Interview: David Rule, Prudential Regulation Authority

Friday 29 March 2019 has been circled in red and as the nation celebrated with fireworks at midnight on New Year’s Eve the countdown officially started until the UK leaves the European Union.

During this year little will be certain but uncertainty and the UK insurers’ best friend could well be its prudential regulator, which should be primed to guide companies through a new claims and underwriting environment untethered to the EU.

David Rule, executive director for insurance for the Prudential Regulation Authority, could, therefore, be on speed dial for many as the details of the divorce hopefully get clearer.

“Our focus is on practical preparations to make sure that we continue to have a regulatory framework whatever happens in March and that we have authorised those insurers operating in the UK,” Rule explains. “The temporary permissions regime, which went through parliament, ensures that all passporting European insurers into the UK can continue to operate after March, regardless of whether there’s a transition period. We are also consulting to ensure that the regulatory framework for insurers under Solvency II is pretty much unchanged from March.”

Rule was promoted to this role two and a half years ago after a long career in banking regulation but insurance wasn’t brand new to him: “At my previous job I had been in charge of both banking and insurance regulation, so I knew a bit about the regulatory framework, but it was new to me to supervise insurers.”

“It’s a very fascinating market to supervise because of what comes across your desk on a daily basis is never the same. I never cease to be surprised by the complexities of Solvency II, which are a challenge to supervisors as much as the firms.”

Gold-plating regulation

Solvency II is never far from UK insurers’ thoughts and the PRA has been accused of gold-plating the regulation, which itself has been criticized for damaging competition.

Rule defends the regulators actions: “The UK was probably the most influential voice in the development of Solvency II. It is a complex piece of regulation, and that reflects that insurance sectors are different in countries around the EU. Solvency II is complex because it has to accommodate that difference. But, I don’t think it disadvantages UK insurers.

“I also don’t think that we have gold-plated, with the exception of a few areas, where either parliament required that, or we have chosen to, such as the Senior Managers Regime, which we believe is absolutely vital, because it makes senior managers accountable.”

The regulations started as a banking regime only. But subsequently, parliament decided to broaden the SMR to other parts of financial services, including insurance, which already had the Senior Insurance Managers Regime, which led to additional changes for insurers and some were less than happy with what they saw as a ‘piecemeal approach’ by the PRA.

“It builds really on the existing SIMR, so I don’t think it’s a major change of direction for us,” Rule responds. “The most significant change is that there is now a certification regime for insurance employees. This reflects the fact that insurance, rightly in our view, has been brought within the statutory framework.”

Beyond individual regulations Rule believes insurers are facing plenty of other challenges in 2019: “There are a lot of big questions for players in the London market. The big challenge is the soft market and low premiums. That then feeds through into challenges around maintaining underwriting discipline and appropriately reserving. Do you stay in markets that are unprofitable in the longer term, to be there strategically, or bite the bullet and say ‘We can’t stay in this market because we’re not making money?’.

“The retail and the commercial markets, are a bit more stable, but there have been big external changes, like the Ogden discount rate. There was a big impact initially on reserving, particularly the motor market. But, firms are now reserving on a different basis, on an expectation of where they think it will land, which may be not quite as extreme as the initial expectation.”

“However, the pressures, in the long run, maybe even more fundamental, because they’re about how technology changes the demand for insurance services and the way that those are supplied.”

Unsustainable reserving

The PRA has previously raised concerns over recent years reserve releases saying they are unsustainable and Rule maintains that discipline will be important here. 

“Our chief general insurance actuary, James Orr, wrote to heads of actuarial function quite recently on reserving. Our sense is that any fat that was left in reserves against prior years has pretty much been used up at this point. We see examples in our supervision of what we think is insufficient reserving, and that can take a number of forms. It can take the forms of firms arguing that they have re-underwritten this business, and, therefore, will expect a better outturn than history would suggest.

“Or, not taking proper account of the merging loss trends, or, for example, not using technical measures, even in markets where those have shown a good track record. We think there is pressure on reserving at the moment, and it’s important for boards to maintain reserving discipline.”

And if being undisciplined doesn’t upset the apple cart then the constant fears of increasing climate change might.

“The Met Office has said UK climate has, over the past 10 years, been more variable and unpredictable than in the previous few decades,” he says. “With climate change, scientists think that’s only likely to continue, and that’s going to make writing various types of home and motor insurance in this country even more risky.”

With this in mind the PRA recently launched a consultation paper on a draft supervisory statement, which sets out expectations regarding firms’ approaches to managing the financial risks from climate change.

He explains its aim: “The big message, and it’s not just for insurers but for banks as well, is that we want them to look at climate change as a risk issue, as well as the corporate social responsibility one. It needs to be seen front and centre as a financial risk. That comes in two ways: the physical risks from a more unpredictable climate, which are clear to see for general insurers.

“And two, the transition risks that come from how public policy adapts to climate change, and what that means for the values of the assets that insurers hold, particularly where those are sensitive to climate change. We want to accelerate that change by having somebody at senior management level responsible for taking a strategic response to climate risks.”

Another increasing area of expose and a relatively new risk for insurers to grapple is cyber exposure. 

“There are firm’s own cyber risks - testing themselves against cyber-attacks - and then there’s the cover that insurers provide. The potential for cyber losses or cyber-related losses to lead to claims on other types of cover, is an issue facing insurers. We’ve seen some examples of that, and claims on property policies are currently being talked about in the market,” he explains.

“We understand that it’s very difficult for firms to assess their exposure to that, because they don’t know how the courts would rule on particular cases. Firms should be proactively looking to understand these risks, and where possible, either excluding it from policies or writing it in explicitly and pricing for it, rather than ignoring it.”

Encouraging competition and making London attractive

But it’s not all doom and gloom for 2019 as Rule says the PRA also has a role to help facilitate competition: “We have a secondary competition objective, which essentially means that as we do our work, we have to do it to the extent possible in a way that promotes competition.

“We’ve set up an insurer start-up unit, and we’re keen to encourage new firms working with the Financial Conduct Authority, and now have a joined-up process where they can approach us for authorisation.

“A number of players may want to set up as a managing general agent. But, if people do want to set up as an insurance company, then the message from us is that the door is open and we encourage that.”

One area that has taken off to date well is insurance linked securities for which the PRA put in place a supervisory framework in 2017. 

“We’re learning about that market. It’s fair to say a number of technical issues come out with each new deal, and we’re learning how that works, as is the FCA. But, we’re confident it’s going to be a great market for the UK, and we’re happy to supervise it,” he says.

“We hope that once there are some deals out there and a track record, then [the market] will grow. The underlying forces are supporting that, because of the soft market, and the continued demand for insurance risk from real money investors. Therefore, the economics of the market are such that it will continue to grow, and there will be more transactions. Some of those will be done in Bermuda and other places, but I believe the UK will get its fair share.”

And Rule believes the changing shape of the market and customers’ developing needs will bring other opportunities too: “The big question over the next 10 or 20 years is what insurances will we buy? Will we continue to buy motor, property, or will we have different levels of risk, or different types, and want different types of products? There’s an opportunity there for insurers to really rethink what general insurance is, and what people need, and how they pay for it. Across virtually all perils, technology will change the nature of the risk. Big data and more powerful computing power may also change the way that insurers assess the risk.”

He predicts this will keep existing providers on their toes: “As a prudential regulator, the trap that we can fall into is protecting the incumbents. If you interpret your job narrowly as safety and soundness, as the majority of policyholders, that essentially means keeping the incumbents in a nice, cosy business model where they make money.

“But, that can’t be our approach, because we have to facilitate competition, and competition means that new players enter the market, and existing players may not survive. The task for us is to make sure that that process happens in an orderly way, where policyholders don’t suffer.”

And Rule says insurers’ treatment of customers is key to this and getting it right can only improve the industry’s reputation: “It’s about treating customers fairly and listening to customers and what cover they need, rather than selling them perhaps the products that the insurer wants to manufacture. So, moving it to giving customers what they need, rather than selling them what you want to sell them.”

Rule believes one factor that will help foster a better reputation and customer representation is inclusion, an area where the industry still has work to do: “Having more women and ethnic minorities in senior positions, so that they look more like the people who they serve can only have a positive impact.

“That’s something we in the PRA are also keen to promote within our own workforce. We want more women, more people from different backgrounds, diversity of thought, as well as a background in our teams. I’m particularly keen to promote flexible working. I work four days a week, with one day volunteering, and having senior people who show that it’s possible to get to these positions and still work flexibly is important.”

This year is unlikely to be an easy year and although Rule hopes the regulator will be able to work well with insurers he is also clear that ‘rules are rules’: “Our preference is to work cooperatively with insurers. But, at the same time, we recognise that we have a job to do to represent the public interest, and we wouldn’t be here as regulators if insurers were always going to act in the public interest.

“Therefore, there will be times when we disagree, and in those situations, we will, I hope, listen, and present our view clearly, and consult. But ultimately, if it comes to it, we will act according to our statutory objectives, and that may mean that we act in a way that insurers disagree with.”