Supervisory Priorities in Uncertain Times - Domhnall Cullinan, Director of Insurance Supervision

Introduction

Good morning, and thank you for attending our Insurance Industry Event, the second of these which we’ve held virtually. Hopefully, as the vaccine rollout continues and restrictions are eased, there won’t have to be a third!

The COVID 19 crisis has brought about a significant amount of change to all of our personal and professional lives, and with it has provided the opportunity to reflect on what is important, and where our priorities should lie.

With this in mind, I would like to take this opportunity to:

• highlight the key challenges that, in my view, are faced by the insurance and reinsurance sectors;
• talk about how these have shaped supervisory priorities; and
• explain what we expect of regulated firms and what they can expect of us.

Our Mission

The insurance sector in Ireland remains diverse and internationally focused. The Central Bank of Ireland (“the Central Bank”) supervises 197 firms that write approximately €80 billion of gross premiums. Of this, more than two-thirds is written ‘cross-border’. Irish insurers provide insurance capacity in more than 70 countries across Europe and the world.¹

Central Bank’s overarching mandate is to deliver effective and purposeful supervision that safeguards the interests of policyholders and supports a robust insurance sector. This entails pursuit of the following outcomes:

• insurance companies that have sufficient financial resources including under plausible but severe stresses, are resilient, and can be resolved effectively in the event of financial distress;
• that have established robust governance and risk management frameworks;
• that behave well and have consumer centric cultures; and
• that are proactively developing their business models in order to operate effectively in the future insurance landscape.
  

Impact of COVID-19

The emergence of COVID-19 brought unprecedented social and economic challenges to Ireland, and has shaped much of our activity over the last year. The Central Bank’s response included the formation of a dedicated COVID-19 Task Force to coordinate activity across the financial system.

Insurance companies play an important role in the economy helping individuals and organisations protect themselves against the financial impact of adverse events. So it is natural that assessment of the sector formed a key part of the Central Bank’s COVID-19 response, enabling identification of those firms that may have been more vulnerable, and focussing supervisory resources on the areas of greater risk. This process resulted in a number additional information requests for insurers, and I’d like to acknowledge your support and cooperation in this regard.

Irish insurance undertakings have, by and large, proved to be financially and operationally resilient. The insurance sector as a whole remains well capitalised, and transitioned to remote working without significant issues, ensuring continuity of service to customers and payment of claims.

However, these positives should not be a cause for complacency.

As we look forward, a lot of uncertainty remains – the exceptional fiscal and monetary interventions during the COVID crisis have provided a buffer to the full economic impacts. Firms should consider what might happen as these supports unwind and the potential impacts on their capital and reserving positions.

And over the longer term, insurers should already be considering the impact of the increasing digitalisation of financial services, and of the climate crisis. There has been a significant shift in recognition of climate as a threat to the financial system, and in the scale of transition required to achieve net zero by 2050 - our own Government’s Climate Action Plan and draft legislation² is ambitious in this regard.

Our Priorities

Addressing these challenges have directly informed key supervisory priorities over the medium term. In summary these are:

1. a continuing focus on the fundamentals of effective supervision;
2. strengthening our regulatory and supervisory frameworks to reflect leading practices, and address vulnerabilities; and
3. understanding the future of the insurance sector, assessing how firms’ are evolving their business models and strategy in response to systemic changes.

Effective Supervision

Significant uncertainty remains in the wake of COVID-19, and we will focus on the adequacy of capital and reserving for all firms under a range of scenarios.

Capital Adequacy

Enhanced analytical capabilities, including stress and scenario analysis, will increasingly form part of our supervisory toolkit. Ongoing analysis of Solvency II data has been embedded at a macro and micro-prudential level so that the information - that I acknowledge firms put a lot of effort into providing - can be fully exploited. However, this will only get us so far, and so will be supplemented with periodic industry stress testing exercises, leveraging the work of EIOPA and of other institutions such as the IMF, where possible.

ORSA

The ORSA must form an integral part of business strategy development and be a fundamental tool through which to consider the impact of key risks, including possible COVID-19 aftershocks. Since the introduction of Solvency II, there have been observed improvements in the quality of ORSA reports. However, in some instances, the focus of the ORSA appears to be more on compliance with regulation, rather than a living process at the heart of a firm’s risk, capital and business planning. As we approach five years under Solvency II, this is not good enough.

Firms must make sure that they have considered their own vulnerabilities in detail, their resilience to shocks and unexpected events. They should also give greater consideration to what actions they would take in the event of adverse events which threaten their financial strength, or indeed liquidity. Insurers should take lessons and data from history but also look ahead to new risks that might emerge.

The Central Bank will expect to see evidence of this, and of engagement and challenge from boards, although clearly the approach firms adopt will be commensurate with the scale and complexity of their businesses.

Operational Resilience
Operational Resilience will also remain in focus. The fact remains that many regulated firms have a significant, and growing reliance on outsourced service providers for delivery of critical business services, including the use of both intragroup entities and third parties.

In keeping with the Central Bank’s strategic commitment of strengthening resilience throughout the financial system, further work will be undertaken in this area. Stakeholders’ views are currently being sought on proposed “Cross Industry Guidance on Operational Resilience”. This consultation will remain open until 9 July.

Upon introduction of the Guidance, the expectation of the Central Bank will be that:

• boards and senior management review the Guidance and adopt appropriate measures to strengthen and improve their operational resilience frameworks; and
• vulnerabilities are actively addressed, with evidence of actions to apply the guidance at the latest within two years of Guidance being issued.

Key Challenges - Non-Life Sector

The domestic non-life insurance market has been an area of focus in recent years, due to both its importance and the challenges in it, including the volatility of premiums and the availability of insurance in certain sectors and for certain risks. The Central Bank will continue to produce research and analysis through the National Claims Information Database, and has examined in detail both differential pricing in the private car and home insurance sectors and the business interruption insurance. Both issues were identified as posing significant risks to consumers. Following supervisory interventions and robust challenge of firms, clear expectations have been set in relation to each. With regard to differential pricing, findings are expected to be published, together with a potential consultation on proposals to further protect consumers, in July.

COVID-19 has highlighted the importance of the protection insurers can provide, but has also shown up weaknesses. For example, ambiguous policy wording in some policies has meant that risk exposures have not been adequately priced and reserved for by some insurers.

This may also be true in respect of cyber risk. The evolution of technology has driven an increase in the frequency and severity of cyber-attacks, including the recent significant and very disruptive attack on the HSE. However, firms’ responses on cyber risk in the recent Climate & Emerging Risk Survey highlighted that the majority have not assessed whether they might be exposed to so-called “silent” cyber - where legacy policy wording fails to exclude cyber risks.

Given recent experiences, the Central Bank expects that firms conduct periodic reviews of policy terms, limits and exclusions, to ensure their product offerings are structured to respond in the manner intended and within each firm’s risk appetite.

Key Challenges - Life Sector

In the wake of the pandemic, life and health businesses should consider the impact on mortality and morbidity of ‘long’ COVID, and of delays in early diagnostic and treatment interventions on non-COVID health issues. When reserving, firms should consider a range of possible outcomes appropriate to their business and risk profile, and be prepared to update assumptions and refresh their approach as actual experience emerges.

Alongside the valuable role life insurers play in providing financial protection should serious illness or an untimely death strike, they also play a central role in helping individuals and households save and invest for the future, notably in the area of retirement planning. And as we know, most people are not saving enough to provide for a comfortable old age. Whatever the savings vehicles used, it is important that consumers can have confidence in the products they are being offered.

EIOPA currently has a consultation on a framework to address value for money risk in the in the European unit-linked market.³ While unit-linked products can and often do offer important benefits for policyholders, concerns have been raised about value for money in other European jurisdictions.

As unit-linked insurance products are facing increased competition from a number of alternative retail investment products, insurers offering these products should ensure that they have robust product oversight and governance processes in place, with a focus on offering value for money for policyholders. At a strategic level, some firms will no doubt be considering whether the level of charges they will be able to levy in the future will be on a par with historic levels or whether new competitive pressures will come into play.

The Central Bank encourages relevant firms to actively engage in the EIOPA consultation process before the deadline of 16 July, and also to have due regard to EIOPA’s previous publications on product oversight.⁴

Strengthening Regulatory Frameworks

Over the last five years, both consumers and the insurance sector in Ireland have been affected by a number of insurance failures, both in domestic firms and firms operating in Ireland on a freedom of services basis. A key priority is therefore to continue to strengthen regulation in discrete areas where vulnerabilities may lie.

Recovery Framework

The Central Bank has implemented Regulations⁵ which will require all insurers to draw up and maintain pre-emptive recovery plans, as part of a recovery framework that will contribute to the protection of policyholders, by both reducing the likelihood and impact of individual firm failure. The Regulations commenced in April of this year and the deadline for preparation of the first recovery plan under the regulations is 31 March 2022. Assessing the quality of those plans will be an area of focus next year.

SEAR

Experience has shown that at the root of many problems within the financial sector is the action or the inaction of senior individuals who should have known better. In our view, individual accountability, combined with appropriate organisational cultures, is fundamental to safeguarding against misconduct. To achieve this, the allocation of responsibilities within firms needs to be clear and comprehensive.

The Central Bank continues to see significant shortcomings in compliance with Fitness & Probity (F&P) obligations and a lack of awareness in the industry regarding the scope of the F&P regime. In response, the Central Bank has been working with the Department of Finance to develop an Individual Accountability Framework.

The core aspects of the reform package include the introduction of conduct standards for individuals in regulated firms, conduct standards for firms themselves, and the Senior Executive Accountability Regime (SEAR). SEAR will impose obligations on firms to set out clearly where responsibility and decision-making lies and will provide for senior executive accountability. It is proposed that SEAR will apply to the boards of insurance undertakings, including INEDs. In addition, a unified enforcement process will allow individuals to be held to account directly for their misconduct under the administrative sanctions procedure.

The Central Bank is working closely with the Department of Finance to progress the Framework.

Other Initiatives

 Outside of new legislation, the Central Bank is continually working to enhance its regulatory framework, including:

• the PRISM risk-based supervisory framework, already in line with international best practices, is subject to regular review ⁶ and
• the design of a Behavioural & Culture Framework, which will build on the foundations of previous reviews undertaken by the Central Bank, and reflect leading international practices; and
• continued monitoring of Diversity & Inclusion across the sector, this being an important component of a strong organisational culture, and one where the pace of change needs to accelerate.

The Future of Insurance

Whilst it has been natural to focus time and attention on the impacts of COVID-19, it is important to recognise that the financial services industry is on the verge of significant change, driven by digitalisation and by efforts to mitigate climate change. The Central Bank’s expectation is that firms identify the risks and opportunities they face over the longer term, and adjust their strategies and business models accordingly.

Climate

Addressing the challenges posed by climate change is a key priority for the Central Bank. Whilst work in this area remains at a relatively early stage – much has been learnt from the climate and emerging risk survey issued late last year, the findings of which were published last month ^7.

These results indicated that physical and transition risks are considered the most material climate change risks by Irish insurers, while 11% of firms indicated that reputational risks were a concern. However, only 4% of firms identified liability risk as their most material concern, a finding that is worthy of consideration for a moment.

Climate change litigation covers a broad range of actions that result from climate-related issues, mitigation and risks. Claimants, including a growing number of activist non-profit organisations, are seeing the potential for litigation to drive an increase in climate change mitigation activity, across a range of claim types^{8 9 10}- so there is a high likelihood that we will see further climate change litigation not just against fossil fuel companies but across all sectors, as climate considerations begin to form a recognised part of directors’ legal obligations and duties. It is therefore important that firms consider their potential exposure to these risks through, for example, Directors & Officers or Professional Indemnity insurance products.

Turning back to the survey results, climate risk has not yet been fully integrated in risk management frameworks. Over half of firms do not have a climate policy, plan or strategy in place. And the vast majority of the 92 firms that responded had not performed forward looking quantitative analysis (stress testing or scenario analysis) to assess the impacts of climate change. So much more work is required in this area - if climate-related risks are deemed to be material, the Central Bank will expect the firms to develop relevant scenarios as part of their ORSA process, in line with the recent EIOPA opinion on this issue.¹²

Firms can expect the Central Bank to formally communicate its expectations of them in respect of climate change in the coming months and to further integrate consideration of climate related risks within the supervisory framework.

In addition to managing and mitigating their own climate risk exposures, insurers must be mindful of the role they can play in supporting the transition to net zero over the longer term, including ‘minding the gap’ between economic and insured losses. Take Irish flood risk cover for example. Data collected by the Central Bank indicates that a high proportion of Irish property insurance policies include flood cover, including in areas protected by flood defence schemes. This, however, does not mean that the system is working perfectly – current flood policy hinges on flood relief measures and on increasing flood insurance coverage . So the onus is on the industry to continue to increase cooperation with stakeholders, such as the Office of Public Works, particularly given the likely increases in the frequency and severity of flood events in Ireland over the longer term.

Digitalisation

Given the upcoming panel discussion on the Future of Insurance, I will keep my comments on this subject brief.

The Central Bank pays close attention to technological innovation in the financial services sector, be it in relation to big data, machine learning, internet of things and other transformative technologies to automate and improve processes across the insurance value chain and since 2018 has had an Innovation Hub to engage with firms on these issues.¹⁴

Whilst technological innovations have the potential to deliver benefits for both insurers and consumers, it is equally important to understand the risks associated with these. The foundation of digital innovation must be robust IT risk controls, protection of consumer data and oversight of outsourcing arrangements.

Closing Remarks

In closing, I’d like to reiterate my opening remarks, that the last year and a bit has been unprecedented. The pandemic has shown the importance of financial and operational resilience, sound risk management, and of clearly defined roles and responsibilities.

And as we look to the future, further change appears inevitable – so whilst lessons should be learned from the COVID experience, perhaps the only thing we can say with certainty is that the next crisis will be different to the last one.

These factors will directly inform the Central Bank’s supervisory approach, and should also be important factors for insurers and reinsurers to consider - the firms that can best navigate in this environment will be those that can identify the threats and opportunities they face over the longer term, and factor these into their strategy, capital, and operational considerations.

I thank you for your attention and look forward to our panel discussion¹⁵.

¹Solvency II Annual Returns (2019)

²Climate Action and Low Carbon Development (Amendment) Bill 2021

³EIOPA Consultation on framework to address value for money risk in the European unit-linked market 2021 (2021)

⁴EIOPA Approach to the supervision of product oversight and governance.

⁵Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1)) (Recovery Plan Requirements for Insurers) Regulations (2021)

⁶Central Bank How we Regulate

⁷Understanding the Future of Insurance (2021)

⁸Banktrack et al -v- ING Bank (2017) (Netherlands)

⁹Torres Strait Islanders Case (2020)

¹⁰In Re ExxonMobil Corp (2019) (Consolidated shareholder actions against company executives for fraud/misrepresentation)

¹¹Pinset Masons Climate change litigation risk growing in UK

¹²EIOPA Opinion on the supervision of the use of climate change risk scenarios in ORSA

¹³Dept. of Finance Public Consultation on Climate Change and Insurance.

¹⁴Central Bank Innovation Hub

¹⁵With thanks to Brian Balmforth, Peter Towers, Anne-Marie Butler, Emily Duffy, Barry Walsh and Nicola Faulkner for their assistance in preparing these remarks.