PRA recovery planning thematic review

May 2024

On 15 May 2024, the PRA published a `Dear CEO' letter with its feedback (PDF 165 KB) from a thematic review of recovery planning. The feedback is based on analysis of the recovery planning capabilities of around 70 non-systemic banks and building societies.

The PRA finds that there are significant areas for improvement, especially regarding the development of recovery scenarios and calculation of recovery capacity.

While directly addressed to non-systemic banks, there is direct read-across to insurers' recovery / solvent exit planning. Indeed, the PRA's `effective practice' examples provide useful additional pointers which complement the draft PRA Supervisory statement (SS) Solvent Exit planning for insurers (PDF 1.7 MB), which is due to be finalised in the second half of 2024.

In this article, we review the implications of the PRA's Dear CEO letter and consider five key takeaways for insurers looking to prepare a solvent exit plan.

First area of improvement: Recovery scenarios

Scenario testing is an important means for firms to understand whether their recovery plan is actionable in practice, under a range of stress scenarios:

The PRA has found that many firms' scenarios are not sufficiently severe — scenarios should bring the firms close to its point of non-viability (PoNV). As a first step, firms should set out how they define and calculate their PoNV.
Firms can also improve their recovery capacity calculation under each scenario. This should reflect the macro/micro environment, the firm's resources, operational capabilities and resilience in adverse conditions.

Firms can use a range of recovery indicators in their planning, applied over time i.e. upon entry into recovery mode as scenario continues to develop.

As an `effective practice', the PRA highlights how scenario testing can be used to demonstrate the robustness of recovery indicators and the viability of preferred options and strategies.

Second area of improvement: Recovery capacity

Again, this should be calculated separately for a range of different stresses and provide management and boards with insight into firm's capital and liquidity strengths and weaknesses.

The PRA finds that firms do not currently calculate and present this information effectively. Areas for improvement include:

Effective application of recovery capacity calculation methodology for each recovery option, alongside timelines and likely benefits (these will vary widely for each scenario). By combining these in a tailored way, for each scenario considered, the firm can then assess the overall recovery capacity.

Recovery capacity calculations should be supplemented by capital and liquidity calculations and an assessment of impact on profitability and the balance sheet.

Setting out available options alongside benefit calculations under stress and BAU scenarios.

Accompanying analysis.

Prioritisation of preferred options depending on scenario, timelines, ease of deployment and any other dependencies.

Presenting the firm's recovery capacity, and capital and liquidity calculations, over time.

Five takeaways for insurers

Recovery, solvent exit and resolution planning — three is a crowd:

The PRA's CP and draft SS on solvent exit planning have blurred the lines between planning for recovery and resolution. On the one hand, solvent exit planning should cover the point beyond which recovery is no longer possible, closer to resolution territory. On the other hand, the plan also needs to accommodate a non-stressed exit, closer to recovery planning (or even more optimistic).

It is not surprising, therefore, that some insurers with an existing recovery (and, in some cases, resolution) plan in place are puzzled as to what the PRA expects from them.

For those without an up-to-date plan in place, it is helpful to draw on lessons learnt across insurance (and banking), as well as leverage existing materials such as ORSAs and materials prepared in accordance with SS4/18 Financial Management & Planning.
Stress scenarios — flawed but vital:

As part of banks' recovery planning, the PRA expects a breakdown of analysis (including solvency, capital and resource calculations) for a range of scenarios.

Firms will be looking to balance the granularity expected by the PRA with an understanding of where accuracy is important and where estimation is sufficient — any scenario developed will be different to real life.
Exit indicators — if you get there:

Under the draft SS, a Solvent Exit Assessment (SEA) should identify the cut-off point for achieving a solvent run-off of its liabilities to existing policyholders (and other liabilities if applicable) in full as they fall due. This is meant to provide sufficient warning of when to start preparing the more actionable Solvent Exit Execution Plan (SEEP). While the Solvency II ladder of intervention is an obvious starting point in considering triggers, insurers may want to model or consider other options e.g. is it realistic to wait until a breach in solvency metrics to develop a more executable plan?

Establishing exit indicators may be more straightforward for insurers than banks, given the usually long period of solvent run off and a well-established framework under Solvency II. However, in practice, both the PRA — and firm executives and board — are likely to ramp up their scrutiny well before formal indicators are reached.
Preferred exit actions and resources to execute — more than a wish list:

Some insurers may be tempted to list a single exit route as a preferred option, such as withdrawal of 4A permission to “effect contract of insurance”. This results in the firm entering into solvent run-off (while maintaining 4A permission to “carry out” contracts of insurance to service its existing book of business).

This may be sufficient for simple, smaller firms — especially in their first SEA iteration. For firms with a more dynamic risk profile, however, a more extensive assessment of exit options may be required. This can be achieved by considering multiple scenarios or a central scenario with additional discussion of how it might vary in different circumstances.

For example, the SEA could reflect that the resources required to continue executing the portfolio in run off can evolve over time. This could be driven by financial considerations e.g. further deterioration of reserving position or availability of adequately priced reinsurance or non-financial considerations e.g. loss of key staff impacts the ability to process claims or to have adequate governance to oversee the exit plan.

SEAs should also identify, and potentially consider mitigating, barriers to executing the firm's preferred strategy. This could include obstacles to the sale of the whole business or specific portfolios, including market capacity, macroeconomic/systemic challenges and competition law. Insurers should also be open to modifying the exit plan during exit execution.

The PRA's thematic review of banks' recovery planning demonstrates that it views analysis of resources of exit execution and recovery capacity as key elements to an effective recovery plan. A similar approach is likely for solvent exit planning, as signalled by the draft solvent exit SS, and firms should therefore develop a dedicated section outlining what is required — and likely to be available — under a range of assumptions.
Interdependencies between different elements of exit planning make an effective solvent exit programme crucial:

There is a significant level of interplay between different sections of a recovery — and solvent exit — plan. A firm's preferred solution(s), as well as exit indicators, governance arrangements and recovery (or solvent run-off) capacity can vary widely depending on exit/stress scenario. Insurers should therefore allow sufficient time for multiple iterations of SEA drafts as assumptions are re-adjusted.

The extent of these interlinkages makes it particularly crucial to have an effective programme to prepare (and maintain) a SEA. This would involve a cross-organisational team bringing together relevant expertise across the business — Risk, Actuarial, Finance, Legal, Compliance, Operations, Investment and Company Secretariat. Effective governance of the SEA programme is thus a challenge in itself.

How KPMG can help

KPMG in the UK has experience in supporting clients through the recovery and exit planning and implementation process. Leveraging our insurance industry knowledge, we believe KPMG professionals are ideally placed to help clients deliver against both regulatory and strategic mandates:

Regulatory support — conducting gap analyses between firms' current arrangements and PRA expectations, and developing solvent exit plans.
Acting as strategic advisers for the solvent exit and recovery planning journey, helping firms to bring together the various related elements of solvent exit, recovery and resolution planning — strategy, operational and legal, scenario analysis and stages of intervention, valuation, and resolution assessment.
Challenging thinking around proposed approaches — review and challenge of key inputs, assumptions and outputs.
Integrating these elements into governance arrangements, risk appetite and risk tolerance frameworks, management decision-making, internal controls and reporting procedures and processes.
Designing and advising on the implementation of programmes that can remove impediments to solvent exit.
Providing internal and external assurance.