On 25 November 2016, the PRA published supervisory statement SS20/16: Solvency II: reinsurance – counterparty credit risk. SS20/16 sets out the PRA’s expectations of firms with respect to general issues regarding reinsurance and the management of reinsurance counterparty credit risk. Key points raised include:
- When deciding where to place reinsurance, the PRA expects boards to understand the risk transfer taking place; ensure that business planning, capital setting and reserving adequately reflects the economic impact; and appreciate the wider associated risks. This will require firms to take into account concentration risks where extensive use of risk-transfer is done through reinsurance. The PRA expects firms to manage concentration aspects of reinsurance counterparty default risk under Solvency II, especially under stressed scenarios.
- Firms are expected to mitigate reinsurance counterparty default risk concentrations by demonstrating prudent risk management and compliance with the PRA Rulebook. When assessment indicates additional measures are appropriate, mitigation may take various forms (such as funds withheld and collateral agreements) and will often be uniquely tailored to a firm’s specific business.
- The PRA expects firms’ assessment of reinsurance counterparty default risk to include their appetite for this risk and their identification, reporting and mitigation of major instances of this risk. Firms are expected to continue monitoring the level of annual cessions as a proportion of their gross premiums and the quantity of reinsurance recoverables compared to their available capital resources and take appropriate actions to manage risks arising. Firms should consider aspects relating to the “prudent person principle” as well as to what extent reinsurance concentrations may impede effective resolution.
- The PRA’s expectations of risk management are proportionate to the size of the concentration and the risk it poses to a firm. For smaller firms, the consideration of the trade-off of different component aspects contributing to the credit risk might be materially different to those for larger firms.