On 6 February 2013, the FSA Managing Director of the Prudential Business Unit, Andrew Bailey, gave a speech in which he commented on: (i) why the Prudential Regulation Authority (“PRA”) will be supervising insurers alongside banks and major investment firms; (ii) the style of supervision the PRA will adopt; and (iii) the issue of systemic risk for insurers.

The reason for locating insurers in the PRA along with banks is said to be that the role of the prudential supervisor is to ensure that the public and users of financial services, including the corporate sector, can be assured of continuous access to the critical services on which they depend.

In terms of the style of supervision the PRA will adopt, the following key points were made:

  • The PRA will be applying judgment around the framework of rules, in order to be focused on the key risks that matter to its objectives. In particular, it will focus on the big risks that threaten the objectives of safety and soundness and policyholder protection.
  • The PRA will be forward-looking to the risks that may arise, e.g. it is focused on the impact of continuing low interest rates, it is considering the prudential impact of possible outcomes on flood insurance in the UK, etc.
  • The PRA faces the challenge of balancing the use of sensible judgment against the risk of creating undue uncertainty which damages the ability of insurers to do business; it was noted that this will require a greater degree of transparency between: (i) the PRA and firms; and (ii) the PRA and firms on one hand and the public and investors on the other.
  • The PRA will be clear and transparent in its judgments and it will be accountable.
  • The PRA will take the supervision of insurers just as seriously as it takes the supervision of banks. It is putting more emphasis on senior level contact in the new approach in order to deliver key messages clearly to senior management and boards and to understand how firms’ governance works in practice.

Regarding the issue of systemic risk for insurers, it was acknowledged that some insurers will pose more risks to the financial system than others, as a result of the interaction of complexity of risk and size, and it was said that supervision should be proportional, with a more enhanced and intensive approach for large and complex firms. A distinction was also drawn between non-life insurance, where the resolution challenge involves ensuring short-term continuity of risk cover, and life insurance, which involves long-term commitments and a greater vulnerability to shocks from the financial markets.

It was, however, said that it does not follow that, just because major banks are systemically important, the same must be true for insurers. Furthermore, if a case can be made for systemic importance of insurers, it does not follow that the same capital treatment of systemic firms and/or a statutory resolution regime are needed as for banks. Any response to perceived systemic risk should be consistent with mitigating the cause of such risk, and work is underway to determine whether insurance would benefit from a special resolution regime that overrides normal insolvency rules in order to enhance the ability to ensure continuity of cover.

Although it was considered that the PRA’s objective of policyholder protection suggests there is a need for some sort of resolution regime for insurers, it was said that it is important to be clear on what sort of regime would be appropriate. Following this speech, on 13 February 2013, the FSA sent a letter to firms that will have the PRA as their lead supervisor, setting out detailed information on how firms should prepare for legal cutover to the PRA on 1 April 2013 and including updated FAQs on the transition to the PRA.

The letter notes that, as the PRA will have a different regulatory and supervisory approach to the FSA, existing individual guidance issued by the FSA will not automatically be transitioned to the PRA. Four categories of guidance will be automatically transitioned: (i) individual capital requirements guidance; (ii) individual liquidity guidance; (iii) individual guidance given by the FSA that enables a firm to move from a higher proportionality tier to a lower proportionality tier; and (iv) guidance on the completion and submission of regulatory returns. Other guidance should be reviewed by firms against the PRA’s statutory objectives. Any guidance that firms wish the PRA to review (which should not include all guidance previously issued) should be submitted to the PRA by 30 September 2013 and can then be relied upon until the PRA decides whether it remains appropriate or not. Any guidance not referred to the PRA for review will cease to have any status as formal individual guidance from 30 September 2013. The letter notes that this does not mean that firms should necessarily change their behaviour and that this does not change recent risk assessments.

The letter also indicates that the PRA handbook, which will replace the relevant parts of the existing FSA handbook, is expected to be published in March 2013. Following legal cutover, the PRA will amend its own policy materials as an independent body in line with the processes laid down in the Financial Services Act 2012, which will include co-operation with the Financial Conduct Authority and external consultation.