This blog series is a practical guide on solvent exit planning for practitioners and those charged with governance. Part 5 explores proportionality.
Proportionality is a key concept in UK regulation. However, the regulatory authorities place the burden of determining what is proportionate on individual insurers with an expectation that they consider the nature, scale and complexity of their business and risk profile. This is no different for solvent exit analysis (SEA) and given the breadth of the regulations, this can be a difficult assessment for firms to make.
In determining a proportionate approach, insurers must ask themselves several questions. These include:
One of the biggest challenges for insurers is calibrating the level of detail for the underlying analysis. However, the answer to this is not one dimensional and will depend on several factors.
The below sets out some of the key considerations:
Firms must consider the difference between what is needed for an SEA and a solvent exit execution plan (SEEP), with a SEEP representing a much more detailed operational plan and only being required when the probability of needing to exit the market is increased.
It is therefore reasonable that a firm that is operating closer to its point of non-viability (or with significant underlying sensitivity to drivers of the point of non-viability) may need to undertake more detailed analysis to give increased confidence over the ability to exit the market in an orderly manner.
While regulatory expectations dictate that all firms, regardless of size, will need to conduct some level of quantitative analysis, firms with more complex business and risk profiles are likely to need to consider a greater degree of qualitative analysis.
Where firms, due to the business structure, risk mix, operating model, or existence of significant barriers, have less confidence over the ability to solvently exit the market, greater quantitative analysis is likely to be required to test the sensitivity of assumptions.
Where an insurer has recently made material changes to its business model (for example new products, new distribution channels or new strategy) or there has been a material change to the risk profile (for example through an acquisition, portfolio transfer or new internal model), it is reasonable to expect a greater degree of analysis focused on these changes and their impact on the ability to solvently exit.
Like with the ORSA, an insurer that is subject to such changes of cycle (that is, between 3 yearly refreshes) is expected to refresh the SEA analysis. Firms may choose to focus the analysis on these elements and perform ‘deep dive’ type analysis to better understand the changing dynamics.
Where an insurer identifies that one aspect of SEA is more complex than others – for example, complex intragroup transactions, non-standard supplier contract clauses, existence of critical economic functions – it is reasonable to expect a greater degree of analysis of the complex issue.
This more detailed analysis will be dependent on the nature of the complexity, but examples include:
As well as business and risk profile related factors, the perspective of key stakeholders may create the need for greater levels of detail. For example:
The Prudential Regulation Authority (PRA) has been clear that it expects firms to perform both quantitative and qualitative analysis as part of its solvent exit analysis. Within this, an assessment is required of the minimum level of financial resources required to support a full run-off of liabilities.
Therefore, firms need to quantitatively assess key financial metrics (such as SCR coverage ratio and liquidity coverage ratio) over the run-off period to identify the dynamics within run-off and the degree of confidence of a solvent exit under a variety of assumptions. This includes the need to project these metrics using a reasonable methodology, which itself should be proportionate to the nature, scale and complexity of the insurer and risk profile.
As a minimum, insurers will need to develop a base case run-off scenario that is consistent with its identified point of non-viability. In practice, most firms will model a stressed run-off, but the PRA also requires firms to consider a non-stressed run-off. Whether to model both quantitatively speaks to the question of proportionality and is a choice to be made by each firm. However, for smaller insurers it may be reasonable to consider a non-stressed run-off qualitatively on the basis that it is likely to be less onerous than a stressed run-off.
Whether to model more than one scenario – for larger insurers, exposed to a diverse and complex set of risks, it may be appropriate to model scenarios that represent different drivers of the point of non-viability. However, for smaller or less complex insurers, it may be reasonable to model a reduced number of scenarios quantitatively – representative of all solvent exits – while considering differences in drivers through qualitative analysis.
Whether to model the impact of different assumptions – similar to modelling more than one scenario, insurers for which the viability of solvent exit is particularly sensitive to one or two central assumptions may choose to quantitatively analyse such a sensitivity. Whereas other insurers may simply choose to comment on the sensitivity to certain assumptions qualitatively.
Whether to model more than one exit strategy – the PRA requires firms to consider a full run-off of liabilities, however for many insurers (particularly smaller ones where economies of scale would be quickly lost in runoff) it is realistic to think that in a closure to new business scenario there would still be value in the underlying portfolios and that they would wish to pursue a sale, reinsurance or renewal rights transaction. Some firms may choose to document such a strategy within the SEA as an alternative to a run-off of liabilities, and in some cases the firm may wish to analyse this quantitatively (for example with different actions, assumptions and costs). Others may choose to include a qualitative discussion of such analysis, or not at all.
