On 23 May 2013, the PRA published two letters from Julian Adams to UK (re)insurers.

The first (available here) repeats what we already know, and can be safely filed under R. (Here’s a précis: Solvency II has been delayed; the timetable is uncertain; things should be clearer in the autumn; we’ll say more when we know what’s happening.)

The second (available here) is more useful because it describes the PRA’s “Early Warning Indicator” implementation plans.

The PRA has developed three Early Warning Indicators. It is proposing to use the pre-Solvency II implementation period to trial them using the ICAS regime for internal model firms. This will help the PRA to test the calibration of the indicators and “monitor” the downward drift in (re)insurers’ capital. (Hopefully, the PRA will do rather more than monitor downward drift!) If and when Solvency II begins to apply to firms, the indicators will be used as a non-modelled cross-check to make sure that firms’ internal models are consistent with Solvency II’s 99.5% confidence level over a one year period.

Life and general insurance business (excluding with-profits business)

In a Solvency II world, firms will be asked to calculate the ratio of their SCR to their pre-corridor MCR (pMCR). Until then, they will be asked to use their ICG as a proxy for the SCR, and to calculate the pMCR using EIOPA’s January 2013 long-term guarantee assessment specification. The PRA has set the ICG to pMCR indicator thresholds at 300% for (non-with-profits) life business, and 175% for general insurance business. It expects 10% of firms to fall below these thresholds. It doesn’t say why.

With-profits business

At this stage, the PRA is asking with-profits insurers to calculate (i) the SCR to pMCR ratio; and (ii) an “alternative modified indicator” using the formula: 15% x (cost of guarantees / moneyness of guarantees) + (10% x size of the free assets) + (2% x non-profit liabilities).

The with-profits indicator thresholds will be 125% for the ICG to pMCR ratio; and 200% for the alternative modified indicator.

Next Steps

From September 2013, the PRA will expect firms to (i) know how their models perform against these indicators; (ii) be prepared to discuss this performance, as well as the reasons for/causes of actual and protected changes, with the PRA. Early Warning Indicator results will also be reviewed on a sector basis every six months, and used as an input into the PRA’s internal ICAS and ICAS+ panel discussions. However, at least at this stage, the way the PRA sets ICG will not change “fundamentally”.

When the FSA first mooted the possibility of requiring firms to calculate and monitor a set of Early Warning Indicators, I suggested that firms would baulk at another set of calculations, and I pointed out that the indicators were probably gold-plating of the first order (my earlier blog is here). In fact, most of the firms I’ve spoken to about this have been unphased; and EIOPA is now considering Early Warning Indicators of its own. If they are adopted, the gold-plating allegation may fall away (at least on this count – I stand by the remainder of my earlier comments), and the FSA will be seen as the thought leader it always thought it was (with some justification, at least in the Solvency II space).

(Moneyness – the extent to which the guarantees are in the money.)