PS12/22 – Insurance special purpose vehicles: Further updates to authorisation and supervision

1. Overview

1.1 This Prudential Regulation Authority (PRA) Policy Statement (PS) provides feedback to responses to Consultation Paper (CP) 10/22 – ‘Insurance special purpose vehicles: Further updates to authorisation and supervision’. It also contains the PRA’s final policy, as follows:

• updated Supervisory Statement (SS) 8/17 – ‘Authorisation and supervision of insurance special purpose vehicles’ (Appendix 1).

1.2 This PS is relevant to firms who wish to apply for, or have obtained authorisation as, an insurance special purpose vehicle (ISPV). It is also relevant to insurers and reinsurers seeking to use UK ISPVs as risk mitigation in accordance with the UK’s onshored Solvency II framework.

Background

1.3 In CP10/22, the PRA proposed making changes to SS8/17 – ‘Authorisation and supervision of insurance special purpose vehicles’ that would:

• change the legal opinion expectation for non-English law governed contracts;
• clarify the number of Senior Management Function (SMF) holders needed for an ISPV;
• clarify its approach to multiple cedants ceding risk to a single cell via a single contract;
• clarify its interpretation of ‘quantifiable risk’; and
• clarify the requirement for written policies submitted for ‘standard’ applications.

Summary of responses

1.4 The PRA received six responses to the CP. Respondents generally welcomed the PRA’s proposals. They also made some comments outside the scope of the CP. Details of these are set out in Chapter 2.

Changes to draft policy

1.5 The PRA proposed that for standard applications, one individual could hold more than one SMF role, but for complex applications, the three SMF roles may need to be held by separate individuals.

1.6 The PRA clarifies that one individual may hold all three SMF roles for standard applications. The PRA also clarifies that in appointing the SMFs, firms should consider any potential conflicts of interest, and how they should be addressed.

1.7 The PRA proposed in its CP that it might, at its discretion, accept multiple cedants ceding to a single cell under a single contract subject to certain criteria.

1.8 One of the criteria was that the cedants should be ‘part of the same insurance group (as per Solvency II) or are group undertakings of each other (as defined in Companies Act 2006) or are Lloyd’s syndicates managed by the same managing agency with a shared economic interest’.

1.9 The PRA has changed this to ‘part of the same insurance group (as per Solvency II) or are group undertakings of each other (as defined in Section 421 of FSMA) or are Lloyd’s syndicates managed by the same managing agent with a shared economic interest’.

1.10 Based on feedback to the consultation, the PRA considers that the FSMA definition of ‘group’ is slightly broader than the Companies Act definition, and is more in line with the existing regulatory framework under which the PRA supervises all firms. The PRA considers that the use of the FSMA definition will make no impact on the safety and soundness of the firms nor on policyholder protection and more closely aligns with the framework under which the PRA supervises these firms. However, since this will allow for a slightly broader definition of what would constitute a group and will be in the context of the regulatory framework firms already operate in, this change may be more beneficial for firms. Further, since it would use the same regulatory framework they already operate under, the PRA does not consider this to be an additional burden over considering the Companies Act definition.

1.11 The PRA proposed in its CP that for standard applications it does not expect firms to submit the full suite of written policies in place. Instead, the PRA proposed an expectation concerning a summary description of the written policies in place that are proportionate to the uses and systems of governance requirements of the ISPV. For multi-arrangement ISPVs (MISPVs), or where the application is deemed ‘complex’, the PRA proposed that it may request to see the written policies (or a sample thereof) on a case-by-case basis.

1.12 The PRA clarifies that, for all cases, it expects a list of the policies in place. However, for all cases, it may request to see the written policies (or a sample thereof) on a case-by-case basis.

1.13 The PRA considers that this will be beneficial to firms as they would not need to prepare a separate document; rather, firms can simply share the list of all policies with the PRA, unless specifically asked for more details on individual policies by the PRA.

1.14 In carrying out its policymaking functions, the PRA is required to have regard to several matters, as set out in CP10/22 in Appendix 2, 'the PRA's Statutory Obligations'. In CP10/22, the PRA explained how it had regard to the most relevant of these matters in relation to the proposed policy. Below, the PRA provides an updated explanation, taking into account consultation responses where relevant.

1.15 In developing CP10/22, the PRA had considered the following ‘have regards’ as significant to the proposal:

• the need to use the PRA’s resources in the most efficient and economic way;
• the principle that a burden which is imposed on a person should be proportionate to the benefits expected to result from that burden;
• the desirability of sustainable growth in the economy of the UK in the medium or long term;
• the principle that the PRA should exercise its functions transparently;
• UK competitiveness; and
• growth.

1.16 The PRA considers the responses received to the CP do not impact its assessment related to the above ‘have regards’, nor do any others become significant.

Implementation

1.17 The policy in the SS will take effect from 23 December 2022.

1.18 The PRA will continue to interact with various stakeholders to assess what further changes may be required to the ISPV regime.

1.19 Unless otherwise stated, any remaining references to EU or EU-derived legislation refer to the version of that legislation which forms part of retained EU law.

2. Feedback to responses

2.1 The PRA must consider representations that are made to it in accordance with its duty to consult on its general policies and practices and must publish, in such manner as it sees fit, responses to the representations.

2.2 The PRA has considered the responses received to the CP. This chapter sets out the PRA’s feedback to those responses, and its final decisions.

2.3 The sections below have been structured along the lines of the various proposals made in the CP. The PRA’s feedback to responses is grouped for every proposal as follows:

• change to the legal opinion expectation for non-English law governed contracts;
• clarification on the number of SMF holders needed for an ISPV;
• clarification of approach to multiple cedants ceding risk to a single cell via a single contract;
• clarification on the interpretation of ‘quantifiable risk’;
• clarification on the requirement for written policies submitted for ‘standard’ applications; and
• other responses not related to CP10/22.

Change to the legal opinion expectation for non-English law governed contracts

2.4 The PRA proposed that a legal opinion for non-English law governed contracts would no longer be generally expected, especially for ‘standard’ applications. However, it would remain at the PRA’s discretion to request a legal opinion, and this would be assessed on a case-by-case basis.

2.5 All the respondents welcomed this change. A respondent suggested that while this was acceptable for ISPVs, it would still be an obstacle for a Protected Cell Company (PCC) structure, and suggested that this be dealt with at the stage of the PCC core establishment (with a positive confirmation that for that family of PCC cells, the opinion will not be required). A respondent also asked if the PRA would be comfortable with authorising contractual arrangements that were entirely governed by a foreign law typically used in ILS structures (eg New York law). A respondent also queried whether it was possible for an English law firm to provide a legal opinion that the operation of English law would not undermine the effect of the transaction and/or arrangements under the applicable foreign law, as expected by the PRA. Another respondent suggested that in the case of complex transactions, it would be helpful to outline which transaction documents would typically be the subject of the legal opinion if the PRA were to request it. A respondent pointed out that it would be helpful if there is certainty that legal opinions would not be required for ‘standard’ applications, as the retention of regulator discretion could be off-putting for applicants due to the potential expenses.

2.6 Having considered the responses, the PRA has decided to maintain the proposal as set out in CP10/22. The PRA will work with PCC applicants and has already approved a PCC MISPV structure. The PRA considers that the ISPV regime does not explicitly require that all contractual arrangements are under English law, and as such could be governed by foreign law. However, the PRA does have a statutory responsibility in authorising ISPVs to ensure that the authorisation conditions are met in each case. Finally, the PRA does not expect in general, where the arrangements were subject to foreign law, but the application was otherwise classified as standard, that the applicant would need to provide such a legal opinion.

2.7 The PRA retains its discretion to ask for a legal opinion, although it considers it unlikely to request one for standard transactions. The decision to ask for a legal opinion (eg in some complex cases) and what it would cover would be decided on a case-by-case basis. For complex cases, the PRA considers that this approach would be preferable to defining a set of documents upfront that it would require an opinion on, which may then not be relevant to each case.

Clarification on the number of SMF holders needed for an ISPV

2.8 The PRA proposed that for standard applications, one individual could hold more than one SMF role, but for complex applications, the three SMF roles may need to be held by separate individuals. The PRA also proposed that this would always be considered on a case-by-case basis.

2.9 A respondent asked for clarification on whether this applied to both MISPVs and single arrangement ISPVs. Another respondent suggested that since it appeared that the intention of the proposed changes was that one individual may hold all three SMF roles in a standard ISPV, this should be made clear in the proposed paragraph 3.3A of SS8/17. A respondent commented that potential conflicts should be considered as the SMF would need to have oversight of the performance of the ISPV, including that of its insurance manager.

2.10 Having considered the responses, the PRA clarifies that one individual may hold all three SMF roles in a standard ISPV. However, whenever all three SMF roles are held by the same individual, the ISPV should have contingency plans in the event that the individual is not able to continue in the role. The PRA also clarifies that in appointing the SMFs, the firm should consider any potential conflicts of interest and how they shall be addressed. The PRA will maintain the rest of the application proposal as set out in CP10/22. The PRA’s proposal on SMF holders does not depend on the type of vehicle (MISPV or ISPV) itself. However, it may be more likely that an MISPV is classified as ‘complex’ rather than an ISPV, especially if it involves multiple unconnected entities, requiring more than one SMF.

Clarification of approach to multiple cedants ceding risk to a single cell via a single contract

2.11 The PRA proposed to clarify that for standard applications, where multiple cedants from the same group ceded short-tail, wholesale, and general insurance risk to one cell via a single contract, then the PRA may, at its discretion, accept that it should treat this as a single cedant ceding risk via a single contract to a single cell. This was subject to a number of criteria including the risks being short-tail, wholesale, and general insurance; and ensuring that requirements related to effective risk transfer, fully funded, and subordination of investor rights to ceding parties were met.

2.12 The same group was defined as ‘part of the same insurance group (as per Solvency II) or are group undertakings of each other (as defined in Companies Act 2006) or are Lloyd’s syndicates managed by the same managing agency with a shared economic interest with the other syndicates managed by the same managing agency’.

2.13 The proposal was subject to the arrangement not undermining effective risk transfer, subordination of investor rights to all ceding parties, or fully funded requirements. This was so that the presence of multiple cedants never resulted in a situation where the cell of the ISPV would be required to pay claims beyond the aggregate maximum risk exposure (AMRE) of the ISPV or that cell. It was also subject to the contractual arrangements setting out how claims would be apportioned between the different cedants. This was expected to include if there were sub limits per cedant within the contract, up to a pre-defined, fully paid-up limit to the value of the AMRE. The contractual arrangements should not allow for the claims of one cedant to be subordinated to that of another cedant.

2.14 A respondent agreed with the proposal in its totality. Another respondent suggested that it might be more appropriate to use the definition of ‘group’ as per FSMA, as opposed to using the definition of ‘group undertakings’ as per Companies Act 2006. A respondent asked to clarify that this would cover all short tail general insurance and not exclude specialty business. A respondent asked to clarify what the PRA expected if sub limits were not in place, as cedants often claimed as the losses fell with no sub limits imposed. Several respondents expressed concern that acceptance of such transfer of risk would be at the PRA’s discretion. A respondent also requested the PRA to consider circumstances where multiple cedants could be covered who are not part of the same group. A respondent also asked the PRA to clarify whether the ability to add or remove cedants within the insurance group over the course of the transaction would be allowed.

2.15 Having considered the responses, the PRA has decided to amend the reference to ‘group’ in clause 3.29A in the SS to refer to FSMA rather than Companies Act 2006 but maintain the rest of the proposal as set out in CP10/22. The FSMA definition of ‘group’ is fairly similar to that of Companies Act but is slightly broader (specifically encompassing friendly societies), and the PRA considers that in the context of regulated firms and in relation to this proposal, it would be more appropriate to use the FSMA definition rather than that in the Companies Act 2006 as it is more in line with the existing regulatory framework under which the PRA supervises all firms. The proposal sets out that it would be relevant to ‘short tail, wholesale general insurance in nature’. This, by definition, includes specialty business. If a contract includes sub limits, the PRA expects it to be clearly set out in how claims would be apportioned. However, if the contract does not have sub limits, the PRA does not, as a general rule, consider that it needs to be introduced as a prerequisite to allow multiple cedants in the first place. The PRA accepts that groups can change at any point in time and changes could be made to a contract to reflect that, as long as the contractual terms allow them to do so within the regulatory framework, the ISPV or the cell of the MISPV continues to only reinsure cedants from the same group, and the PRA is informed in advance of such changes. The PRA does not currently consider that it would be appropriate or within the scope of the existing legal and regulatory framework for multiple cedants who are not part of the same group to be able to cede to one cell via one contract.

Clarification on the interpretation of ‘quantifiable risk’

2.16 The PRA proposed that for standard applications, its assessment of quantifiable risk for standard applications would consider, at the least, insurance risk, market risk, operational risk, and asset risk which may exist in the ISPV.

2.17 A respondent welcomed this clarification while another noted it.

2.18 Having considered the responses, the PRA has decided to maintain the level of application proposal as set out in CP10/22.

Clarification on the requirement for written policies submitted for ‘standard’ applications

2.19 The PRA proposed that for standard applications it does not expect firms to submit the full suite of written policies in place. Instead, the PRA proposed to expect a summary description of the written policies in place that are proportionate to the uses and systems of governance requirements of the ISPV. For MISPVs, or where the application is deemed ‘complex’, the PRA proposed to request to see the policies (or a sample thereof) on a case-by-case basis.

2.20 A respondent welcomed the proposals. Another respondent queried the benefit of this change as it would be an additional document that the firms will have to prepare, especially since the firms are already required to have these policies. A respondent suggested that a summary of policies should be sufficient for most complex ISPVs as well. Another respondent suggested that the PRA should clarify what it would expect in the summary description, and in particular, whether this also applies to the investment policy.

2.21 Having considered the responses, the PRA clarifies that for all cases it expects a list of the policies in place. However, for all cases, it may request to see the written policies (or a sample thereof) on a case-by-case basis.

Other responses not related to CP10/22

2.22 Respondents made comments on a number of other issues that were not within the scope of CP10/22. These included suggestions on areas such as requirements related to fully funded, timelines for authorisation, suggested changes to the ISPV application form, and issues related to taxation. Since these were not part of CP10/22, the PRA will not respond to them in this PS; however, the suggestions made may be considered by the PRA as part of its further policy making process in the future.