Recovery Planning for Insurers: Some Practical Considerations

Recovery and Resolution

Solvency II was the most significant reform that the insurance sector has experienced in many years and while one of the benefits of Solvency II has been the strengthening and increased resilience of insurers, Solvency II was never intended as a zero-failure regime.

In recognising that bad insurers can fail, and must be allowed to fail, there has been an increasing focus on the importance of insurers developing plans which seek to provide for the recovery of those firms which get into difficulty. The push to advance recovery and resolution initiatives gained momentum following the financial crisis where the failure of firms, particularly banks, exposed grave shortcomings in the financial services’ supervisory frameworks.

Recovery Plans and Banking

Recovery plans are already a key feature of the supervision of the banking sector.

The Bank Recovery and Resolution Directive (“BRRD”) was adopted by the EU in 2014 and was subsequently transposed into Irish law[1]. This framework and related legislation enhances the resilience of banks and should mean that they are better prepared to deal with, and recover from, a crisis situation.

The Irish transposition measure requires credit institutions and certain investment firms to prepare recovery plans which identify actions that can be taken to reduce the likelihood of failure in the event of a significant financial deterioration of the institution. In addition, the BRRD conferred a set of early intervention powers on supervisors, which include the requirement for institutions to execute recovery options, the removal of management and changing the structure of the institution.

Recovery Plans and Insurance

According to the European Insurance and Occupational Pensions Authority (“EIOPA”), in the period between 1999 and 2016, there were 180 instances of the failure (or near-misses) of insurers in Europe[2]. The two most common general causes of failure and near miss recorded by EIOPA are: (i) the risk that management or staff lack the necessary skills, experience or professional qualities; and (ii) the risk of inadequate or failed systems of corporate governance and overall control. The primary causes of failure that relate to “core” insurance and financial risks noted by EIOPA are: (a) the technical provisions evaluation risk, (b) the investment/asset liability management risk, and (c) fraud.

Spurred on by the adoption of recovery planning in the context of banking supervision, in more recent years much consideration has been given to the role that recovery plans can play in the context of the management and supervision of insurers.

EIOPA’s first consultation paper on recovery planning for insurers was published in 2016[3]. In the following year it published its Opinion on recovery and resolution frameworks for insurers[4] in which it called for a minimum degree of harmonisation in the field of recovery and resolution for insurers. EIOPA continues to advocate for the introduction of a minimum harmonised recovery and resolution framework and a European network of national Insurance Guarantee Schemes.

The European Systemic Risk Board (“ESRB”) is also supportive of the introduction of recovery and resolution obligations on insurers, In 2017, the ESRB expressed the view that an effective recovery and resolution framework would reduce risks to financial stability from a failure in the insurance sector[5]. In 2019, the International Association of Insurance Supervisors (“IAIS”) published its paper on recovery planning[6].

Recovery Planning and the Central Bank of Ireland

In the absence of a European legislative proposal for a harmonised recovery and resolution framework for (re)insurers, in June 2020, the Central Bank of Ireland (“CBI”) published a set of draft Regulations which would require pre-emptive recovery planning by insurers and reinsurers in Ireland and invited submissions on its proposals[7].

According to the CBI, the objectives of requiring firms to develop pre-emptive recovery plan is to: (i) promote awareness and allow firms to prepare for a range of possible adverse situations; (ii) enable firms to consider and evaluate the most appropriate and effective mitigation without the resulting pressures of actual severe stress; and (iii) enable firms to make more effective, comprehensive and thoughtful measures to ensure their timely implementation.

New Regulations

Having considered submissions received during the consultation process, in April 2021 the CBI proceeded to make new Regulations - Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1)) (Recovery Plan Requirements for Insurers) Regulations 2021 (“2021 Regulations”) - to provide for the introduction of recovery planning for insurers. The CBI also published a set of Guidelines[8] to accompany the Regulations.

Key Elements of the Regulations

Introduced under section 48 of the Central Bank (Supervision and Enforcement) Act 2013, the 2021 Regulations require an insurer to prepare a recovery plan by 31 March 2022. This requirement also applies to captives as well as third-country branches. Firms are required to review and update their recovery plans every 12 months in the case of firms with a High or Medium-High PRISM rating, and every 24 months for firms with a Medium-Low or Low PRISM rating.

There is also a requirement to update the recovery plan after any change to the legal or organisational structure of the insurer, its business or its financial position, where such a change could have a material effect on, or necessitate a change to, the recovery plan.

The 2021 Regulations require that each version of the recovery plan be formally assessed and approved by the Board. There is also a requirement that each version be reviewed by the internal audit function, external auditor or risk committee.

The matters that are required to be addressed in a recovery plan are detailed under a number of headings in the Schedule to the 2021 Regulations, as follows:

• Governance;
• Strategic analysis;
• Recovery indicators;
• Recovery options;
• Scenario analysis;
• Communication plan;
• Information on preparatory measures.

Development of Recovery Plans – Factors to Consider

In addition to ensuing that the recovery plan addresses all of the requirements that are spelled out in the 2021 Regulations, insurers in Ireland should seek to draw upon the very many lessons that have been learned from recovery planning in the banking sector. For example, the ECB’s 2018 “Report on Recovery Plans” presents the ECB’s lessons learned and some of the best practices observed after three successive cycles of recovery plan assessments in banking.

When insurers in Ireland are developing their recovery plans they should do so in the expectation that at some point the CBI will be reviewing the quality and effectiveness of those plans. The Director of Insurance Supervision at CBI has indicated that assessing the quality of insurers’ recovery plans will be an area of focus for CBI in 2022[9].

We can anticipate that, when reviewing recovery plans, the CBI might seek to challenge the robustness of a firm’s recovery plan. Examples of areas that may be ripe for challenge include:

• the stress scenarios provided in the recovery plan not being sufficiently severe, and not placing the insurer under a degree of stress that actually threatens its viability;
• the appropriateness of the trigger framework for the purpose of invoking the recovery plan in a timely manner;
• the sufficiency of the menu of recovery options;
• the practical feasibility of valuations or anticipated execution timeframes of recovery options; and
• the failure to adequately consider impediments to the recovery plan and/or recovery options.

When assessing the adequacy of recovery plans, in addition to considering some of the above-mentioned factors, the CBI is also likely to seek evidence of the involvement of the Board and senior management in developing and challenging the recovery plan.

The CBI will be looking for assurance that a firm’s recovery plan is not viewed as a tick-box exercise or that it is regarded as merely being a task for the compliance function to handle. In this regard the CBI will want to satisfy itself that the recovery plan is firmly embedded in the firm’s risk management framework.

The operational effectiveness of the firm’s recovery plan will be key. When the time comes for implementation of the plan, the existence of a play-book - a concise implementation guide – will be more conducive to speedy and effective decision-making by the management team. One of the best ways to demonstrate operational effectiveness of a recovery plan is through the conduct of dry-runs of the activation of the plan.

In addition to looking at each firm’s recovery plan in isolation, CBI may also seek to review recovery plans in a comparative way across the market and are also likely to consider potential scenarios where stresses present in the external environment might cause a number of insurers to trigger their recovery plans concurrently.

Due to the prevalence in Ireland of group entities and also the number of firms which have operations in other jurisdictions, we can anticipate that the CBI will place a considerable degree of importance in coordinating with supervisory colleagues in other jurisdictions and the likelihood that recovery planning will be a recurring topic for supervisory colleges.

Lastly, firms would do well to remember that recovery planning is not a task that is ever “done” – it is not a task which is complete once the Board signs off on the recovery plan, rather it is an ongoing, continuously evolving thing. The plan will need to be continuously reviewed and updated to keep apace with changes that naturally occur within the business.

The Financial Services Regulatory Team at RDJ is well-placed to advise firms on the development of their recovery plans in advance of the CBI’s March 2022 deadline.