Key points

Important supervisory guidance has been published by the PRA affecting bonus/incentive arrangements for senior employees of UK insurers.

  • A minimum of 40% of variable remuneration (bonus) must be deferred for a minimum period of three years.
  • The PRA is proposing a wide scope of individuals who will be covered by the remuneration rules.
  • An annual remuneration policy statement will be required, with some firms required to provide an initial statement by 30 September 2016.
  • The UK proposals are more stringent than in many other European jurisdictions but there are more onerous requirements in the Netherlands.
  • There are a number of practical steps outlined at the end of this note that insurers should consider.


Since 1 January 2016, UK insurance and re-insurance firms and groups within the scope of the Solvency II directive have been subject to the provisions of the European Commission's Delegated Regulation 2015/35. Among the provisions of the Regulation are obligations in relation to governance/employee remuneration including a requirement to establish and maintain remuneration policies and procedures which avoid conflicts of interest and promote sound and effective risk management, so as not to encourage excessive risk taking.

The Prudential Regulation Authority (PRA) has now issued a consultation paper seeking feedback on draft supervisory guidance on the Regulation's remuneration provisions. The supervisory guidance is intended to clarify PRA expectations of how firms should comply with relevant requirements such as identification of affected staff, deferral and performance measurement. The consultation closes on 2 June 2016.

PRA's draft guidance

Key points arising from the draft guidance are:

  • Firms must comply with both the Regulation's remuneration requirements and with EIOPA's 2015 'Guidelines on system of governance'.
  • The expectations set out in the draft guidance are limited to Category 1 and 2 firms (ie the UK's most significant insurers). However, smaller firms are still expected to 'give proper consideration' to the Regulation's requirements when designing remuneration policies. This aspect of the PRA's proposals follows the proportionate approach of the Regulation.
  • Firms with group structures should ensure that their remuneration policies are consistent across the group in line with its risk management strategies.
  • Firms are expected to carry out an identification process to ascertain which staff fall within the scope of the regime. The PRA expects that the following will be covered:
    • Board members
    • Executive Committee members
    • Senior Insurance Manager Function holders and Significant Influence Function holders
    • Key Function Holders
    • Material risk takers.
  • The PRA expects the 'Key Function Holder' category to encompass those with significant responsibility for risk management, compliance, actuarial and internal functions across all material business lines. It also expects firms to assess if there are other additional key functions of specific importance to their business such as investment, IT or claims management.
  • To identify those that fall within the 'Material Risk Taker' category, firms must develop consistent materiality thresholds across their identification process, including for example quantitative risk thresholds. To meet the standards expected, firms must identify both individuals who are able to take material risks and those who are able to influence material risk taking. A record must be kept for each performance year of the assessment made and the final list of staff identified.

The Regulation requires firms to defer a 'substantial portion of the variable remuneration component' for a period of not less than three years. The PRA guidance:

  • Clarifies that the 'variable remuneration component' is the aggregate amount awarded in a performance year from bonus plans, long term investment plans or any other variable remuneration plans.
  • Notes that the three year deferral period is the minimum and firms should set the deferral period at a length which aligns with its business, risks and activities.
  • Specifies that it believes that a minimum of 40% represents a 'substantial portion' of variable remuneration and recommends use of this as a minimum deferral threshold.
  • Recommends that firms should ensure that, where there are specific risk management failures, they are able to apply downwards adjustments to awards during the three year deferral period before vesting.

It is interesting to note that the PRA has selected 40% of variable remuneration as the appropriate minimum deferral threshold. Not only does this represent current industry practice but it aligns with the threshold used in the banking industry where the relevant legislation specifically specifies a 40% threshold. In general, however, the remuneration rules which apply to the insurance industry are not as rigid or detailed as those that apply to bankers under the CRD IV regime where there is, for example, a cap on variable remuneration (which, in general, may not exceed 100% of fixed remuneration) as well as scope for up to 60% of remuneration to be deferred and for the deferral period to be as long as 7 years.

  • To implement the Regulation's requirement that variable remuneration awards must be based on performance criteria, including non-financial criteria related to adherence to effective risk management, the guidance:
    • Recommends use of risk-adjusted metrics alongside regular discretionary factors.
    • Recommends that individual performance assessment should be based on a balanced scorecard comprising financial and non-financial criteria.
    • Requires termination payments to be fair and proportionate relative to prior performance.
  • Firms will be required to demonstrate how their policies, practices and procedures meet the requirements of the Regulation and of the PRA guidance. The PRA has designed a remuneration policy statement (RPS) which firms can, but don't have to, use to provide the required information. Firms with an accounting reference date of 31 December 2016 must provide information by 30 September 2016. Firms with an accounting date of later than 31 December 2016 must provide the information no later than 9 months after the end of the preceding financial year.
  • Assessing compliance with the remuneration rules will be part of the supervisory activities which the PRA undertakes generally in relation to insurance firms. As is made clear in its Statement of Approach to the Supervision of Insurers, the PRA requires firms to be open and straightforward in their dealings with the PRA. In terms of cooperation in relation to remuneration requirements, the draft supervisory statement makes clear that, for example, firms will be expected to engage with their PRA supervisor prior to finalising their approach to identifying material risk takers and that the annual remuneration policy statement should be shared with their supervisory contact. Ultimately, failure to comply with the expectations of the supervisory statement may provide evidence of and lead to the PRA identifying a breach of a relevant requirement, potentially rendering the firm subject to a financial penalty.

Pan-European perspective

An interesting angle for consideration is how the PRA's proposals compare with implementation of the Regulation's remuneration provisions elsewhere across the EU.

In some jurisdictions, such as Germany and Italy, remuneration rules applying to insurance companies are already in place. In others, legislation is more recent with, for example, Spain bringing new laws into effect from January 2016 although these largely go no further than the requirements of the Regulation itself. Other countries have implemented some minor additional requirements, for example in Belgium the recent implementing legislation requires the remuneration policy to be reviewed at least annually and requires annual remuneration statements to be submitted to the Belgian financial authorities.

The approach of the UK's PRA therefore appears, in some respects, to exceed the Regulation's requirements and be more stringent than elsewhere in Europe, for example with 40% being specified as the minimum amount of variable remuneration which must be subject to deferral. These requirements are not, however, the most draconian given that in the Netherlands, for example, insurance firms are subject to detailed regulation which applies to all financial services sector firms and which closely tracks the more onerous requirements of CRD IV. Among the restrictions imposed on affected employees of Dutch firms are a maximum bonus of 20% of fixed yearly salary; a maximum severance payment of 100% of fixed yearly salary; and the prospect of adjustment/claw back of excessive bonuses. Firms are also required to publish their full remuneration policies.

Practical steps

This guidance, although not yet finalised, gives a clear view of the PRA's approach to the remuneration requirements of the Regulation. Although many firms will have already considered the impact on their business of the Regulation, some further steps are likely to be necessary to ensure full compliance with this guidance. It will be relevant, for example:

  • To assess the proportionality position for the firm's business to establish what level of compliance the PRA will require.
  • To check that remuneration policies are consistent across all group entities.
  • To review the list of staff that have been identified as falling within scope, paying particular attention to the wide definition which the PRA suggests for 'Key Function Holders' and 'Material Risk Takers'.
  • To review the arrangements that have been put in place for deferral of variable compensation Issues to consider will include ensuring that 40% is the minimum deferral threshold and that three years is the minimum deferral period. Employment contracts, bonus/LTIP schemes and remuneration policies should be reviewed accordingly.
  • To review performance measurement arrangements to ensure that balanced criteria are being used and that all staff within scope are subject to a proper performance procedure and are aware of the criteria against which they are judged.
  • To begin planning for submission of the firm's initial remuneration policy statement in line with the deadlines proposed by the PRA.
  • Insurance groups may also want to consider responding to the consultation as soon as possible and in particular with a view to clarifying the ways in which the Regulation may work in practice, for example, regarding consistent policies and their application across non-UK operations.