory Statement (SS44/15) setting out its approach; the PRA follows Article 174 of the Solvency II directive and expects third-country branch undertakings to comply with the EIOPA Branch Guidelines. - Implementation costs and communication: - The implementation costs of Solvency II for the PRA are estimated to be GBP 100–150 million. This does not include PRA staff time allocated in normal duties. - A well-managed IT project reduced costs from the original budget of GBP 150 million. - The PRA maintains a dedicated website on Solvency II and BoE website pages provide industry information, clarifications and expectations. - Effectiveness, macroprudential concerns, and EU-level vulnerabilities: - The effectiveness of Solvency II in the U.K. will depend on forthcoming regulatory changes and supervisory actions in the U.K.; implementation will be tested in economic downturns. - Under macroeconomic conditions affecting insurers throughout the EU, pressure on the U.K. to support a weakening of the market consistent valuation principle of Solvency II will be challenged. - Consideration should be given to macroprudential tools to manage macroeconomic risks instead of relying on adjustment measures in the Solvency II framework to address cyclical conditions. - The maximum harmonization implementation of Solvency II creates vulnerabilities that need to be addressed at an EU level: complexity (particularly with internal models) requires significant highly qualified supervisory resources, presenting a challenge to several EU jurisdictions. - There is a theoretical risk that onerous Solvency II requirements could motivate use of freedom of service to search for jurisdictions with lighter application of Pillars Two and Three; monitoring and acting to prevent such a trend on an EU-wide level is important. ### Pillar One: Standard Formula limitations - Some risks are not covered in the Standard Formula (SF). - EIOPA’s document on the SF lists assumptions and bases used when calibrating the SF, including in respect of sovereign risk, and clarifies the SF’s limitations and the fact that some risks are not covered by the SF. - Solvency II requires an assessment as to whether the SF may or may not be appropriate for a firm; where the firm’s risk profile is not appropriately addressed by the SF, an internal model (full or partial) may be needed or capital add-ons may be required. *International Monetary Fund — Article IV staff report excerpt (content unit: _cr16158 - 43.)* ### 68. Consideration should be given to addressing the long-term exposure of certain lines of ### _cr16158 - 68. Consideration should be given to addressing the long-term exposure of certain lines of ### Long-term exposure in nonlife insurance - Prudential buffers from the reserve requirements under Solvency I have been stripped off in favor of capital charges based on statistical distribution, an approach particularly sensitive to insurance of extreme infrequent events. - The one-year horizon of the Solvency II framework is potentially insufficient for some complex emerging risks insured in the London market, some of which may give rise to losses several years after the policy was underwritten (asbestos claims given as an example). - These risks have the characteristic of intrinsic long-term latent liabilities for which the one-year horizon required under Solvency II for the calculation of the SCR may not be appropriate. - While the one-year horizon is complemented by the required ORSA exercise that should consider multi-years exposure, the supervisor’s powers to take action under pillar two requirements are weaker. - Recommendation: Consider supplementing the one-year horizon with complementary analysis for complex business, for example, explicit stress testing scenarios that address long-term latent losses. *Footnote references present in source (not reproduced): EIOPA and PRA documents.* ### Use and calibration of the Matching Adjustment (MA) and Volatility Adjustment (VA) - Purpose: MA and VA are intended to better account for the long duration of insurers’ liabilities and to limit unwanted volatility from a market consistent regime; both are relevant for the U.K. life sector underwriting long-term annuity business. - MA specifics and impact: - The MA gives insurers relief for holding certain long-term assets that match the cash-flows of a designated portfolio of life or annuity insurance and reinsurance obligations. - Firms with long-term, fixed, and predictable liabilities (e.g., regular annuity payments) can match obligations with assets having the same cash-flow characteristics and recognize reduced spread risk. - Delivering advice on calibrations is the responsibility of EIOPA, subject to European Commission endorsement. - Over 20 U.K. life insurers have applied (or indicated to the PRA that they intend to apply) for approval to use the MA. - Significant work by U.K. industry to ensure compliance with Directive requirements; PRA does not expect nonlife firms to apply. - Estimated benefit: applying the MA to the U.K. life insurance market would be a substantial increase in own funds, with some additional benefit from reduction in capital requirements. Precise impact contingent on portfolio decisions and will be a public number in annual reports of insurers applying the measure. - Matching adjustment approval was announced to the companies individually during the FSAP. - VA specifics and comparative impact: - The VA measure is expected to have a much smaller impact on the solvency position of U.K. firms than the MA due to lower calibration and lower uptake on eligible liability pools. (For a given liability pool, firms can apply either the MA or VA—not both.) - Key calibration differences: - The VA allows for a smaller proportion (65 percent, compared to 100 percent for the MA) of the risk adjusted spread to be used in discounting the technical provisions. - The VA is based on a currency-specific reference portfolio that excludes assets held within MA portfolios and has a lower overall yield. - The PRA has not permitted firms to assume any change in the VA under stressed conditions. In contrast, the MA can increase and this can reduce the solvency capital requirement. - Supervisory concerns and recommendations: - The VA’s simplifications (e.g., use of a model portfolio) could distort the market consistent approach to capital determination as required by IAIS and, if applied indiscriminately, could allow weak insurers to continue operating beyond recovery. - The PRA has used the option to require supervisory approval for firms to use the VA. - For the MA, eligibility of unrated assets requires close scrutiny of firms’ internal ratings and relies on strong expert judgment. - Recommendation: The PRA should introduce a series of well-defined actions to monitor the levels of impact that both measures have on insurers’ solvency positions. ### Stress testing and multi-year scenarios - Sophisticated stress testing will be necessary to allow appropriate preventive measures. - Multi-year stress testing: - Is a tool to allow the PRA to take preventive measures to offset effects of no longer having matching and volatility adjustments. - The legal risk of changes to the illiquidity of liabilities underlying the use of the matching adjustment will, in most cases, not materialize in a one-year horizon; similarly, challenges to the volatility adjustment justification of transitory market volatility will arise only in multi-year scenarios. - Specific stress-testing needs: - Stress testing using the matching adjustment, under spreads and widening shocks in a persistent low interest rate environment beyond the one-year horizon, needs to be used regularly. - Matching long-term liabilities with unrated or below investment grade securities can result in a dual hit to SCRs: credit risk and loss of the matching adjustment simultaneously. - Recommendation: Use multi-year stress scenarios, including persistent low interest rate and spread-widening shocks, to assess resilience. ### Transitional measures and monitoring - Transition measures allow for a smoother move into Solvency II and phase in the impact of the move to a going concern regime. - The estimated initial benefit for the U.K. industry is important on day one and falls gradually over time. Without transitional measures, some U.K. life insurers would have a surplus deficit, largely due to the introduction of the risk margin that has a fixed cost of capital independent of prevailing economic conditions. - The longest transition period is 16 years for the risk-free interest rate and technical provisions. - The U.K. industry (mainly life insurers) is expected principally to make use of the technical provision transitional measure. - Concern: Adverse macroeconomic conditions could increase the challenge of meeting scheduled transition milestones. - Recommendation: The PRA should consider developing a framework of actions that could be taken in case of a delay in meeting transitional milestones to support a no-forbearance regime; important given the PRA intention to allow dividend payments taking transitional measures into account for SCR determination. ### Regulation for non-Solvency II firms (Nondirective firms, NDFs) - The PRA has consulted on a recast Rulebook covering the prudential regime for firms out of scope of Solvency II (NDFs). - The recast Rulebook rationalizes and removes obsolete rules, presenting current sourcebooks in the new PRA Rulebook style specifically for NDFs, maintaining current regulatory standards without increasing burden on these relatively small firms. - The FCA has instituted conduct-related changes to implement the NDF regime, including a proportionate change to the Approved Persons Regime. ### Solvency II internal model approvals and model governance - History and approvals: - The ICA solvency regime introduced in 2005 permits the use of internal models and aided firms’ preparedness for Solvency II internal model approval. - Initially, around 120 insurers intended to apply for an internal model approval; ultimately, 19 internal models have been approved. - The reduced number of applicants likely reflects high PRA expectations on internal models and improved calibration of the SF that reflects risk for more companies. - Approval process structure: - The process is structured to encourage consistency and avoid competitive advantages, using pre-defined templates for approval “panel packs.” - Process steps: - Firm-specific “recommendation panel” to assess the individual internal model application and the reviewing team’s recommendation; - Recommendation reviewed by an oversight panel of PRA senior management to reach a “minded to” decision; and - All “minded to” decisions are reviewed and final decisions taken and communicated simultaneously to all firms. - Supervisory engagement: - The PRA (and FSA previously) extensively engaged with industry during Solvency II run-up through briefings, EIOPA guideline adherence, conferences, “Director’s Letters,” and seminars for smaller insurers. - The PRA issued a supervisory statement on pre-application expectations and ran Commitment panels to form views on firms’ internal model progress. - Monitoring model drift and toolkit recommendation: - The PRA should maintain strong focus on internal model supervision and develop an approach to monitor potential internal model drift after approval. - Rationale: Insurers may make model changes or business choices that favor models generating lower capital requirements over time, risking deterioration of solvency standards. - Recommendation: Develop an analytical toolkit with a suite of measures and ratios based on independent and external measures as well as the internal model SCR. These measures should not be hard regulatory thresholds but should inform supervisory review work. - Consideration should be given to raising with the EU Commission the merits for the supervisor of a nonobjection rather than approval of the model, to avoid legal risk. ### Governance, Senior Insurance Managers’ Regime (SIMR), and risk management - Strengthening governance and fit/proper requirements: - Compliance with Solvency II as of January 2016 requires strengthening governance requirements; Solvency II Level 2 Delegated Act and EIOPA System of Governance (SoG) guidelines contain provisions on governance, organization of functions, and risk management (e.g., EIOPA GL 67). - PRA rules updated to transpose Directive provisions covering firms and groups—see PRA PS2/15 and related policy statements and supervisory statements. - PRA issued PS 22/15 and made final rules for the new SIMR, and issued SS35/15 and SS41/15 outlining expectations regarding governance, risk management and internal controls. - Directors and senior management responsibilities: - Functions and responsibilities established in Senior Management Arrangements (SYSC) 2, SYSC 3.2, and SYSC 14.1 of the PRA Handbook to ensure effective system of risk management at Board level. - Individual directors currently need pre-approval (SUP 10B) as fit and proper; skills, knowledge, and experience of individuals and the board as a whole are assessed. - Conduct principles in APER include due skill, care, diligence, organization for effective control, and compliance with regulatory requirements; supplemented by proposed supervisory statement in CP 18/15. - PRA proposed application of equivalent SIMR rules to non-Solvency II firms in CP12/15. The FCA consulted on revised Approved Persons Regimes to be implemented from March 7, 2016. Following an HMT announcement on October 15, 2015, further changes expected by March 2018 at the latest. - FCA interaction and expectations: - All authorized firms, including (re)insurers, are subject to the FCA’s Principles for Business in PRIN, including dealing with regulators in an open and honest way. - FCA firm supervisors establish schedules of meetings with senior managers and NEDs, including MI requirements; expectation of timely information to supervisors on key issues. - SIMR responsibilities and governance maps: - Each senior manager (and director) will have clear responsibilities allocated under SIMR; firms must establish a governance map showing roles, reporting lines, and accountability. - A prescribed responsibility must be allocated to a senior manager or director to lead development and monitoring of induction, training, and professional development policies for governing bodies. - Business conduct rules for senior managers (and directors) include ensuring firm compliance with regulatory requirements and standards. - FCA’s APR changes aim to capture Significant Influence Function holders (SIFs) outside SIMR and retain some SIFs for NDFs that PRA has not included. - Risk management framework enhancements: - Existing strong risk management requirements are strengthened under Solvency II. - Current regulatory requirements on risk assessment are contained within SYSC 3, SYSC 12, SYSC 13 and SYSC 14 of the PRA Handbook and are implicitly covered through ICAS and stress tests required by GENPRU 1.2 and INSPRU 7.1. - EIOPA System of Governance (Section 4: Risk Management) and EIOPA ORSA Guideline 13 cover firms’ need to ensure robust risk management at all stages of the business. *Italic source attribution: IMF staff report excerpt as provided in the supplied content.* ### 85. The risk management system will be further enhanced under Solvency II through the ### _cr16158 - 85. The risk management system will be further enhanced under Solvency II through the ### ORSA and risk management enhancements - All companies subject to Solvency II have submitted their ORSA to the PRA. - There is no formal approval process for ORSAs, but firms are required to submit them to the PRA for review. - The PRA has issued a series of recommendations on best practice and coverage of different risks. - The FCA has the right to ask firms to submit ORSA reports to them and is likely to do this for firms who are required to hold an Annual Strategy Meeting (ASM) with them, or as required for any other conduct supervision initiative for which they are relevant. - The range of ORSAs varies with the complexity of the business model and size of the firms. - The ORSA is forward-looking and should identify risks that pose a threat to the firms strategic goals, such as conduct risks relevant to the FCA, but that may not be covered under Solvency II pillar 1. - The PRA has issued SS26/15 “Solvency II: ORSA and the ultimate time horizon—nonlife firms,” expecting such firms to demonstrate that they have considered the ultimate time horizon in their ORSA supervisory report. - The FCA is currently finalizing its approach to the review of ORSA reports, but has been active in reviewing elements of the ORSA process and procedures in its day-to-day supervision of firms. ### ORSA frequency, content, and standards - Under Solvency II, insurers should prepare their ORSA at a minimum once a year and submit it as part of the supervisory report. - The ORSA supervisory report is to comprise: - results of each regular ORSA performed and conclusions, both in qualitative and quantitative form; - methods and main assumptions used; - comparison of own solvency needs with regulatory capital requirement and own funds. - See (Article 304 and 306 of the “Solvency II Delegated Acts”) and the EIOPA guidelines on ORSA (GL 16). ### Supervisory arbitrage and group-level supervision - Supervisory arbitrage remains a risk when key aspects of the solvency framework are not subject to equivalent or centralized supervision. - While regulation under maximum harmonization is equivalent across all EU member countries, important differences remain in supervisory practices. - The supervision of internal models and ORSAs at group level are subject to colleges of supervisors and coordination arrangements, under the direction of the group supervisor, to ensure appropriate level of review and assessment that Solvency II requires. - Recommendation: The U.K. should consider supporting centralized (or subject to strict peer review) supervision of internal models and ORSAs for the largest insurance groups. ### Pillar 3: reporting infrastructure and BEEDS portal - The PRA has designed and implemented a system for collecting the regulatory reporting data to support Solvency II reporting requirements. - As the period for the first set of preparatory phase returns for in-scope firms approached (July 1–15, 2015), the PRA issued communications and provided online training; the process is working smoothly. - The PRA is working to ensure firms not in-scope for the preparatory phase are aware of the process for submitting their first regulatory data returns in 2016. - To facilitate Solvency II Pillar 3 reporting, PRA is implementing the BEEDS portal, a system that firms will use to submit the regulatory returns including group returns. - As part of on-boarding to the BEEDS portal, a complete list of all groups within the scope of Solvency II, where the PRA is the group supervisor, will be available. ### Disclosure, SFCR, and RSR requirements - All firms and groups within the scope of Solvency II are required to publish a Solvency and Financial Condition Report (SFCR) annually. - SFCR narrative must explain key aspects of their approach to Solvency II, such as the use of an internal model (where applicable) and any noncompliance with regulatory solvency requirements. - SFCR contents include: - insurer activities and results; - risk profile; - principles used to value assets, technical provisions and other liabilities; - management of capital; - quantitative templates providing Solvency II balance sheet information, including technical provisions; the firm’s SCR and eligible own funds; impact of long-term guarantee measures and transitional adjustment for technical provisions; information on premiums, claims and expenses; details of own funds by tiers and solvency ratios; the SCR by risk modules or risk components (for internal model firms); and, for solo insurers only, the MCR and technical provisions. - Groups will need to disclose the group structure. - All firms and groups within the scope of Solvency II are required to produce a Regular Supervisory Report (RSR) (full or a summary) annually. - The Full RSR has to be submitted at least every three years. - In any financial year where there is no requirement to submit full RSR, firms must submit a summary report. - Supervisors may require submission of full RSR every year. ### Quantitative reporting templates (QRTs) and exemptions - The requirement for QRTs applies to all firms. - The PRA has not exercised its discretion regarding exemptions for “item-by-item” reporting (listings of assets); all Solvency II firms are required to submit the full QRTs package (as appropriate) on an annual basis. - QRTs capture information on balance sheet, off-balance sheet items, detailed listings of asset portfolios (including derivatives), SCR, MCR, technical provisions, variation analysis and reinsurance. - There are specific reporting requirements at a ring fenced fund level and the material matching portfolio level. - The PRA has decided that only Category 4 and Category 5 firms would be eligible for quarterly reporting exemptions. - Exemptions may be granted when certain criteria are met (subject to 20 percent of market share cap). - Under Article 35 (6) and (7) of the Directive, the PRA set out its approach in SS11/15 “Solvency II regulatory reporting and exemptions.” - The PRA has decided not to exercise any discretion under Article 35 (7) regarding item-by-item reporting—i.e., all Solvency II firms and groups are required to submit a detailed list of assets on an annual basis. - All Category 1 to 3 firms are required to report to the PRA on a quarterly basis. ### Day 1 reporting and preparatory phase - Article 314 “transitional information requirements” of the “Solvency II Delegated Acts” sets out information required to be submitted by all Solvency II firms and groups at the first day of Solvency II application (once-only submission). - Firms are required to report their opening valuation of assets and liabilities (explaining differences in comparison with Solvency I), opening SCR, MCR and own funds. - Submission is via templates defined in Article 5 (solo) and Article 22 (groups) of the “Solvency II Supervisory Reporting ITS,” together with a narrative report explaining valuation differences to Solvency I. - Under EIOPA Guidelines, the PRA is required to “review and evaluate the quality of the information submitted and progress made by firms.” - The PRA required all Category 1 to 3 firms to take part in the preparatory phase, reaching well over 80 percent market coverage. - Each firm was required to make one annual submission, based on December 31, 2014 year-end; and one quarterly submission, for 3rd quarter of 2015 year end (e.g., September 30, 2015). ### Data challenges and recommendations - The large amount of detailed data will be a challenge despite long preparation. - Recommendation: The PRA should develop over time appropriate tools to exploit the data to enhance thematic and outlier approaches. - Recommendation: Continue compiling time series for the currently reported statistics. ### Stability of the insurance sector — market structure and performance (key statistics) - The life insurance premium in the U.K. accounts for almost 9 percent of the world’s life insurance premium and 5.5 percent of the world nonlife premium. - Insurance penetration is fifty percent higher than in the EU or other advanced markets. - Expenditure per capita in insurance: USD 5,429 in the U.K. versus USD 3,815 in other advanced markets. - Around 600 insurers operate in the U.K. - Current annual premium amounts to GBP 233 billion (GBP 140 billion life and GBP 83 billion nonlife). - Total assets held by the sector: GBP 2,161 trillion, of which GBP 1,882 billion correspond to life insurance and GBP 279 billion to nonlife business. - The estimated occupational pension fund sector is GBP 1.4 trillion. - The top 10 individual U.K. authorized insurers account for 60 percent of the life market but only 37 percent of the nonlife market. - Life gross premiums by year: - 2010: 144,703 - 2011: 140,895 - 2012: 161,635 - 2013: 149,371 - 2014: 139,785 - Life total assets by year: - 2010: 1,716,853 - 2011: 1,635,956 - 2012: 1,714,351 - 2013: 1,784,213 - 2014: 1,882,131 - Nonlife gross premiums by year: - 2010: 76,393 - 2011: 78,220 - 2012: 81,287 - 2013: 84,561 - 2014: 82,951 - Nonlife total assets by year: - 2010: 252,548 - 2011: 280,343 - 2012: 286,169 - 2013: 281,332 - 2014: 278,874 - Life insurance — market concentration (top life firms, Total Assets and % of industry): - Legal & General (Pensions Management) 260,944.76 — 16.0 - Standard Life Assurance 137,119.82 — 8.4 - Prudential 127,149.63 — 7.8 - BlackRock Life 102,411.11 — 6.3 - Aviva Life & Pensions UK 98,848.54 — 6.0 - Royal London Mutual Insurance Society 62,191.79 — 3.8 - Friends Life 62,014.51 — 3.8 - Scottish Equitable 57,221.50 — 3.5 - Legal & General Assurance Society 46,203.29 — 2.8 - Managed Pension Funds 38,440.92 — 2.4 - Nonlife insurance — top individual firms (Total Premiums and % of industry): - AIG Europe 4,835.63 — 6.0 - Aviva Ins 4,708.35 — 5.9 - Royal&SA Ins 3,896.44 — 4.9 - AXA Ins UK 3,292.92 — 4.1 - UK Ins 3,099.01 — 3.9 - ACE European Grp 2,322.94 — 2.9 - BUPA Ins 2,217.13 — 2.8 - Allianz Ins 2,088.14 — 2.6 - Great Lakes UK 1,949.96 — 2.4 - QBE Ins Europe 1,400.07 — 1.7 ### Insurance product trends and investments - Life insurance product gross premiums (selected figures, GBP million): - Total gross premiums written (Life) 2011: 140,895.23; 2012: 161,634.58; 2013: 149,370.74; 2014: 139,785.2 - Unit-linked (Domestic risks) 2011: 105,387.1; 2012: 118,060.35; 2013: 110,701.33; 2014: 101,439.99 - Annuities (Domestic risks) 2011: 16,704.52; 2012: 24,163.3; 2013: 20,838.33; 2014: 22,473.76 - Note: The main driver of life premium volatility were changes in occupational pensions that now make up approximately 60 percent of the entire U.K. life business excluding unit link products, up from 50 percent in 2011. - Fewer participating and nonparticipating policies have been sold, reflecting a reduction in premium of 15 percent since 2011. - Individual annuity and impaired annuity business are declining but have been replaced by annuity block transactions; the removal in 2014 of mandatory requirements for DC pensioners to purchase an annuity at retirement is effective as of April 2015. - Nonlife insurance product gross premiums (selected figures, GBP million): - Total gross premiums written (Nonlife) 2011: 78,219.88; 2012: 81,287.18; 2013: 84,561.27; 2014: 82,951.3 - Property 2011: 19,050.05; 2012: 20,079.52; 2013: 20,884.11; 2014: 20,145.49 - Motor 2011: 13,524.54; 2012: 13,344.77; 2013: 12,860.46; 2014: 12,594.93 - Liabilities 2011: 10,933.02; 2012: 11,428.47; 2013: 13,171.77; 2014: 13,665.11 - Reinsurance 2011: 12,650.81; 2012: 13,316.82; 2013: 13,520.53; 2014: 13,657.2 - Note: Nonlife insurers view the U.K. as a saturated market and expect future growth mainly from overseas business. - Investments (2014, and trends): - Total investments in 2014: GBP 1.7 trillion or 92 percent of GDP. - 71 percent of investments correspond to assets that support unit linked business (up from 60 percent in 2010). - Of the 29 percent of other investments belonging to insurers, 72 percent is invested in bonds. - Percentage of investments in derivatives remains around one percent. - Nonlife investments (In GBP millions and percent of total investments): - Investments in 2014: 164,844 - Government securities as percent of total investments: 32.15 - Corporate securities as percent of total investments: 46.31 - Equities as percent of total investments: 13.27 - Real estate and real-estate related as percent of total investments: 1.51 - Cash and bank balances as percent of total investments: 8.77 - Other Investment Assets as percent of total investments: 9.74 - Collective Investment Schemes: 8.67 - Derivatives: 0.20 - Loans: 0.78 - Other Investment Assets: 0.09 *Italic: Extracted from the United Kingdom section of the IMF staff report PDF content unit _cr16158.* ### 102. The low interest rate environment has eroded investment returns but U.K. insurers ### The low interest rate environment has eroded investment returns but U.K. insurers remain resilient ### Investment returns and insurers’ responses - Persistently low interest rates have significantly impacted investment profits of insurers worldwide and in the U.K. - Life insurers’ responses: - Tightened asset-liability duration matching (the duration gap was less than one year in May 2014). - Lowered guarantees offered (0.5 percent averaged weighted guaranteed rate). - Moved into unit linked products where the policyholder carries the return risk. - Nonlife insurers have improved underwriting losses, in particular motor insurance results. - Vulnerabilities noted: - Diminishing attractiveness of life products leading to fewer new business. - Delicate situation in the EU of insurers increases contagion and reputational risk for U.K. insurers. ### United Kingdom: Life insurance investments (key figures from Table 8) - Investments in GBP millions: - 2010: 1,388,628 - 2011: 1,383,219 - 2012: 1,442,940 - 2013: 1,501,008 - 2014: 1,559,076 - Composition (in percent of total investments) selected items: - Government securities: 8.64 (2010), 9.19 (2011), 8.49 (2012), 7.52 (2013), 8.20 (2014) - Corporate securities: 11.79 (2010), 12.13 (2011), 13.43 (2012), 12.97 (2013), 12.96 (2014) - Equities: 6.81 (2010), 5.90 (2011), 5.43 (2012), 5.34 (2013), 5.36 (2014) - Real estate and real-estate related: 1.53 (2010), 1.51 (2011), 1.42 (2012), 1.39 (2013), 1.50 (2014) - Cash and bank balances: 2.05 (2010), 1.99 (2011), 2.00 (2012), 2.12 (2013), 2.24 (2014) - Investments supporting unit-linked: 59.96 (2010), 58.92 (2011), 62.63 (2012), 68.40 (2013), 71.18 (2014) - Other Investment Assets: 9.21 (2010), 9.99 (2011), 10.52 (2012), 10.37 (2013), 10.83 (2014) - Collective Investment Schemes: 6.66 (2010), 6.63 (2011), 7.23 (2012), 7.10 (2013), 6.82 (2014) - Derivatives: 0.64 (2010), 1.07 (2011), 0.92 (2012), 0.68 (2013), 1.17 (2014) - Loans: 1.87 (2010), 2.21 (2011), 2.31 (2012), 2.55 (2013), 2.77 (2014) - Other Investment Assets: 0.04 (2010), 0.08 (2011), 0.06 (2012), 0.04 (2013), 0.07 (2014) ### Credit quality and allocation trends - Shift to lower-rated bonds 2010–2015 described as small and gradual; may reflect retaining downgraded securities or lack of supply of highest investment grade securities rather than uncontrolled search for yield. - BBB rated sterling corporate bonds increased from 21 percent to 32 percent (2010 to 2014). - Life investments in BBB corporate bonds increased from 27 percent to 35 percent (2010 to 2014). ### Alternative capital, reinsurance market dynamics, and pricing pressures - Absence of large insured catastrophic events has attracted alternative capital to reinsurance and high exposure risks operations. - Globally, alternative capital increased from USD 20 billion in 2010 to USD 60 billion in 2015 (available reinsurance capacity). - Premium income rates written in the U.K. have fallen by 10 percent to 15 percent for property catastrophe insurance for the third consecutive year. - Risks concentrated in reinsurers; as soft market conditions continue, risks likely to migrate to direct insurers (commercial and retail). - Further softening in terms and conditions could increase future loss payments, leading to reserve deterioration and impact on capital. ### Nonlife underwriting and profitability (selected observations) - Nonlife underwriting results improved, particularly in motor insurance (2009–2014 data referenced). - General insurers’ profits from investment activities tracked 2000–2014 (data to end-2014; general insurers exclude Lloyd’s of London). ### G-SIIs supervision, recovery, and resolution - U.K. is home supervisor of two of the nine designated G-SIIs and advanced supervision in line with FSB guidance. - G-SII deliverables developed: - SRMP, Liquidity Risk Management Plan (LRMP), and Recovery and Resolution Plan (RCP). - Group-wide liquidity monitoring with monthly reports and stress scenarios to the PRA. - PRA and CMGs produced resolution strategies; resolvability assessments scheduled by end-2016 and development of institution-specific cross-border cooperation agreements (COAGs). - PRA timetable to implement the BCR and Higher Loss Absorbency (HLA) follows the FSB timetable: - Confidential (voluntary) reporting of the BCR will commence as part of the IAIS field testing (2015–2018). - BCR and HLA requirements to be applied to all G-SIIs designated in November 2017 and in future years (January 2019). - Implementation depends on developing necessary EU-wide legislation in a timely manner. - Capital implications under HLA proposal: - Traditional insurance activities: capital surcharges between 6 percent and 13.5 percent. - Nontraditional noninsurance activities: surcharges between 8.5 percent and 27 percent. - G-SIIs (including Aviva and Prudential) expected to hold capital resources at least equal to the sum of the BCR and HLA requirements at the group level. ### Stress testing and scenario outcomes - PRA’s supervisory approach supported by comprehensive stress testing requirements (GENPRU 1.2.42 to 1.2.59 and SYSC 20 including SYSC 20.2.22). - Market-wide stress tests carried out, including EIOPA stress test in 2014 and PRA nonlife stress test in 2015. - EIOPA 2014 stress test: - Covered 19 different scenarios (core and low yield modules including prolonged low interest rates and snapback in yield curves). - All scenarios undertaken on a ‘best efforts’ Solvency II standard formula basis. - For U.K. participants: only in 2 of the 19 stress scenarios did aggregate capital fall below solvency requirements. - U.K. insurers most significantly impacted by the mass lapse, longevity, and provision deficiency stresses. - Tests exploring low yield environment on U.K.-regulated solo insurance entities had positive results, reflecting progress in asset-liability matching practices. ### Interest rate risk and scenario implications - A sharp increase in interest rates would have both direct and indirect effects: - Rising interest rates would generally benefit insurers’ business models. - Substantial increases in credit spreads for corporate bonds could materially affect life insurers, particularly annuities with large corporate bond portfolios. - Life insurers are generally well cash-flow matched and use market-consistent valuation; relatively insensitive to upward shifts of the risk-free yield curve. - Nonlife insurers are generally less vulnerable to interest rate risk. - Established insurers might lose new business to newcomers if they leave positions unhedged to new higher interest bearing instruments. ### Interlinkages, asset allocation, and geographic exposures - Insurance sector interlinkages monitored by the FPC and the PRA due to the sector’s role in risk transfer and provision of long-term investment. - Insurers are liability-driven investors; asset allocation must ensure duration matching and adequate investment return. - As significant investors in bonds and equities, insurers could exacerbate asset price falls (e.g., by fire sales). - Investment assets are generally well diversified. - Insurers’ exposure to overseas has grown to over 37 percent of all assets. - Largest U.K. groups have as much as 50 percent of their assets related to foreign operations. - Geographic diversification protects against a U.K. downturn but could increase vulnerability to overseas economic shocks that need monitoring and stress testing. ### Nontraditional noninsurance (NTNI) activities and counterparty risks - NTNI activities involve maturity transformation, liquidity mismatch, or leverage (examples: products with liquid liabilities, derivatives, securities lending, complex hedging). - NTNI may increase insurers’ fragility and interconnectedness. - Longevity swaps and annuity block transactions have grown: - Grew from GBP 5.5 billion in 2010 to GBP 38.1 billion in 2014. - Transactions include buy-in/buy-out or swaps to transfer longevity risk from pension funds to insurers. - Counterparty risk can be important, especially when the ultimate risk carrier is in a jurisdiction with light regulatory requirements or where risk transfer is insufficient. *Source: Based on information provided by the authorities from PRA regulatory returns and the IMF staff report content.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16158.pdf_