(Re)Insurance: Five Key Areas of Regulatory Focus
Regulatory developments in the (re)insurance sector have continued apace in the second half of 2022. In recent weeks, the Central Bank of Ireland (the “Central Bank”) highlighted the challenging uncertain economic environment for (re)insurers and emphasised that the “direction and ambition for the industry over the coming years should be to meet these various challenges...in a manner that is responsive and forward-looking”. In this briefing, we have identified five key areas of regulatory focus (based on recent communications from the Central Bank and EIOPA) which firms should be aware of.
1. Climate Change and Sustainability
Climate change and sustainability continues to be a focus of regulators, as highlighted by the Central Bank’s ‘Dear CEO’ letter to firms outlining supervisory expectations relating to climate and sustainability issues.1 (Re)insurers will also be aware of recent legislative requirements (a) to integrate sustainability factors, risks and preferences into product governance requirements; and (b) to integrate sustainability risks in the governance of (re)insurance undertakings.2
In August 2022, the Central Bank launched consultation paper no 151 ‘Guidance for (Re)Insurance Undertakings on Climate Change Risk’ (here). This consultation highlights that climate change is no longer an ‘emerging risk’ facing (re)insurers and the Central Bank expects all (re)insurers to monitor their exposure. The Central Bank notes that “over half of (re)insurers do not have a climate-change risk management strategy, plan or policy in place… two-thirds of (re)insurers have not incorporated climate change risk factors into their pricing”.
The proposed guidance is intended to clarify the Central Bank’s expectations on how a (re)insurer should address climate change risks and to assist in developing (re)insurers’ governance and risk management frameworks. An infographic is included in this consultation setting out steps to assess the financial impact of climate change risk, integrate climate change risk into strategy and embed same into business (here). Feedback is requested on the proposed guidance by 26 October 2022.
In September 2022, following a thematic review, the Central Bank set out its observations in respect of the identification and assessment of sustainability risks within own risk and solvency assessments (“ORSA”).3 The Central Bank expects (a) each (re)insurer to take a forward-looking perspective on climate change risk over the short, medium and long term; (b) use available industry resources to inform its stress testing of potential exposures; and (c) link climate change risk assessments to its strategy and business planning.
Concerns around the effect of climate change on pricing of insurance coverage and the creation of an insurance protection gap is also a key focus of regulators. EIOPA has cited research showing that in the past only a quarter of the total losses caused by extreme weather and climate-related events across Europe were insured which, EIOPA states, indicates a large insurance protection gap in Europe.4 In its recent consumer protection review discussion paper (here), the Central Bank has asked stakeholders to consider the consumer impacts of climate and sustainability factors in terms of pricing and availability of products and services. Stakeholders are requested to provide feedback on this discussion paper by 31 March 2023.
While the Central Bank acknowledges that individual firms may be at different stages of development in relation to their management of climate change risk, the Central Bank states “there still scope for the majority of firms to be more ambitious in their consideration of climate change risk (particularly life firms, which appear less developed than non-life firms)”.5
You will recollect that in December 2021, the Central Bank published its cross-industry guidance on outsourcing (here). The Central Bank focus on outsourcing continued in 2022, with a thematic inspection of governance and oversight controls in relation to (re)insurers’ use of underwriting managing general agents (“MGAs”).
As a result of this thematic inspection, the Central Bank concluded that the governance and the quality of oversight controls over MGAs should be enhanced. In particular, the Central Bank identified instances where specific risks arising from MGAs were not adequately assessed or independently tested and monitoring procedures did not exist, were incomplete, or lacked adequate detail. The Central Bank states that it expects each (re)insurer to align its approach to the governance and oversight of underwriting MGAs with the Solvency II requirements on the outsourcing of critical or important operational functions or activities.
The Central Bank further noted that the governance of underwriting MGAs was typically not performed at board level and in some cases was performed by teams which formed part of the wider group located outside Ireland. The Central Bank emphasised that, under Solvency II, a (re)insurer remains fully responsible for discharging all of its obligations when it outsources functions.
We suggest that (re)insurers should take note of the Central Bank observations in respect of MGA arrangements, as these observations would apply equally to other outsourcing arrangements (re)insurers enter into. In particular, (re)insurers should note that a key component of the Central Bank’s cross-industry guidance on outsourcing is the expectation that the board and senior management of regulated firms are ultimately accountable for the effective oversight and management of outsourcing risk within their business and “while the performance of functions and activities can be outsourced, boards and senior management of regulated firms cannot outsource their responsibilities”.
The Insurance Supervision Directorate in the Central Bank is planning to issue a digitalisation survey to a sample of insurers later this year to gather further information on the level of digitalisation in the sector and inform further supervisory work in this area.
In the Central Bank’s consumer protection review discussion paper (here), the Central Bank highlights that the availability of digital technologies and Big Data may result in benefits for customers and insurers through more efficient new business and claims processes, however the Central Bank states there is also a risk of poorer customer outcomes. The Central Bank states that it is reviewing the ethical use of data in the various stages of the insurance lifecycle while considering the range of potential risks that may arise for consumers and possible mitigants to these risks.
A related issue arises pursuant to Article 18(1)(a) of the Solvency II Directive which requires insurers to limit their objects to the business of insurance and operations arising directly therefrom, to the exclusion of all other commercial business. Stakeholders have highlighted that a restrictive interpretation of this provision could limit the ability of (re)insurers to experiment with new business models and technologies. EIOPA states (here) that a possible solution may be to ensure that digital activities directly linked to insurance activities and insured risks (such as risk prevention and customers’ risk management services) should be considered insurance or ancillary business. EIOPA states it will consider further analysis “to bring more clarity to this issue, taking into account the potential impact for consumers, insurance sector and its supervision”.
4. Under-insurance Risks
Linked with wider concerns around rising inflation, a particular focus of the Central Bank is the risk of under-insurance in the home insurance sector. Earlier this year, the Central Bank conducted a thematic review of the risk posed to consumers of not having sufficient home insurance cover. On 22 September 2022, the Central Bank published a letter to the CEOs of insurance firms that offer home insurance policies (here). The ‘Dear CEO’ letter confirms that the thematic review identified evidence of under-insurance in the home insurance market and sets out the Central Bank’s supervisory expectations of insurance firms in an appendix thereto.
The Central Bank’s supervisory expectations include implementing a comprehensive communications plan to inform and build an understanding with customers around the issue of under-insurance and firms objectively assessing the effectiveness of their consumer protection risk management frameworks against the Central Bank’s expectations in this area. In particular, the ‘Dear CEO’ letter states that consumer protection risk management frameworks need to “look beyond firms’ direct interaction with customers to identify, mitigate and manage risks arising to consumers from external factors including changing economic and geo-political circumstances”.
Firms are required to submit plans addressing the points raised to the Central Bank by close of business, 28 October 2022. Firms are also required to share the contents of the ‘Dear CEO’ letter with their board of directors and ensure that the board has appropriate oversight of the firm’s plan to address gaps identified or actions required.
5. Intragroup Exposures
On 4 July 2022, the Central Bank launched a public consultation on proposals to introduce guidance for (re)insurance undertakings on intragroup transactions and exposures (here).
This consultation seeks stakeholder views on the proposed guidance, the intention of which is to set out expectations for intragroup transactions and exposures. (Re)insurers which are part of a group, including captive (re)insurers and branches of third-country undertakings, are the focus of the proposed guidance. The Central Bank focuses on three key exposures: (a) intragroup assets, (b) intragroup reinsurance and (c) cash pooling/treasury function arrangements. The Central Bank expects (re)insurers to evaluate the guidance and adopt proportionate measures to guarantee that risks associated with intra-group transactions are properly identified and integrated in capital considerations, governance and risk management frameworks.
The proposed guidance will have a wide impact given that (re)insurers in Ireland are often part of large international groups. We expect a final guidance to issue in due course and that each (re)insurer will need to factor same into its regulatory planning.
It is clear that (re)insurers are facing increased focus from both a prudential and a consumer perspective in relation to, in particular, climate change risk, the sector’s swift uptake of digitalisation and the impact rising inflation will have on both pricing and the costs of claims. This regulatory focus will inevitably lead to challenges to (re)insurers as they look to allocate resources and operational capabilities on various fronts to address regulatory requirements. However, the Central Bank has emphasised that it expects insurers to “understand their risk exposures, adopt a forward-looking perspective, accompanied by strong oversight and pre-emptive identification of remediation actions, and to be prepared for the possibility that the current environment may last for some time”.6
Also contributed by Jonathan Murchan
- Further detailed in our briefing (here)
- Commission Delegated Regulation (EU) 2021/1257 and Commission Delegated Regulation (EU) 2021/1256
- Central Bank September Insurance Newsletter (here)
This document has been prepared by McCann FitzGerald LLP for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.