The Prudential Regulation Authority (PRA) has set out its high level requirements for the composition and effective governance of insurers’ boards. The regulator is consulting on a draft supervisory statement which identifies the key aspects of good board governance in a well-run business. The statement clarifies how the specific accountabilities of individual directors established by the Senior Insurance Managers Regime (SIMR) are additional and complementary to the collective responsibility shared by the directors as members of the board. The statement is likely to become required reading for current and future board members of PRA-authorised insurers.

According to the PRA, an effective board is one that:

  • establishes a sustainable business model and a clear strategy consistent with that model;
  • articulates and oversees a clear and measurable statement of risk appetite against which major business options are actively assessed; and
  • meets its regulatory obligations, is open with the regulators and sets a culture that supports prudent management.

The PRA sets out guidance on its expectations relating to the key issues for boards to consider and, whilst not intended to be a comprehensive guide to good corporate governance, the supervisory statement indicates the issues that the regulator will pay close attention to in its supervision of firms. The guidance covers the following issues.

  • Setting strategy. The PRA will expect to see evidence that the board has established, and takes decisions consistent with a sustainable business model and manages the firm to a clear and prudent strategy and risk appetite. The setting of corporate strategy is core to the responsibilities of the board and should be owned by the board as a whole, however, the SIMR recognises that the chairman and chief executive office have leading individual roles to play in the board’s development and maintenance of the firm’s business model.
  • Culture. The board should articulate and maintain a culture of risk awareness and ethical behaviour for the entire organisation to follow in pursuit of its business goals. Non-executive directors (NEDs) have a key role to play in holding management to account for embedding and maintaining culture.
  • Risk appetite and risk management. The business strategy should be supported by a well-articulated and measurable statement of risk appetite and the PRA will expect to see evidence of this active oversight of risks according to the risk appetite. Firms should be able to evidence that the board and its relevant sub-committees exercise effective oversight of risk management and controls, supported with meaningful and well-targeted management information used to inform board discussions. The chair of the risk committee (where relevant) will be deemed responsible for safeguarding the independence, and overseeing the performance of, the firm’s executive risk function, including the chief risk officer.
  • Board composition. The board should include a sufficient number and quality of independent NEDs who between them have sufficient breath of understanding of the business of the firm to provide effective challenge to the executives. For listed firms, best practice is that at least half of the board (excluding the chairman) is comprised of independent NEDs. Smaller firms are expected to have at least two independent NEDs.
  • Roles of executive directors and NEDs. All board members, regardless of their specific duties as executive or non-executive directors, share in the wider board duty to promote the success of the company and to ensure the regulated firm continues to meet the Threshold Conditions under the Financial Services and Markets Act 2000. NEDs, and the chairman in particular, are expected to play a key role in challenging executive management and holding them to account effectively. The PRA expects boards to be precise over what duties and responsibilities are delegated to the chief executive or executive management and the limitations and accountabilities associated with each matter. Boards should articulate clearly and unambiguously those matters reserved to the board and the manner in which executive management must report and escalate matters to them.
  • Knowledge and experience of NEDs. Between them, NEDs need to have sufficient current and relevant knowledge and experience to understand the key activities and risks involved in the business model. The PRA will expect to see evidence of effective challenge particularly in relation to key strategic decisions. Board responsibility is collective, however, and NEDs should not simply delegate responsibility for major decisions to individuals among them who are considered specialist in the area.
  • Board time and resources. NEDs should ensure they have sufficient time to fulfil their duties and boards should set clear expectations when recruiting new NEDs. The chairman has a particular responsibility to ensure that board meetings are genuine, open discussions. The PRA expects NEDs to be given adequate support and training to enable them to carry out their duties. Under the SIMR, the chairman is expected to lead the development and monitoring of effective policies and procedures for the induction, training and ongoing professional development of board  members, in particularly non-executives.
  • Management information (MI) and transparency. Provision to the board of timely, accurate, complete and relevant MI is a fundamental component in supporting the board to fulfil its duties and responsibilities. The chairman and NEDs are expected to manage the nature, specific content and frequency of MI provided to the board. Management should be open and transparent with the board and ensure it is adequately apprised of all significant matters including key business developments, decisions and activities about which the board should be aware, as well as issues outside the board’s stated risk appetite that, due to the nature or impact of the issue, warrants disclosure or escalation to the board.
  • Succession planning. Boards should ensure they have robust succession plans that recognise current and future business needs and address the unexpected loss of key individuals, particularly those covered by the SIMR.
  • Remuneration. The PRA expects board to oversee the design and operation of the firm’s remuneration system ensuring the incentives are aligned with prudent risk taking.
  • Subsidiary boards. In general the principles of good governance should also apply to regulated material subsidiaries to help ensure that the subsidiary board is alert to the potential for conflicts of interest and able to take decisions independently where required. The PRA considers it generally undesirable for some key positions on the subsidiary board, such as chairman, chair of the key sub-committees, chief executive or finance director, to be occupied by executive members of the group or parent company board. This does not prevent group NEDs from chairing or sitting on the subsidiary board as NEDs. The extent to which the PRA believes subsidiary company boards need to be independent will be influenced by a number of factors. Where the degree of strategic and operational independence, the size and nature of the business, the business model or the incentives of the subsidiary are substantially different or separate from the wider group, for example, this should be reflected in the board’s composition.
  • Board committees. The role of sub-committees is to support the board. Committees are accountable to the board but should not relieve the board of any of its responsibilities.

The supervisory statement focuses on the collective responsibility of the board and complements the individual accountability rules under the SIMR. Insurance firms should consider this latest PRA paper alongside the various policy statements and consultations on the SIMR in preparation for the new regime. The final rules on how the SIMR will apply to NEDs are yet to be published, however, the PRA is clear about its expectations of NEDs and the crucial role they play in challenging the board and executive management and embedding firm culture.

The PRA’s expectations in relation to NEDs echo many of the recommendations of the 2009 Walker Review of corporate governance in UK financial institutions including time commitment, knowledge and understanding of the business, and training and qualifications. The PRA notes that failures of governance or the management of risk by boards have been a key factor in many of the major financial sector failures of recent years. Both the Walker Review and the PRA supervisory statement highlight the vital role of NEDs in providing effective challenge and adequate oversight of the governance structure to ensure the safety and soundness of a firm.

Firms should consider responding to the consultation by the deadline of September 14. The PRA will consider the feedback and publish a finalised supervisory statement in due course. In the meantime, firms might consider how their current corporate governance structure and allocation of responsibilities compares with the PRA’s expectations.

For further information:

Corporate governance: Board responsibilities, May 2015