Insurer regulation in the UK
Andrew Stoker
All companies carrying out insurance business in the UK are authorised by the Prudential Regulation Authority (PRA) and regulated by both the PRA and Financial Conduct Authority (FCA). In this article we describe the key powers and requirements of the regulation landscape for insurance companies in the UK.
The regulatory landscape for insurers
The PRA and FCA have extensive powers to supervise and intervene in the affairs of insurers to protect policyholders.
This includes the ability to sanction companies and individuals. Any change in control of an insurer must be approved by the PRA who must also consult with the FCA.
Insurers must comply with the Financial Services and Markets Act 2000 as well as the rules made by the PRA and the FCA. Prudential standards require (amongst other things) that insurers are suitably resourced and that they have appropriate risk management systems and controls. The Senior Managers & Certification Regime ensures that the appointment of key individuals is subject to regulatory approval and ensures individual accountability. Conduct of business rules make sure that business is conducted fairly.
The PRA and FCA have extensive powers to supervise and intervene in the affairs of insurers to protect policyholders.
The Solvency II regime
From 1 January 2016 insurers have been subject to the Solvency II regime which will still apply post-Brexit unless alternative rules are adopted.
The regime has three pillars:
- PILLAR 1: quantitative requirements covering the amount of capital an insurer should hold
- PILLAR 2: qualitative requirements in relation to risk management and supervisory activities
- PILLAR 3: enhanced public and supervisory disclosure. For example, all insurers are required to publish a Solvency and Financial Condition Report setting out information in relation to governance, risk management and solvency.
Under Pillar 1, insurers are required to hold sufficient assets to cover:
- Their technical provisions which consist of a best estimate of their liabilities plus a risk margin. The risk margin is intended to be the discounted value of the future cost-of-capital relating to risks (other than hedgeable market risks) required to be held under Solvency II; and
- Capital required to have 99.5% confidence that the insurer could survive extreme losses over the course of a year (the solvency capital requirement). For insurers writing life assurance or travel insurance that might be the impact of a pandemic such as Covid-19. For annuity providers, it could be the impact of a financial crisis.
Liabilities must generally be discounted at a risk-free rate of interest but insurers with illiquid liabilities such as annuities are permitted to discount their liabilities using the risk-free rate plus an illiquidity premium (the matching adjustment) derived from the risk-adjusted yield on the assets backing the liabilities. In order to qualify, these assets must have fixed cashflows, i.e. be assets such as corporate bonds and gilts. Assets such as equities and property would not be eligible. And of course, to the extent that insurers invest in riskier assets they must also hold additional solvency risk capital. In addition, insurers are required to abide by the prudent person principles when making investments. These ensure that insurers only invest in assets whose risks they can properly identify, measure, monitor, manage, control and report.
Insurers must hold enough capital to have 99.5% confidence that they could survive the most extreme expected losses over the course of a year
Risk management and interventions
The board of the insurer determines its risk appetite – the risks it is prepared to take, the risks it wants to minimise and the solvency range it wants to target. Insurance companies are required to put in place recovery plans which would automatically be triggered were solvency to fall below a company’s target operating range. Plans might include cancelling dividends, raising new equity or debt, cutting costs, ceasing to write new business, reinsuring more or making changes to investment strategy.
Ultimately, in the event of problems, the PRA has extensive powers to intervene including the ability to prevent dividends and to revoke approval to write new business.
About the author
Andrew Stoker
Andrew is Rothesay’s Chief Financial Officer. He joined Rothesay in 2014 and is responsible for the finance and actuarial functions. Andrew was previously a partner in EY’s risk and actuarial practice and prior to that was Chief Actuary at Lucida plc. Andrew has also held roles at PwC, Tillinghast and Legal & General.
Andrew is an Associate Trustee of the Great Ormond Street Hospital Children’s Charity.