Bank Of England: The Feeling Is Mutual − Speech By Shoib Khan, Given At The Association Of Financial Mutuals Annual Conference 2023

Speech

Introductory remarks

Good afternoon and thank you very much to Stuart and Andrew for the invitation to speak today. It’s a privilege to be at my first Association of Financial Mutuals (AFM) Conference and I’m excited to have the opportunity to meet with AFM members and hear about the opportunities and challenges facing mutual insurers.

While I only assumed responsibility for supervising insurance mutuals last year, I’m not new to the principles that underpin mutuality. That’s because between 2018 and 2021 I had responsibility for supervising the UK’s building societies sector - so I have been well schooled by your deposit taking colleagues on those principles.

By operating in often under-served markets, you play an important societal role in supporting financial inclusion, and whilst the PRA is impartial as to the legal status of firms, we recognise the value of corporate diversity and understand the unique role that mutuals play in the fabric of the wider financial system. Mutuals have stood the test of time and, coupled with the long term view that members take, are aligned with the PRA’s enduring objectives of safety and soundness and policyholder protection – so, in short, we are inherently keen to see this sector thrive.

We are also mindful of the collective significance of the mutual insurance sector in the UK - employing circa 30,000 people, holding over £160 billion in assets and collecting annual premiums of nearly £20 billion^footnote[1].

So today I plan to elaborate on why insurance mutuals are important to the PRA’s objectives; explore some of the opportunities and challenges that we see ahead; and clarify how we will take a proportionate approach in our supervision of the sector.

Economic challenges and PRA priorities

The overarching aim for the insurance sector is to provide a stable supply of protection to UK households and businesses - through good times and bad. The PRA will play its role in delivering that goal, but so too must the industry, including mutual insurers. Indeed, I chose the title of this speech – ‘the feeling is Mutual’ – to reflect this shared responsibility.

I speak to you today in the context of challenging economic conditions. Whilst CPI inflation fell to 6.7% in August, it is still above the target, UK GDP is estimated to have declined by 0.5% in July, and interest rates are at their highest levels since 2008. This outlook is likely to present challenges to both the life and general insurance sectors and for corporates and mutuals alike.

Through these challenges, the PRA has sought to make clear its priorities for the insurance industry and you would have seen this in our annual ‘Dear CEO’ letter^footnote[2] published earlier in the year. I’ll explore some of those priorities and how they apply to the mutual sector. 

• Beginning with the theme of financial resilience, we see the UK life and GI sectors as resilient. Reassuringly, our 2022 Insurance Stress Tests^footnote[3] concluded that, in aggregate, both the sectors’ solvency coverage remained above 120% in our adverse scenarios. There are, however, ongoing challenges that have implications for financial resilience; including in general insurance, where we see claims inflation pressures increasing as economic inflation passes through to settlement costs. And, for those of you in the life market, we see growing credit and concentration risks and expect life insurers to robustly stress test their balance sheets against adverse credit scenarios.
• Another priority we flagged is the importance that firms take steps to ensure that risk management frameworks operate effectively in an environment quite different to the conditions since their inception. We know this can mean incurring cost, but firms need to be able to respond to market and credit risk conditions different to those that prevailed in the past. I spoke in detail on these topics earlier this year at the Westminster Business Forum, so you may wish to give that a read^footnote[4], especially if you’re struggling to get sleep one night.

Regulatory reform

I’ll now spend some time talking about how regulation, if applied in a proportionate way, may be able to support competition, growth and innovation within the mutuals sector; and there are a number of evolving areas within our approach which we think will help tackle regulatory challenges facing mutuals.

Solvency II reform and mutuals

The first of these is the work underway in delivering the government’s proposed reforms of the Solvency II regime, or Solvency UK.

We issued a consultation paper in June (CP 12/23)^footnote[5] setting out detailed proposals for reforming the Solvency II regime. That consultation closed just recently, and we’re carefully considering the responses we received. I know this work is certainly no ‘silver bullet’ for the challenges facing mutuals, but we believe that a number of these reforms would be supportive of mutuals, and it’s therefore worth looking at these in a little more detail.

• First, we are looking to increase the size thresholds at which smaller insurers are required to enter the Solvency II regime. This involves increasing the gross written premium threshold from €5 million to £15 million, and the technical provisions threshold from €25 million to £50 million. Given that more than half of smaller firms operating near the thresholds are mutuals, we think it is the firms in this sector that will benefit most from these changes.
• We are proposing to streamline reporting requirements for the UK insurance sector, to increase proportionality and reduce complexity. The proposals should lead to an overall reduction in reporting requirements, and therefore cost savings for firms, but again we think they’ll particularly benefit smaller mutual insurers.
• And we are proposing a new ‘mobilisation’ regime to facilitate entry for new insurers and facilitate competition. Under these proposals, the PRA would offer new insurers the option of using a period of time to build up systems and resources while operating with business restrictions. This would also enable the PRA to lower minimum capital requirements during mobilisation.

Alongside this, the government has said it will legislate to reduce the risk margin by around 65% for long-term life insurance business and 30% for non-life business. And in light of the government’s conclusions on the Solvency II review last year, the PRA launched a consultation a few days ago, on 28 September^footnote[6], designed to improve investment flexibility for insurers; which the government hopes will incentivise insurers to invest in long-term productive assets. Whilst these measures centre on the matching adjustment used predominantly by larger life insurance firms, they reflect the desire of managers of long-term investments, which includes some mutuals, to consider how they can responsibly contribute to tackling societal and economic challenges.

We believe that pursuing our reforms - especially those set out in our June consultation - will further support the principle of proportionality by resulting in a less burdensome and more streamlined regulatory regime for mutual insurers.

Competition, competitiveness, and growth

Tailoring our rules to the specifics of the UK, such as reforming Solvency II, should help to better facilitate effective competition. In this respect, I see connections between the secondary competition objective that we already had, and the PRA’s new competitiveness and growth objective. My colleague Vicky Saporta spoke last month about the role of financial regulation in international competitiveness and growth^footnote[7], so I’ll only add that competitiveness and growth will be facilitated through the PRA’s general functions rather than at the level of firm-specific decisions.

The importance of competition means we need to act when rules - that are suitable for large firms - are not proportionate for small ones. We know there is more to think about in this regard and so hearing your views on the ongoing proportionality challenges that mutuals face is key for us.

We are also aware of the upcoming Friendly Societies Review which is being led by the Law Commission. Whilst this is not within the PRA’s remit, we hope that any changes to the legislation here will impact the sector positively.

Also, in the pursuit of greater competition and competitiveness, we and the FCA have jointly established the New Insurer Start-Up Unit^footnote[8]. The unit forms part of our efforts to improve and streamline the authorisation process for new insurance firms and also acts as a forum for raising concerns around barriers to entry into the insurance market and explore measures to address these.

PRA expectations

Whilst there is much underway that can support a more proportionate regime for your firms and boost competition, we as regulators still have clear expectations of the mutual sector and I’ll mention some of the more important ones now.

Ease of exit

Beginning with ease of exit, which is a topic that my colleague Patrick Connolly spoke to you about last year - so, whilst I won’t dwell on it, I’ll reiterate that it is a priority for the PRA and is of relevance to mutuals.

As part of our supervisory approach, we believe it is important that firms should be ready to make the mindset shift from recovery to exit, that will allow for an orderly end which protects policyholders and ensures financial stability. Boards should be carefully monitoring their firm’s viability and not wait to engage with the PRA only once capital requirements have been breached. Where a breach of capital requirements cannot be remediated, some firms may be able to run-off solvently; whilst for other firms, a breach of capital requirements may come at a point at which it is too late to achieve solvent run-off and so other options will be needed to ensure an orderly exit from the market. This requires planning and, the more confident we are that a firm can exit in an orderly way should the need arise, the less we will expect to intervene.

Transfers and mergers

We understand that for some firms, the preferred exit option might be a transfer of business to a third party. We also know that consolidation through business transfers and mergers are a tried and tested means of supporting non-organic growth and for the sector to strengthen itself. Some of you attended the PRA’s recent roundtable on business transfers and restructuring, and the high level of engagement there indicated this was a useful initiative.

Our intention at that event was to give you a better understanding of the PRA’s willingness to take a proportionate and flexible approach within the boundaries of the relevant legislation, provided this does not adversely impact our objectives. It’s important that you, the people running the firms, understand how your preferred mechanism to transfer or exit interplays with your firm’s legal structure, constitutional rules or voting arrangements.

These challenges reinforce the need for you to take early steps to identify and overcome any barriers, and ensure you have sufficient resources available to undertake this assessment and work-up a contingency plan if your preferred option is unsuccessful or unavailable. It’s not the PRA’s intention to make the process more difficult or costly as we understand the importance to you and your members of using resources effectively. But we are mindful that there may be costs associated with not pursing transfers - specifically by maintaining infrastructure, governance and staffing for multiple organisations. Our starting point is that you know your business better than anyone else, and the information you need to make these types of assessments should already be available to you through your internal management reporting or Board papers. Again, the better prepared you are, then the more confident we will be to take a proportionate approach if such a situation arises.

Collaboration between mutuals

Turning to how mutuals may work with each other, I know that potential areas of collaboration between mutuals is high on the AFM’s agenda at the moment. Such an approach would be another example of your mutual values in action, so it is certainly sensible to explore - for example, sharing technology resources or services such as back-office functions, which could build on your collective strength, reduce costs and bring tangible benefits to your members. Our starting point is to be supportive of this, but we remind you to think about the potential risks - as well as the benefits - and to engage with us on such plans early where they may have implications for the PRA’s objectives.

Connected to the theme of collaboration, I’m conscious that the mutual sector faces a number of common operational challenges - such as cyber risk, outsourcing and third-party risk. We believe that sharing of cyber threat intelligence - to name just one example - would be a sensible area to explore; and our specialists are engaging with the AFM about a discussion on the common operational resilience issues faced by mutuals.

Conclusions

Prospects for the future leads me onto my concluding thoughts including the PRA’s ongoing supervisory relationship with mutual firms. This year, the PRA has sought to engage more with the mutual sector through the AFM’s visit to our offices, the roundtable on transfers and restructuring, and our inaugural smaller insurers conference in June. I would like to thank you all and the AFM for engaging with us during these events.

I mentioned the importance of talking to us early about the challenges and issues that you face - I can assure you that we have seen it all before and we won’t be easily shocked. As the regulator, we hold a macro view of the sector and may therefore be able to share our experience on matters that you may not have considered.

And we do hear what you tell us about your challenges. While we recognise that there is no regulatory silver bullet to resolve the challenges facing your firms, we do think our agenda will help to deliver our commitment to further proportionality in our regulation of the mutual sector.

Finally - in the spirit of this speech’s title and our mutual objective of ensuring the safety of a thriving mutual sector - do continue to bear in mind our expectations of you. Be it enhancing financial resilience, building robust risk management, or considering how best to ensure an orderly exit from the market if needed.

I look forward to working with you on these - thank you very much for listening.

I am grateful to Caroline Parsons and John Adams for their assistance in preparing these remarks. I am also grateful to Beth Rees, Deborah Bowles, Anthony Brown, Patrick Connolly, Anooj Dodhia and Nimra Mahmood for their support and comments.