The PRA has published SS4/14: Capital extractions by run-off firms within the general insurance sector. The aim of the supervisory statement is to set out the PRA’s expectations of firms’ compliance with the PRA Handbook provisions applicable to general insurance (GI) firms in run-off. Before approving an extraction of capital, the PRA will wish to establish that the firm has reviewed the impact of the proposals on its capital, both immediately after the extraction but also over the longer term.

SS4/14 highlights certain factors that the PRA will expect the senior management of a run-off firm to take into account when considering making a request to the PRA to extract capital from the firm during run-off. It also sets out the approach that the PRA will take when assessing such a request.

The PRA requires GI firms in run-off to read this supervisory statement alongside SS3/14 published in relation to their approach to schemes of arrangement.

The PRA will expect firms in run-off to hold sufficient regulatory capital to ensure that they can continue to meet their obligations to policyholders as they fall due. The PRA will also expect firms to be able to satisfy themselves and the authority that their capital will remain adequate after the proposed extraction of capital.

What is capital extraction and what are the regulator’s concerns?

Firms in run-off occasionally wish to extract capital from the business. The PRA has concerns that such extractions have the potential to weaken the level of protection available to meet policyholders’ claims. As run-off firms often do not have the same access to sources of capital that a ‘live’ business might have, the PRA is concerned that should new risks emerge in the book or should there be a change in the frequency of claims, it can be hard for businesses in run-off to continue to maintain sufficient capital levels. In addition, the PRA is concerned that inadequate policy records held by some businesses in run-off make it harder to accurately estimate potential future claims.

The PRA does, however, recognise in SS4/14 that in certain circumstances requests to extract capital may be appropriate. This might be the case, for example, where there are significant levels of surplus regulatory capital and claims have developed favourably over a long period of time.

What expectations are there of run-off firms proposing to extract capital?

SS4/14 states that the PRA will hold senior management in firms responsible for ensuring that firms maintain financial resources that are adequate at all times. Both the quality and quantity of those resources will be considered. In meeting this requirement, firms must comply with the requirements set out in the PRA Handbook. Accordingly, firms will need to undertake an Individual Capital Assessment (ICA) and to consider the future capital needs – including under stressed conditions.

The PRA will expect senior management and boards to assess the level of capital required for the business on an ongoing basis, taking into account capital requirements in adverse conditions. Where a firm wishes to extract capital while in run-off, the PRA will expect senior management and the board to be satisfied that solvency levels after the proposed extraction will remain adequate for the duration of the run-off.

In SS4/14, the PRA sets out steps that firms should take before proposing to extract capital. These are:

  • the firm should undertake a review of its capital in order to assess its solvency position after the proposed extraction. This should include a review of the Minimum Capital Requirement (MCR) under the existing prudential requirements and an updated ICA. The assessment should take into account any restrictions on capital and the quality of the policy records available. The firm should also review how the capital position may change under Solvency II;
  • in addition to assessing its current ICA, the firm will need to consider the expected future progress of the run-off, looking at least to the next 3-5 years. This assessment should be based on realistic assumptions on claims, reserve development and investment income and should reflect the experiences of the run-off to date. The firm should use this information to prepare a projection of its likely capital resources, MCR and ICA over this future period; and
  • board approval should be sought for the proposal taking into account the review of the firm’s capital situation (including the results of the ICA). The Board should only approve the proposed extraction of capital where it is satisfied that the firm will be able to maintain adequate financial resources after the proposed extraction (i.e. it must be able to continue to meet both its MCR and ICA at all times over the 3-5 year period).

How the PRA will review proposals to extract capital?

Any request to make a capital extraction must be made by an approved person. The request must include a confirmation that the Board has considered all the factors raised in SS4/14 and approves the proposal. In addition, firms should provide the PRA with copies of its latest ICA review and analysis submitted to the Board demonstrating the projected evolution of the MCR and ICA. The PRA may ask the firm to commission an independent review of its analysis to ensure that the data provided is robust. The PRA is more likely to ask that an independent review of underlying data and assumptions is undertaken where the proposed capital extraction is either: significant in size; would result in a projected coverage of a firm’s ICA of less than 200 per cent; or where the PRA has concerns about the data being used.

Having reviewed the data provided by the firm, the PRA may issue Individual Capital Guidance (ICG). The ICG will specify the amount and quality of capital that the firm considers appropriate in order that the firm maintains adequate financial resources. Where the ICA will not be appropriate or does not adequately reflect uncertainties, the PRA may require the run-off firm to hold more capital.

View SS4/14: Capital extractions by run-off firms within the general insurance sector, 25 April 2014