Planning for exit — upcoming PRA guidance

October 2023

Policymakers and regulators are strengthening recovery and resolution frameworks for insurers to ensure that a firm's deteriorating financial position does not have a material adverse impact on policyholders and financial stability — not least due to recent market turbulence.

The UK government is looking to introduce, via primary legislation, a resolution regime aimed at the largest insurers. In addition, the Prudential Regulation Authority (PRA) is expected to, this year, consult on guidance for ease of exit planning for insurers more generally.

Smaller firms may have to formally plan for exit for the first time, while all insurers would need to align themselves to a significantly more detailed set of standards. This article explores what the PRA's enhanced guidance for insurers' exit planning may cover — we expect this to materially increase both the reach and detail of the PRA's expectations.

In the UK, there are concurrent regulatory workstreams linked to planning for possible insurance failure:

• Insurance Resolution Regime (IRR): In August this year, the HM Treasury published (PDF 391KB) the outcome of its consultation to create a Resolution Authority (RA) within the Bank of England (BoE), empowered with tools to intervene, restructure and stabilise in the event of an insurance failure. This framework will only apply to the largest insurers, or those whose failure is most likely to create ripples through the financial system and the real economy. To read about the IRR, please refer to KPMG analysis of the upcoming regime here.
  
  
• Supervisory guidance on exit planning: Separately to the above, the PRA has communicated (PDF 196KB) its intention to consult on more detailed supervisory expectations on how insurers should be meeting the requirement to adequately plan for recovery and exit. These enhanced supervisory expectations are likely to apply to all Solvency II insurers, subject to usual caveats around proportionality.

This article focuses on the second workstream, although there is a degree of commonality across both e.g. large insurers will need to prepare resolution plans for the Resolution Authority, and ease of exit plans for the PRA. (Refer to KPMG in the UK's article on the IRR for analysis on the interplay between the two). In line with the PRA's approach, we will use the terminology of 'ease of exit planning', rather than previously more common 'resolution planning' for consistency and to avoid confusion with requirements under the IRR.   

For background reading on current requirements for recovery and exit planning, an overview of how these have evolved and 'lessons learnt' from banking, please refer to our publication A resolution framework for insurers. (PDF 2.14MB)

In its 'Dear CEO' letter (PDF 196KB) of January  on insurance supervisory priorities for 2023, the PRA notes that, while Fundamental Rule 8 (PDF 152KB) requires a firm to prepare for resolution so that this can be carried out in an orderly manner with a minimum disruption of critical services, many smaller insurers remain without an exit plan. The PRA approach to date has been to leave supervision of exit planning largely to the discretion of its teams, with no formal guidance for insurers — so this sharpened focus on planning will be a step change.

The PRA said it expects firms to start considering how they might exit the market if needed, what the obstacles might be and how these can be overcome. If the insurer is looking to rely on a transfer of books in run-off (which is often the exit strategy of choice), both the selling and acquiring firms should fully understand the risks within these books — and the PRA will likely want to understand if such changes in control could lead to a concentration of legacy business in a handful of run-off firms.  

While the Dear CEO letter suggests the focus is on exit planning, it will be interesting to see if the PRA will also address its expectations for recovery planning for insurers, which tends to go hand-in-hand.

So, what might insurers expect from the PRA's upcoming consultation on exit planning:

• Scope of the regime: We expect all Solvency II firms to be impacted, subject to proportionality — see below for likely impact and EU parallels.
• Critical functions: The PRA may clarify its thinking on critical functions, and set out its expectations on supporting critical shared services, maintaining policyholder protection and ensuring operational continuity under resolution. The PRA applies this approach to banking — and previously considered extending critical function identification to insurers in light of the Financial Stability Board's (FSB) approach. If a firm is required to be able to operationality support a sub-section of its operations for operational continuity, while exiting the remainder of the market, this could be a material challenge for firms operationally, strategically and resource-wise.
• Key considerations as part of exit planning: As signalled in the Dear CEO letter, there is likely to be a focus on pre-emptive due diligence to support a potential exit, with a focus on operational readiness, mitigating structural barriers to exit (e.g. operational structures, identifying reliance or contractual obligations to third parties) and valuation. As with many of its other regulatory priorities, the PRA will likely want firms to ensure that the management actions they devise can be implemented in a real-world scenario. 

As noted above, we expect the PRA's upcoming guidance to apply to all Solvency II firms — in line with the existing requirement to comply with Fundamental Rule 8.  

There is a similar direction of travel in the EU under Insurance Recovery and Resolution Directive (IRRD). It is currently under negotiation but as proposed, insurers would be required to submit resolution plans covering 70% of the relevant insurance market to new resolution authorities. Stand-alone insurance companies classified as low-risk profile undertakings under Solvency II will be exempt, however groups, regardless of size or significance, will be in scope. 

The PRA's enhanced guidance on exit planning could impact firms by type:

• Smaller insurers: These may be the most impacted as they are likely to be required to either prepare exit plans for the first time or significantly revise existing plans to meet supervisory expectations (which are currently not detailed).
  
  
• Large insurers: Category 1 and 2 firms are likely to already have plans in place but these would need to be checked against clarified supervisory expectations. There is currently a range of approaches to planning depending on the firm and its supervisory team, which the PRA could look to converge:
  
  
  • Exit planning process: There are a number of considerations here including who is holding the pen? Is it the PRA's plan, with the firm required to respond to queries and supply requested information? Or is the exit planning firm-lead, and then submitted to the PRA? How often are the plans reviewed and what level of governance should this be subject to? 
    
    
  • Substance: There is currently variability on what plans focus on and the level of detail — as well as the extent of supervisory engagement and scrutiny. The current approach is for the PRA to consider firms' resolution plans as part of the cyclical PSM assessment, considering issues like the financial strength of the entity, the role of the wider group including its strength, willingness to support the entity in question and the existence of inter-group transactions, and the substitutability of business underwritten by the firm. Once the PRA finalises its approach to exit planning, it will need to consider supervision of this process and firms will likely need to be prepared for more formal engagement and assessment of their plans.   
    

A detailed Supervisory Statement on exit planning would aim to converge approaches by firms and supervisors alike.

• UK branches of oversees insurers: If a UK branch of an overseas insurer identifies a critical function' as part of its exit planning, there could be a knock-on impact. For example, the PRA may look to assess if there are legal obstacles to the resolution of UK branch and whether UK policyholders have adequate priority. This would be in line with the PRA's clarified approach to UK branches, which considers additional factors for when subsidiarisation may be appropriate for firms below the FSCS threshold. This is in parallel to the PRA's approach to banks — Sam Woods, in his October 2023 Mansion House speech on bank failures questions if the PRA is well set up to spot the emergence of issues similar to those that led to recent subsidiarisations in banking.
  
  
• Providers of specialised products: Small insurers with a material market share in a niche sector may find themselves caught by the definition of 'critical functions' i.e. whose sudden withdrawal would have an adverse impact on the real economy (see below). This would require more extensive planning for operational continuity compared to the level of proportionality they are used to, including potentially changes to operating structure.

We expect the PRA to adopt an approach similar to the IRRD, which itself is aligned to the FSB Key Attributes (PDF 661KB) framework.  

The IRRD defines critical functions as activities, services or operations performed by an insurance or reinsurance undertaking for third parties that:

• Cannot be substituted within a reasonable time or at a reasonable cost, and 
  
  
• Where the inability of the insurance and reinsurance undertaking to perform the activities, services or operations would be likely to have a significant impact on the financial system and the real economy including by:

o Affecting the social welfare of a large number of policyholders, beneficiaries or injured parties or,

o Giving rise to systemic disruption or by undermining general confidence in the provision of insurance services.

The FSB's view is that the consideration of criticality and substitutability of functions is a key component of any robust resolution framework — this involved a competition-style analysis of market share and substitutability across lines of business/key product propositions. 

If critical functions are identified, firms need to assess how they can be maintained in an exit scenario. Operational continuity, as defined by the FSB, relates to ensuring ongoing operation of the critical shared services that are necessary to maintain the provision or facilitate the orderly wind down of a firm's critical functions in resolution. These services are split into finance-related (e.g. treasury function, risk function, actuarial and accounting etc) and operational-related (e.g. IT, HR, payroll, transaction processing, real estate etc). These are the services the insurer would need to keep running to support the provision of critical functions — imposing a level of operational cost and complexity.

Some general insurance firms, whose current plan is to withdraw from the market in a resolution scenario, may find that they are instead required to find a way of continuing to offer some 'critical function' products and services to their policyholders. Even if another firm is likely to eventually fill the gap in capacity, this may not be within a reasonable time or cost for policyholders. Exit plans for these critical functions therefore may require a different strategy from that for the rest of the undertaking. Life insurers with long-term products that policyholders rely on for retirement may be more clearly identified as having critical functions but are also more likely to have already considered operational continuity in case of exit.

We expect that, as part of exit planning, the PRA will require firms to consider:

• Systemic importance/impact on policyholders in the event of any failure or the failure of the supplier, both in the short term and longer term. For this purpose, firms need to consider 'Systemic' both in terms of their impact on other institutions and the wider economy, for example the impact on the ability of pensioners to continue to receive pension payments, or on the availability of statutory cover such as employers' liability. Consideration of how the systemic risk is mitigated will be key to PRA dialogue concerning what is required.
  
  
• Stress and scenario tests/reverse stress tests, to identify/understand potential exit triggers and the underlying scenarios and their outcomes to proactively identify mitigating actions.
  
  
• Potential impact of insolvency on their business and critical services provided. This could include contemplating the business/operating model and structure, and identifying feasibility resolution strategies (i.e. which resolution strategies will be available and in which circumstances).
  
  
• Adequacy of management information systems to generate information for internal purposes and regulatory reporting.
  
  
• Ease of access to key assets and records, include those held externally to the firm.
  
  
• Potential barriers to a firm's resolvability, for example nature of capital instruments and capital structure, legal entity structure and intra-group relationships/interconnectivity, shared services and reliance on key suppliers, third party rights such as banking covenants, pensions etc.
  
  
• Potential need to undertake pre-emptive actions/necessary changes to structure/operations to the extent there are possible barrier to an orderly resolution of the firm or specific systemic issues, so that these can be managed in a way that supports the business.
  
  
• Boards also need to ensure they understand the directors' legal responsibilities and implications of moving from recovery to resolution. In this, understanding the group-solo interaction is key.

Exit planning is set to become an even more significant tool in helping the BoE and PRA to monitor risk within the insurance sector. As the risk landscape continues to evolve — climate change, increasing levels of investment in illiquid assets, cyber, geopolitical tension, inflation — the need for robust recovery and resolution planning is as important as ever. We expect the UK framework to develop at pace. Insurers should consider now how they can best position themselves to respond, and consider how these become more than esoteric regulatory exercises to drive value in the organisation.

KPMG member firms have extensive experience in supporting clients through the recovery and exit planning and implementation process. Combined with insurance-focused industry expertise, we are ideally placed to help clients deliver against both regulatory and strategic mandates: 

 We can support you with: 

• Board/senior management training.
• Developing exit plans that meet regulatory expectations.
• Impact assessment/gap analysis.
• Implementation and programme support.
• Financial resource optimisation.