Resolution regime for insurers

HM Treasury (HMT) is consulting until 20 April on a resolution regime for insurers (IRR). As anticipated in KPMG's 2022 paper A resolution framework for insurers — what can the industry expect?, HMT proposes a dedicated resolution framework for insurers and a new Resolution Authority (RA), housed within the Bank of England.

The RA has been tasked with:

1. Pre-resolution planning: conducting resolvability assessments and recovery and resolution planning (RRP) to ensure the RA has an executable strategy for dealing with a potential failure.
2. Exercising judgement (in consultation with the PRA, FCA and HMT), as to whether an insurer that is `failing or likely to fail' (FOLTF) should be subject to its new stabilisation powers (such as transfer to a third party or a bridge entity, and bail in) — and then deploying these. 

Failure of insurers in the UK has been a rare occurrence. The exits that have happened have been successfully managed primarily via solvent run offs and portfolio transfers under Part VII of the Financial Services and Market Act (FSMA). We envisage that these will continue to be the usual routes towards exit, with the IRR stabilisation powers only triggered in exceptional cases.

The reach of the IRR is intentionally broad, able to draw in all UK authorised insurers¹. Out of scope are insurers not subject to Solvency II, friendly societies, and Lloyd's and its market². However, HMT envisages only a subset of insurers to be subject to the IRR in practice.
RA-led preparation for resolution is primarily intended for systemically important firms. HMT points to the list of the UK firms designated as Internationally Active Insurance Groups (IAIGs) as a useful — but non-exhaustive — indicator of who might be caught. Insurers deemed to provide `critical functions' may also be asked to plan for a smooth exit and continued provision of these services to policyholders. Critical functions are only loosely defined in the consultation as those whose sudden discontinuation would be likely to disrupt services that are essential to the UK economy or endanger the financial stability of the UK.

The RA would also need to exercise judgement, largely based on a public interest assessment, at the point of FOLTF as to whether to take charge of the insurer's resolution and apply stabilisation powers or let the usual winding down or insolvency processes run their course. Again, HMT envisages that only a small number of cases would require recourse to the RA tools.

The IRR has parallels to the resolution regime for banks (Part 1 of the Banking Act) and the EU's proposed Insurance Recovery and Resolution Directive (IDD). It also closely mirrors the framework set out in the Financial Stability Board's paper on Key Attributes of effective resolution regimes for financial institutions.

There are some notable differences, however, including the absence of a minimum requirement for own funds and eligible liabilities as in bank resolution reflecting the different structure and risk profile of an insurer's balance sheet, and the addition of tools specific to the restructuring of insurance liabilities.

The IRR would sit on top of existing approaches to recovery and resolution, including:

• Existing — and about to be expanded — PRA requirements to prepare for recovery and exit.
• PRA's `ladder of intervention' powers under Solvency II.
• Insolvency regime for insurers currently being modified as part of the Financial Services and Markets Bill (FSMB), the implementation of which the PRA is currently consulting on.

Insurers will effectively face a two-tier system for recovery and resolution planning and exit. Firms deemed systemically important, particularly complex or as providing critical services will be subject to scrutiny by new RA (as well as the PRA). The remainder will continue to be in the PRA's domain and should keep an eye out for a consultation later in 2023 which is expected to extend and clarify expectations. This is consistent with the PRA's `Dear CEO' letter to insurers, which highlighted its expectation for smaller insurers to consider how they might exit the market.

As ever, the extent and degree of impact will depend on the supervisory approach, and the consultation leaves open important aspects such as the precise definition of systemic insurer and critical services. Insurers in the grey area will want to have clarity as soon as possible as to whether they are within the RA's remit, but all firms would benefit from early preparation and regulatory engagement on their recovery and resolution plans given this is a key area of supervisory focus.

Insurers would benefit from being proactive in demonstrating how any potential barriers to resolvability can be mitigated or resolved, rather than waiting for enforceable direction from the RA.

Firms could get on the front foot by:

• Considering governance and resourcing arrangements to effectively engage with the RA on information requests, simulation exercises and operational assessments.
• Reviewing existing recovering and resolution plans and mapping out to what extent they demonstrate readiness for the application of the stabilisation powers. Elements such as corporate structure, contractual features, outsourcing and operational processes may be covered already but require an additional level of analysis to assess for barriers to resolvability.
• Assessing the challenges of preparing for the valuation of balance sheets in distress, particularly life insurers with long-term liabilities and assets matched to support these.
• Considering if any of products or services could be deemed critical, via a two-step assessment of substitutability (do others in the market offer similar products or could easily take over their continued operation?) and policyholder impact of sudden withdrawal. Firms will then need to have an operational plan to ensure the critical products can continue operating — by being clear on the functions that underpin them (customer-facing services such as claims handling, internal functions such as finance, operations and HR, and including any third party providers) and how these can continue to support continued operation in times of distress. 

Given an increasingly complicated patchwork of requirements, insurers would benefit from their preparations dovetailing with related workstreams, including operational resilience. Similarly, firms may consider how the stress testing of operational continuity could interlink with simulation exercises of resolvability.

Finally, with two authorities involved in pre-exit planning, impacted insurers will be hoping for effective information sharing and commonality of purpose between the PRA and RA to avoid significant duplication. HMT envisages close cooperation between the PRA and RA on their recovery and resolution work but, in practice, a degree of overlap — or even divergence — may be inevitable given distinct, if complementary, statutory objectives.

After the consultation closes, HMT and the PRA will have some way to go to finalise the policy. The proposals would require legislative change, the granting of a delegated power to HMT to define critical functions and the development of a Code of Practice for the use of the Resolution tools.

As mentioned above, this would be in parallel to the modifications being made to the insurance insolvency framework as part of the FSMB. The PRA is also expected to consult this year on requirements for insurers to prepare exit plans — of broader applicability than the IRR.