Solvent Exit Planning: Implications of the PRA proposals in CP2/24
On January 23, 2024, the Prudential Regulation Authority (PRA) published a consultation paper (CP) (CP2/24) outlining its proposals for PRA-regulated insurers to prepare for an orderly ‘solvent exit’ as part of business-as-usual (BAU) activities, and to be able to execute such a solvent exit, if needed.
This consultation is the culmination of PRA interest in exit plan requirements for insurers flagged throughout its 2023 market correspondence and highlighted as a regulatory priority for insurance supervision in the PRA’s 2024 Dear CEO Letter. The regulator’s focus on ‘Ease of Exit’ is of relevance to all insurers with the consultation proposals, if implemented, adding a new Preparations for Solvent Exit Part to the PRA Rulebook, along with the introduction of a new Supervisory Statement (SS) (set out in Appendix 2 of CP2/24).
Whilst the PRA has recognised that some work has already been completed in this area by larger insurers, it highlights that many smaller firms remain without any plans for exit. Fundamental Rule 8 requires insurers to prepare for resolution such that they can exit the market in an orderly fashion (i.e. with minimum disruption of critical services), if required. The aim of the consultation is to develop more specific regulatory expectations for the preparation of exit plans as part of insurers’ business-as-usual activities (the detail of which the PRA suggests will be designed to reflect and be proportionate with the size and impact of the relevant insurer).
The CP proposals include:
Solvent Exit Analysis (SEA): New rules and expectations that firms must prepare for a solvent exit as part of their BAU activities, including documentation of those preparations in a SEA; and
Solvent Exit Execution Plan (SEEP): New expectations, which would apply only if solvent exit became a reasonable prospect for a firm, to: (a) prepare a detailed SEEP; and (b) monitor and manage a solvent exit.
The proposals are designed to make solvent exits more efficient, cost effective and less disruptive to policyholders compared with insolvency, with the PRA aiming to achieve better and more consistent outcomes.
All PRA-regulated insurers, except for UK branches of overseas insurers and firms in passive run-off (i.e. firms that have ceased effecting contracts of insurance, or those whose Part 4A permission for effecting contracts of insurance has been removed and which are not run-off acquirers) are in scope of the CP proposals.
This CP is, therefore, relevant to UK Solvency II firms, the Society of Lloyd’s and its managing agents, non-Directive firms and run-off acquirers.
The PRA notes that UK Solvency II firms that are part of an Internationally Active Insurance Group (IAIG) may be able to build upon their resolution plans already in place as part of the International Association of Insurance Supervisors (IAIS) ComFrame. Those UK Solvency II firms that are a member of a Solvency II group will need to consider the implications and risks from group membership when preparing their SEA. While groups are not within the scope of these proposals, solo firms who wish to submit a group wide (as opposed to solo level) SEA will be able to do so, subject to prior PRA agreement.
Solvent Exit Planning
The CP defines a solvent exit as: “the process through which a firm ceases its insurance business (including both effecting and carrying out contracts of insurance) in an orderly manner while remaining solvent throughout.” This is typically achieved through commuting liabilities with policyholders and/or transferring some liabilities to another insurer, followed by the removal of the firm’s Part 4A PRA permission once the obligations to policyholders and the insurance liabilities have been extinguished.
The PRA recognises that firms may consider options other than a solvent run-off for a solvent exit, including sale or partial sale, a Part VII transfer, a solvent scheme of arrangement or restructuring plan. Any solvent exit will still, however, require compliance with the PRA’s statutory Threshold Conditions. Where firms prefer recovery to a solvent exit, the capital management plans must comply with SS4/18 and the ‘ladder of intervention’ applies under the Solvency II regime, requiring insurers to provide the PRA with a recovery plan on Solvency Capital Requirement (SCR) breach or expected breach and a finance plan within 3 months of breach or expected breach of the Minimum Capital Requirement (MCR).
In addition, the PRA notes that the HM Treasury is developing an Insurer Resolution Regime (IRR) which (if implemented) will need to be taken into account as part of the PRA’s solvency exit planning policy.
The PRA proposes new rules and expectations for insurers to prepare for a solvent exit as part of their BAU activities, including drafting a SEA (to be updated with any material changes and, in any event, at least every 3 years); as well as taking into account the new expectations in Chapter 2 of draft SS to guide firms’ compliance. These would apply to all firms in scope, regardless of how unlikely or distant a prospect the need for a solvent exit may seem at the current time.
Such expectations are intended to inform insurers’ understanding of when and how they would exit from their insurance business while still solvent, looking at indicators to support their decision-making on when to stop writing new business and the main barriers and risks.
The following minimum contents of a SEA is outlined in the SS (with the level of detail which must be set out required to be proportionate to the nature, scale and complexity of the firm):
Solvent exit actions, setting out:
- how a firm would carry out a solvent run-off of its liabilities, being prudent about its ability to sell or transfer any part of the business or its insurance liabilities to another insurer and the valuations achieved during such sales or transfers;
- appropriate alternatives, such as partial sale, full / partial Part VII transfer, solvent scheme of arrangement and/or restructuring plans;
- actions that would be needed to cease its PRA-regulated activities whilst remaining solvent, likely to include several management action options (e.g. selling businesses or assets, selling renewal rights, securing appropriate reinsurance for run-off liabilities or other mechanisms for transferring liabilities) to facilitate the firm to complete a solvent exit; and
- a timeline for execution of the above solvent exit actions;
Solvent exit indicators:
- identifying and monitoring financial and non-financial indicators (calibrated to be forward-looking) that a solvent exit is needed, including quantitative indicators: solvency coverage, relative loss of capital, P&L, underwriting loss, reserves deterioration, asset losses, relative increase in lapse rate; and qualitative indicators: operational difficulties or staff turnover;
- setting a trigger point at which, if its Part 4A PRA permission is removed, the firm would be able to achieve a solvent run-off of its liabilities to existing policyholders;
- potential barriers and risks: assessing and taking reasonable steps to mitigate or remove material barriers or risks to execution of a solvent exit, including potential dependencies such as advice required from external specialists;
- resources and costs: setting out the financial resources, including capital, reinsurance, funding and liquidity needed to execute a solvent exit;
- communications: detailing the internal and external stakeholders that may be impacted by a solvent exit e.g. policyholders, regulators, board of directors, rating agencies, reinsurers, creditors, shareholders, staff and other market participants; and adapting the internal communication plan developed under SS4/18;
- governance and decision-making: drawing up clear governance arrangements with an accountable Senior Manager; and
- assurance: conducting an adequate assurance review of the solvent exit preparations, including confirmation that the SEA is approved by the Senior Manager in accordance with the firm’s governance arrangements.
Solvent exit is a reasonable prospect
Chapter 3 of the draft SS outlines the PRA’s proposals for insurers once it becomes clear that a solvent exit has become a reasonable prospect (as informed by a firm’s solvent exit indicators), covering: (a) drafting a detailed SEEP (within one month or on request by the PRA); and (b) executing and monitoring a solvent exit (keeping the PRA and other stakeholders, as appropriate, informed of the process throughout).
With these proposals, the PRA aims to advance its primary objectives to promote the safety and soundness of firms and ensure appropriate policyholder protection. It also considers that the proposals would promote its secondary objective to facilitate effective competition, by ensuring minimal disruptions to the market arising from any solvent exit of a PRA-regulated activity (including providing assurance to investors of an exit that does not rely on insolvency procedures). As the PRA notes: “It allows new entrants in and non-viable firms out.”
The PRA recognises that barriers to a solvent exit for insurers can be complex and multifaceted, depending on the nature of the firm, its operations and its market position. As such, the PRA assures that it will be proportionate in its expectations.
The PRA identifies various benefits of its proposals, including: (a) the increased likelihood of a successful solvent exit, which should help reduce the risk of losses to firms; (b) more efficient and less costly exits; (c) reduced disruption to the wider market; (d) potential reduction of compensation payments by Financial Services Compensation Scheme (FSCS); and (e) a more dynamic and competitive market.
Whilst the PRA recognises that there will be some additional costs to firms (and the regulator) to implement and comply with the proposals, the PRA considered these are outweighed by the above benefits.
The well-developed UK legacy market, the various life insurance consolidator groups and the specialist brokers and advisers who work with them should expect that their clients may be encouraged to engage with them about possibilities for resolution and exit certainty at an earlier stage of the insurance product life cycle as they prepare and plan their SEAs. Any exit planning carried out by insurers as part of the CP proposals, could also help identify: (a) areas of business that may need improvement or adjustment for continued viability (whether on an open and closed book basis); (b) transferability; or (c) saleability.
The consultation closes on April 26, 2024. The PRA intends to publish a Policy Statement in the second half of 2024, with the proposed implementation date for any changes in Q4 2025.
The Insurance Team at Norton Rose Fulbright LLP has a wealth of experience in the insurance industry across all segments of the market, including Lloyd’s, life & pensions and the run-off/legacy market. To find out more, please contact Matthew Foster, Maria Ross or Clare Douglas.