Articles - Solvent exit planning now the way is clear

 By Iain Maclugash, Associate and Actuary at Barnett Waddingham

 The new rules require that insurers prepare for a solvent exit as part of their business as usual (BAU) activities, which should be documented in a Solvency Exit Analysis (SEA). Once solvent exit is considered likely to happen, the PRA expects the insurer to produce a solvent Exit Execution Plan (SEEP), detailing the insurer’s plans for implementing the solvent exit.

 For most, the SEEP should be nothing other than a distant nightmare and so the real work is focused on developing a SEA that supports good risk management within the business and complies with the regulatory requirements.

 The PRA has set out the key information that should be included in the SEA. The text in blue is the summary info of what the PRA has outlined. The text below is our opinions and recommendations.

 Actions
 A SEA should include a list of potential actions that would be needed to cease PRA-regulated activities while remaining solvent. There will be many ways to conduct a solvent exit, with the PRA setting out some examples of the actions they would expect to see, e.g. selling businesses or assets, selling renewal rights, securing appropriate reinsurance for run-off liabilities, or other mechanisms of transferring liabilities) to facilitate the firm to complete a solvent exit.

 While some actions will be needed on all solvent exit plans, the approach a firm is likely to take is going to be dependent on the scenario that brought them to this point of no return. As such, we recommend firms consider this as an ‘actions library’ rather than a to-do list/plan and build out decision trees on when such actions will be considered.

 Indicators
 A firm should identify and monitor indicators that would inform when it may need to initiate a solvent exit and whether the execution of a solvent exit is likely to be successful. This should include the minimum trigger point at which it would be able to achieve a solvent run-off of its liabilities to its existing policyholders.

 An obvious first indicator will be the firm’s solvency position (both at the point in time and projected over the business plan period). Firms will already have done a lot of work to support this type of analysis. ORSA projections, reverse stress testing and any potential ‘closure to new business’ scenario analysis should provide a fantastic starting point for solvency ratio indicator calibrations.

 However, there are also broader indicators that would lead a firm to close and the firm should look wider at what scenarios could result in a decision to close the business, even if solvency remained in a strong position.

 Barriers and risk
 The PRA requires firms to set out in its SEA the potential barriers and risks to the execution of a solvent exit, including those that are market-wide and firm-specific. This will include consideration of how barriers and risks could affect the outcome and effectiveness of any potential actions.

 Adding this element of risk management to any existing recovery and resolution plans will likely require work from firms, including discussions with a range of stakeholders to understand the scenarios/events that could impact the viability of each action.

 Developing the right structure around the actions’ library will enable firms to build out and present this analysis clearly, having a list of risks for each action. We suggest this should be accompanied in the main SEA by some of the top-down risks to delivering a Solvent Exit under a range of scenarios.

 Costs
 The SEA will need to document the costs of conducting an exit. This will include the financial resources, including capital, reinsurance, funding, and liquidity needed to execute a solvent exit.

 It is likely that some modelling will be required to support this analysis. As there are multiple ways of exiting, there isn’t a single answer to this question. This should be a key output of some scenario tests where different exit paths are considered and the estimated costs of each are factored in.

 Communications
 Firms should set out in their SEA the stakeholders that may be impacted by a solvent exit. These may include policyholders, regulators, board of directors, rating agencies, reinsurers, creditors, shareholders, staff, and other market participants.

 This section will link closely with what firms already do in terms of business continuity and crisis management, where communication plans should already exist. Many of the key contacts and stakeholders will be consistent for a solvent exit, but the plans will likely need to be adapted for a ‘longer term’ event rather than an immediate crisis.

 There is no doubt that your business continuity planning (BCP) experts will be a great source of experience for developing this section.

 Governance
 Firms should set up clear governance arrangements, with a Senior Manager accountable, for the firm’s BAU preparations for a solvent exit, including the review and approval of the SEA and the escalation and decision-making regarding a solvent exit, including whether a SEEP should be produced; and whether, how and when the firm would initiate and monitor a solvent exit.

 As with any good risk framework, appropriate governance structures are standard practice and as you would expect of such a document.

 Assurance
 Firms should undertake adequate assurance activities for their solvent exit preparations. These assurance activities can be performed internally, or externally if the firm would like to do so.

 There are many ways a firm could look to achieve this assurance. Regulatory compliance checklists, industry benchmarking, desktop scenarios and war-gaming all offering different tests of the SEA.

 Clearly, it is important to test if the SEA reflects how things will work in practice and ensure that the necessary actions can adapt to changing circumstances.

 What are the key challenges with the requirements?
 To answer this question, it’s first easier to highlight what we think will be easy to do. And that is to build a document that ticks all the boxes or, at least appears to tick them.

 The PRA has given a very clear set of requirements, and it will be easy enough for firms to develop a SEA that has the right headings and pays lip-service to the requirements. But while this might pass the initial checklist review, it will come unstuck as soon as the SEA is reviewed in any detail.

 The key challenges are:

 Delivering something that adds value to the business.
 Being pragmatic and understanding how much detail to include.
 Let’s take these in turn.

 Building a SEA that works for the business
 Insurance companies have been managing risk for a long time and there are already a suite of tools, documents and processes that support the business in achieving its goals, including monitoring and managing the solvency position.

 ORSAs, solvency risk appetites, management actions, recovery and resolution plans, are just a few tools which will be great resources in supporting the development of a SEA.

 One of the most important elements to think about first, is how this document will be structured and where does it fit best - will it sit as a separate section in an ORSA, where most of the stress and scenario testing is conducted? Or is it best to be added on as a new section on existing recovery plans?

 For us, as a starting point, the most important links will be with recovery and resolution planning. After all, a firm isn’t going to agree to conduct a solvent exit without trying to recover first. Considering how you might combine these documents together could bring economies of scale, generate consistencies and ensure that the ‘story’ flows with how the business will work in practice. Generating a list of SEA actions that make no allowance for potential recovery actions, which should have been implemented before, is both misguided and undermines the value of the analysis.

 It should also be noted that many firms will not have documented recovery plans. For those, there will be significant economies of scale and value in building out these documents together. Otherwise, a SEA will become an isolated document with no material links to how the business is likely to be run, right up until the point at which this document is required.

 There is also no doubt that firms should be looking to use their 2025 ORSA to do some of the heavy lifting on the analysis necessary to support some of the more quantitative elements of the SEA. Expense run-offs and a range of stresses that bring the company to a point of ‘no return’ should help to set the scene for the type of actions that will be involved in a SEA scenario. This means that work should be done early this year to ensure you line up the right scenarios and build efficiencies where possible.

 Being pragmatic and identifying the right structure and level of detail
 We should be under no illusion as to the amount of detail required to make a SEA valuable. As set out above, the PRA is not only asking for the range of actions, but the risks to them, the costs of them and the communications and governance that will sit around them. For any individual action, this could be a full detailed report. So, how do we make this document in a way that works best?

 Now more than ever, this type of report could be an opportunity to embrace technology and step away from the traditional ‘paper’ reporting structure, to a more dynamic report that enables the user to navigate through the details as needed, while not drowning the reader in information.

 This could involve a combination of a report-based framework, accompanied by a web-based dashboard detailing a database of scenarios, risks and required actions necessary. Think closer to the traditional governance, risk and compliance platform, but with the detail required for a SEA.

 If this seems a bit over the top and your Board still prefers the touch of A4 to an iPad, there are still ways to build a SEA that enables a top-down view of actions, risks and dependencies, while adding the necessary detail where required. Including the right dashboards, decision graphics and desktop scenario case studies can lift the report and better facilitate the discussions that lead to improved risk management.