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PRA updates insurers’ investment management requirements

Insurance Consulting and Technology
Insurer Solutions

By Alberto Scarsini , Gareth Sutcliffe and Nambassa Nakatudde | July 21, 2020

Through its Policy Statement 14/20, the PRA requires companies to review their interpretations of the Prudent Person Principle requirements of CP 22/19.

In October 2019, we published an article on the changes proposed by the Prudential Regulation Authority (PRA) in a consultation paper (CP 22/19) on the supervisory statement (SS) ‘Solvency II: Prudent Person Principle (PPP)’. We previously commented on what this might mean for insurers’ investments and their risk management systems of governance. This article provides an update to our earlier piece, detailing where the PRA has made amendments to the draft policy in the construction of ‘Policy Statement 14/20’.

Changes made to the draft policy reemphasise the requirements for companies to possess robust investment risk management frameworks and to develop a better understanding of more complex risks, such as, climate risks (physical and transitional) and valuation uncertainty risks for investments in illiquid assets. Companies are also expected to further elaborate stress testing and scenario analysis to better assess robustness and diversification of their asset portfolios based on risk appetite and solvency levels.

Recent turmoil on financial markets and possible long-term structural implications caused by the tragedy of COVID-19 means that companies will have to reconsider appropriateness of their investment risk strategies, diversification levels of their asset portfolios and sustainability of their liquidity plans under a new set of economic scenarios and assumptions.

Background

The Policy Statement came into effect on 27 May 2020, with the aim of building on the clarification provided by the PRA on inconsistency in PPP understanding and its application by companies, particularly in light of increased allocations to non-traded assets.

To recap, the original proposals in CP22/19 focused on:

  • investment governance and risk management framework
  • management of asset concentration in particular
  • management of holdings of non-traded-assets (including valuation uncertainty)
  • assets backing technical provisions and
  • intra-group loans and participations.

The PRA received responses to in seven key areas including: general expectations and objective standards, investment strategy, investment risk management, outsourcing, non-traded assets, valuation uncertainty, intragroup transactions and reinsurance.

Changes to the draft policy

After considering these industry responses, the most significant changes made to the draft policy involve amendments and clarification on:

  1. objective standards,
  2. the extent of risk management and outsourcing expectations
  3. the distinction between valuation uncertainty at a point in time, and uncertainty over the realisable value of an asset under stress.

  1. 01

    Objective standards

    Responses received by the PRA reflected general uncertainty as to the meaning of objective standards for investment. In response, the PRA has amended the wording of the SS to clarify that the objective basis of the PPP does not imply the same investment policy, or the same quantitative investment limits for distinct companies. Hence, the PRA framework for supervising compliance with the PPP does not include quantitative benchmarks. Objectivity needs to be assessed from the standpoint of the hypothetical prudent person in similar circumstances rather than a company’s subjective view about the prudence of its investment standards. In doing so, companies are expected to pass a test that is analogous to the ‘reasonable person’ test that applies in criminal and civil law.

    In addition, the PRA has explicitly clarified that the expectations in the SS should be applied at a portfolio level or at a more granular level and should be specific to company circumstances with consideration for the principle of proportionality. For example, companies must demonstrate compliance to the rule of investing in derivatives and quasi-derivatives only for cases of risk reduction and or efficient portfolio management for each asset and not at portfolio level.


  1. 02

    Risk management and outsourcing expectations

    The PRA expects companies to pay particular attention to several key risks (such as climate transition and political risk) in their investment risk management policies and has amended the SS to clarify this. Within this context, it details precisely what constitutes ‘moderate’ and ‘severe’ stress scenarios as dependent on individual company circumstances. The PRA expects a company to be able to demonstrate that solvency is not threatened in a severe stress scenario, and that it is able to recover from a severe shock and restore compliance with all its regulatory requirements.

    In the case of outsourcing, the PRA considers the onus to be on insurers to ensure their asset managers invest in line with the PPP, though the detail of how they achieve this is a matter for companies. Where investment management activity is outsourced, firms must have sufficient in-house expertise to appropriately monitor the risks associated with outsourcing – this may not always be the same level of expertise that would be required to manage the investments in-house.


  1. 03

    Valuation at a point in time, and over the realisable value of an asset under stress

    The PRA considers valuation uncertainty at a point in time to be distinct from uncertainty about the value of an asset that will be realised under stress. Following several consultation responses, the PRA has made amendments to clarify that although not all risks are captured in a company’s SCR (Solvency Capital Requirement), the expectation is that companies will have effective systems and controls in place to limit and manage their exposure to valuation uncertainty. This should include a framework for quantifying or grading their exposure to this risk.


Actions required

With the clarifications introduced by Policy Statement 14/20 to the Consultation Paper 22/19, companies are now required to review their original interpretations of the PPP requirements and conduct a gap analysis of their existing risk management system and governance to ensure that necessary expertise, systems and processes are in place to value the asset, and to identify, measure, manage, monitor, control and report associated risks.

The PRA also expects companies to improve their understanding of more complex risks, such as climate (physical and transitional) and political risks and to develop appropriate risk frameworks to avoid over-exposure to such risks.

How we can help

At Willis Towers Watson, we have an established team of experts in investment risk management and sustainability that can support you to;

  • Assess your risk management system and perform a gap analysis based on the latest PPP requirements and industry best practices
  • Review your investment strategy and develop economic scenarios to evaluate concentration risk and impacts on your risk appetite and solvency position
  • Develop climate risk policy to address reporting expectations, such as the Taskforce for Climate-related Disclosures (TCFD)
  • Review valuation of non-traded assets and risk modelling
  • Perform detailed analysis of your asset portfolio and assess security, quality, liquidity and profitability of your investments
Contacts

Alberto Scarsini
Director, Insurance Investment Team

Gareth Sutcliffe
Head of Insurance Investment Team

Nambassa Nakatudde
Lead Associate, Insurance Investment Team

Contact Us

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