The UK general insurance prudential regulator’s five key concerns and why they matter
The UK’s Prudential Regulation Authority (PRA) sent two letters late last year to the general insurance market: one Dear Chief Actuary letter and one Dear CEO letter. These letters outline findings from the PRA’s latest reserve reviews and priority areas for general insurance supervision.
This blog highlights five key themes from these PRA letters and from our broader experience of the regulator’s perspectives and priorities. In summary, we expect general insurers will see the following themes raised increasingly frequently by the PRA in 2020:
- Reserve adequacy: The PRA has observed material reserve strengthening by some firms, and emerging risks particularly in US casualty lines, medical malpractice and general liability classes of business. The PRA has signalled it is ready to adopt a more interventionist supervisory approach to address its concerns in this area.
- Culture and conduct: the FCA has been actively pursuing concerns about culture and customer outcome standards in the general insurance sector.1 However, the PRA is also becoming increasingly concerned about such issues where they may have prudential implications.
- Market conditions coupled with persistent catastrophe losses: the PRA continues to be concerned about the profitability implications of soft market conditions. Despite signs of hardening market conditions, the PRA will continue to focus on firms’ remediation plans and exposure management as well as investment strategies.
- Cyber underwriting risk: the PRA has led the way globally in the regulation of cyber underwriting, with a particular focus on silent cyber risk. As the PRA, EIOPA and Lloyd’s of London develop their cyber insurance regulatory frameworks, firms should expect further scrutiny in this area.
- Climate change: the PRA has been gathering comprehensive information from firms on different aspects of their management of climate change in the past year, and is likely to use this to support market feedback or more formal supervisory guidance.
Detailed analysis – what firms may expect from the PRA
1. Reserve adequacy
The PRA has been concerned about the adequacy of firms’ reserves for several years. In 2018 the PRA highlighted potential weakening in casualty case reserves in particular, which it observed could point to potential future reserve deterioration. The 2019 Dear CEO letter specifically notes reported material reserve strengthening by some firms, and increasing areas of emerging risk in some US casualty lines such as financial and professional lines, medical malpractice and general liability classes of business. Casualty lines of business have also been included in the PRA’s recent reserve reviews.
This may not come as a surprise to many, given that casualty lines have historically been problematic for insurers. For example, it was partly casualty policies, in the form of a surge in US general liability claims related to asbestosis and pollution, which lead to significant challenges for Lloyd’s of London in the 1990s.”
Firms with what the PRA characterises as “material exposures to longer-tail casualty lines, who show a poor track record for reserving developments compared with initial assumptions, and those who have shown rapid growth” should thus be prepared for a more interventionist supervisory approach. Specifically, the PRA states that it will consider the use of s.166 skilled persons’ reviews of the adequacy of firms’ reserving governance, controls and reserving levels.
2. Culture and conduct
The PRA has shown increasing interest in the prudential implications of cultural and conduct weaknesses. The Dear CEO letter stresses the need to address corporate culture and individual behaviour issues within the London Market. The letter also re-iterated a point made in a speech by Anna Sweeney, one of the PRA’s Executive Directors of Insurance, which stated that instances of non-financial misconduct could speak to personal integrity and may have implications under the SMCR regime for the PRA’s view of the fitness and propriety of individuals.
This chimes with the FCA’s recent Dear CEO letter to general insurers restating its expectation that firms tackle misconduct and its associated poor culture. As the Pricing Market Study and Distribution Chain Reviews have demonstrated, the FCA is increasingly using tools such as price intervention and SMCR accountability provisions to tackle some of these issues. The two UK regulators appear to be following a highly coordinated and complementary approach in this area.
3. Pricing and investment strategy responses to market conditions
Soft market conditions, coupled with catastrophe losses in 2017 and 2018, have put a strain on general insurers' profits from both an asset and liability point of view. This has meant that the PRA, together with Lloyd’s of London, have to date focused on firms’ business planning and associated remediation of under-performing books of business and this will undoubtedly continue despite recent signs of the market hardening. General insurance supervisors have so far been more focused on how current market conditions are affecting insurers’ underwriting activities compared to their investment activities. However, this year’s expected supervisory statement on the Prudent Person Principle (PPP) is likely to prompt further supervisory scrutiny of firms’ investment strategies, especially as firms increasingly “search for yield” in the low interest rate environment.
Market conditions have been exacerbated by recent years’ catastrophe losses, which have prompted a series of exposure management reviews by the PRA. The PRA appears particularly worried about loss creep, referring to significant ongoing uncertainty in gross loss estimation related to, for example, the 2018/2019 Japanese typhoon losses. The PRA intends to undertake a sample review of firms’ exposure management approaches to assess the adequacy of firms’ aggregated risk quantification against the changing characteristics of natural and man-made perils. The PRA also highlights concerns about data quality and model risk management in relation to the changing nature of both natural and man-made catastrophe risks, and we expect these to be pursued in supervisors’ practical review work, including in the climate change context.
4. Cyber underwriting risk
The PRA first raised its concerns about cyber underwriting risk in 2016 and was the first regulator to issue specific guidance to firms, for example a supervisory statement, on the topic. Cyber underwriting has now also gained traction at an international level, with EIOPA prioritising the establishment of a sound cyber insurance market in 2020 (a topic which we discuss further in our recent blog on EIOPA’s 2020 Work Programme). The PRA’s review work in this area is likely to remain intense as many firms are still at the early stages of understanding and managing their silent cyber risk exposures.
5. Climate change
This is of course a big focus area for the PRA and Bank of England more widely. The PRA has primarily been in an information-gathering mode over the past year, with general insurers having had to submit 1) input to the insurance stress test exercise, which included a climate change scenario; and 2) an initial plan to address the PRA’s expectations on climate change and an updated Senior Management Function (SMF) form, as per its policy statement. We expect the PRA increasingly to action its findings from this large amount of information gathered: formal supervisory guidance coupled with increasing on-site reviews, aimed at assessing the effectiveness of firms’ governance and risk management response to the PRA’s climate change requirements, are likely.
1 The FCA also recently sent two letters to the general insurance market; one Dear CEO letter and one Dear Board of Directors letter. Alongside these the FCA has been working on a General Insurance Pricing Market Study and a General Insurance Distribution Chain Review. These publications and initiatives allow us to see where the FCA’s general insurance conduct priorities lie and how these align with the PRA’s own conduct concerns.