Articles - Regulatory hot topics for 2022

It’s a new year and an opportunity for insurers to set their risk and regulatory priorities for the next 12 months. The PRA has given firms a clear steer as to what should be on the agenda, setting out their supervisory priorities in a January “Dear CEO letter”. Topics covered in the letter include; financial and operational resilience, climate change, D&I, Solvency II reform, and Brexit temporary permissions.

 By Edward Harrison, Senior Consultant at Lane Clark & Peacock
 This article explores the most immediate of these issues and sets out the actions insurers should consider taking to meet the PRA’s expectations.
 Financial resilience
 Inflationary risks have become a major concern over 2021 and the PRA notes that it expects inflation to “factor into prudent reserving decisions”. The implication is that firms should be able to set out and justify the appropriateness of inflation assumptions used in setting reserves.
 Quantifying the exact inflation assumption used in the best estimate may be challenging for insurers relying on methodologies that capture inflation implicitly, but it is clear from both the PRA and also Lloyd’s that insurers need to sharpen up their practices and take steps towards a more quantitative approach.
 Credit / counterparty risk is also on the PRA’s agenda. The economic uncertainty following Covid-19 has increased the risk of rating downgrades and potential insolvencies, which the PRA sees as posing an increased risk to insurers in 2022.
 The management and modelling of credit / counter-party default risk has historically not been subject to the same degree of scrutiny as premium and reserve risks at most insurers. It seems the PRA will be expecting firms to tighten up in this area, with a particular focus on setting appropriate risk appetites and conducting thorough stress and scenario testing on key counterparties.
 Finally, the PRA also looks likely to focus on insurers’ exposure management processes, noting some of the systemic losses arising from the Covid-19 pandemic. A key focus area looks to be liability risks, where exposure management approaches are much less mature than for physical risks. The PRA’s main concern here seems to be the robustness of exclusionary language in insurers’ policy wordings – designed to protect from aggregations of liability risk.
 Operational resilience
 2022 marks the “end of the beginning” for operational resilience, with the SS1/21 implementation period ending on 31st March. The regulatory focus on operational resilience is a natural complement to Solvency II:
 • Solvency II: focus on ensuring firms can withstand extreme stresses financially.
 • Operational resilience: focus on ensuring firms’ important business processes can withstand significant disruption.
 From a policyholder’s perspective, operational resilience is as important as financial resilience. For example, it is of limited use for an insurer to financially survive a large scale cyber attack, only to find itself unable to administer any claims for months on end.
 In simple terms, the new operational resilience rules require insurers to:
 1. Identify their important business services and map out key people, processes, data and systems that are critical to that service.
 2. Assess the “impact tolerance” of each of those business services; ie how much disruption those processes should be able to withstand before they pose a risk to a firm’s safety and soundness or cause intolerable harm to policyholders.
 3. Perform scenario testing to ensure that critical business services don’t breach their impact tolerances, even in relatively severe situations.
 The PRA expects firms to have identified their business services and set impact tolerances prior to the 31st March. From this point, there follows a 3 year transition period where firms will need to invest and develop their key business functions to ensure they are resilient against severe but plausible stresses.
 The ultimate objective is to ensure that by 31st March 2025, insurers’ important business functions are fully resilient against relatively extreme stresses.
 Climate change
 Over the past year, insurers’ have been focussing on meeting the requirements of the PRA’s 2019 supervisory statement (SS3/19).
 As a reminder, broadly those expectations were:
 • To place responsibility for managing climate change risks with a suitable person under the Senior Managers’ regime.
 • To embed the monitoring and management of climate change risk within the risk management framework, and to set out a range of appropriate KPIs to monitor climate risk.
 • To perform stress and scenario testing of climate risks over a suitably long time horizon.
 • To put in place appropriate climate change disclosures in regulatory reporting.
 In this latest letter, the PRA notes the quality of climate risk management varies considerably from firm to firm. Going forward, the PRA will be incorporating climate change risks into the regular supervisory cycle for insurers, so insurers can expect more regular scrutiny of their approaches.
 The PRA also hints at expectations on firms to enhance their climate change risk management beyond the SS3/19 requirements. For example, the PRA notes that “firms should take a forward-looking, strategic and ambitious approach in managing climate-related financial risks across their business, including in both underwriting and investment.” Aside from the language feeling aspirational, the focus on managing climate risks in underwriting suggests there may be a greater focus on the carbon footprint of the risks insurers choose to underwrite in the future.
 Regulatory outlook
 With inflation risk, credit risk, operational resilience and climate change making up just part of a packed regulatory agenda, it certainly looks to be a busy year for insurers from a risk and regulation perspective.
 It’s a busy year too for the PRA, with feedback due from the 2021 Climate Biennial Exploratory Scenario and the 2022 Insurance Stress Test to conduct, as well as ongoing work reviewing amendments to the on-shored version of Solvency II.
 However you look at it, there’s likely to be a lot of focus on regulation in the coming year, and that’s without even mentioning Downing Street parties!

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