Insurance supervision in an uncertain environment - Remarks by Domhnall Cullinan, Director of Insurance Supervision, at Financial Services Ireland

Introduction

Good morning everyone. Thank you for inviting me to speak here today.

Before I begin, I’d like to acknowledge the important role played by Financial Services Ireland in advocating for its members, and in promoting the Irish financial services sector, both here and abroad. Whilst the respective missions we undertake are undoubtedly different, we have a shared interest in a strong and stable financial services sector.

It is claimed that the phrase “may you live in interesting times” is a translation of a traditional Chinese curse and that in fact, it is better to live in uninteresting times.  What can be said with certainty is that the period since 2016 has been interesting, and recent weeks particularly so.

In this context, it is worth reflecting upon:

• The current environment in which insurers operate;
• Why the Central Bank of Ireland’s ("Central Bank") approach to authorisation and supervision remains appropriate;
• Some current and future areas of focus.

An Uncertain Environment

In its July World Economic Outlook¹ the International Monetary Fund concluded that the global outlook is now “extraordinarily uncertain”. Analysis² undertaken by the Central Bank has found that domestic demand has abated; and that inflation will weigh on Irish businesses and households in the short term. All things considered, insurers operate today in a more uncertain and rapidly changing risk environment than at any stage in at least the last two years.

There are a number of drivers of uncertainty and change, and the task of assessing and mitigating risk is becoming more challenging, both for firms and supervisory authorities.  

The Central Bank remains acutely aware of the suffering that war is visiting upon the people of Ukraine, and would remind firms of the importance of compliance with the various financial sanctions now in place³.  Continued vigilance and monitoring is essential, as these requirements simply must be adhered to.

Inflation

In the twelve months to August 2022, there was an 8.7% rise in Irish consumer prices⁴, a multi-decade high. Whilst there has been a strong policy response globally from central banks (including significant interest rates rises and a withdrawal of support of bond markets), this action is likely to negatively impact economic growth. Furthermore, it may not fully control inflation, which is being driven by other factors, notably in relation to energy supply. Reduced economic growth, or even recession, may in turn reduce profitability of, and demand for insurance products.

Insurers should be mindful of the impact of inflation upon costs of claims and operating expenses which exceed allowances previously made in reserving for existing business. Firms should reflect appropriate inflation assumptions in their pricing and reserving processes, and incorporate robust scenario analyses in ORSAs and other key planning processes.

Energy Supply Constraints

Perhaps the greatest threat to EU economies over the medium term is linked to energy pricing. Sanctions have embargoed Russian coal from August 2022 and will affect seaborne oil from 2023, while Russia’s response has seen a very significant reduction in gas supplies to EU countries. In addition to the inflationary effect that this will bring, European economies could face energy rationing or even blackouts in the near future.

Market Volatility

From the point of view of financial markets, this year has so far been defined by deterioration in the macro environment. Interest rates are rising rapidly against a background of very significant debt levels. Corporate and sovereign bond spreads have widened, foreign exchange rates have moved considerably, and a widespread asset price correction has taken hold.

Uncertainty surrounding the short and medium term outlook remains high and reflects a risk that financial markets will exhibit volatility for some time to come. Indeed, the current turmoil which was triggered by the UK government’s ‘mini-budget’ has demonstrated that markets have a limited capacity to absorb further surprises in what is already a high risk environment.

All of this underlines the need for continued resilience and careful risk management, as highlighted by the ESRB in recent days⁵. The Central Bank expects insurers to understand their risk exposures, adopt a forward-looking perspective, accompanied by strong oversight and pre-emptive identification of remediation actions, and to be prepared for the possibility that the current environment may last for some time.

This assessment may appear gloomy. However it is also worth reflecting upon the financial resilience that the Irish insurance sector has demonstrated, particularly since the implementation of the Solvency II regime.

Through the COVID-19 pandemic period, insurers’ median solvency coverage dropped by 10 percentage points and had almost entirely recovered to its pre-pandemic position by year-end 2020. In the first half of this year, median solvency coverage increased one percentage point to 198% despite very significant market movements occurring in that period.

The Irish insurance sector has, in aggregate, experienced a remarkable period of growth in recent years. In the 5 years since the implementation of Solvency II, there has been a 55% growth in assets of Irish (re)insurance companies and a 46% growth in net liabilities⁶, driven by the Brexit referendum in the UK and growth in individual firms.

Gatekeeping 

Ireland remains an important centre for financial services, particularly as a jurisdiction from which to access EU markets, which has driven an increase in authorisation activity.

Over the course of 2020 and 2021 the Central Bank authorised a total of 15 (re)insurers. However, this doesn’t fully illustrate the activity in the (re)insurance industry in Ireland, as over the same period, the Central Bank oversaw 52 portfolio transfers and material change in business plans.  The supervision of these transactions follows a process consistent with that for new authorisations.

Naturally, this increase in activity has been accompanied by a focus on authorisation processes. A proportionate risk-based approach is at the centre of all of the Central Bank’s regulatory and supervisory activity, including gatekeeping. The Central Bank’s objective is a process that is timely, transparent, fair and predictable, supported by engagement with European Supervisory Authorities to ensure consistency and convergence. It is important to remind ourselves that the overriding objective of regulation and supervision of the financial system is to protect the customer.  Specifically for insurance and as stated in Article 27 of the Solvency II directive, the main objective of supervision is “the protection of policy holders [sic] and beneficiaries”.   

Specific details of the authorisation process for (re)insurers, details of levies and the approach to supervision are set out on the Central Bank’s website⁷. In practical terms, the components of a successful application for authorisation often include:

• Early, open engagement at the pre-application phase;
• Allowing sufficient time and resources to prepare a thorough application, and to respond to  follow up questions; and
• A clear understanding of the Central Bank’s expectations, particularly with regard to governance, internal control and “substance” in Ireland.

It is difficult to overstate the importance of authorisation as a safeguard, from both a conduct and prudential perspective.  Put simply, firms that would materially undermine the achievement of the supervisory objectives set out above cannot be authorised.

All of you here today lead firms that have earned authorisation and continue to meet the ongoing obligations and responsibilities involved in holding that authorisation.  You and your teams should feel a sense of accomplishment and pride in earning and maintaining the authorisations that you have.  Any lowering of those standards would cheapen those achievements but more seriously, would diminish the level of protection that policyholders of Irish insurance companies enjoy today.

Insurance Industry Focus

Let me take this opportunity to highlight a number of issues that are at the forefront of the Central Bank’s consideration of the insurance industry as we look forward to 2023: 

Unit Linked ‘Value for Money’

Life assurance plays a very important role in society by facilitating customers to plan and save for the future. The unit linked market in Ireland is well established in providing retirement and savings solutions to customers in Ireland and the EU.

As with many other products, there is a careful balance to be struck between firms making a reasonable profit while at the same time, allowing a customer to achieve, or at least having a reasonable chance of achieving, a return on their investment.

There have been instances in recent years in other European markets, where concerns have been raised that particular unit linked products for sale in those markets, did not prima facie offer good “value for money” for the policyholders. As such, EIOPA has strengthened its focus on this topic as noted in a general way in its Union Wide Strategic Supervisory Priorities of 13 January 2021⁸, and in a more targeted way in its Supervisory Statement of 30 November 2021⁹.

Aligned to this, the Central Bank is progressing its own thinking on the matter. It is acknowledged that “value for money” is a complicated concept that can be looked at from a number of different perspectives and at different points in time. This is particularly so in respect of long tail products such as many unit linked policies, where there may be many stakeholders in the value chain in addition to the life assurance firm, such as the broker and the fund manager.

You will be aware that the Central Bank has asked all life firms’ currently selling unit linked products in Ireland or abroad to complete a survey in relation to the costs, charges and commissions associated with those products. The purpose of the survey is to provide a reasonable picture of the costs and charges associated with unit linked products across the industry in Ireland. To be clear, there are no preconceptions as to what the data in the survey will tell us and as such, analysis will be concluded before determining the next steps.

Notwithstanding, it is expected that firms adopt a customer centric approach in the application of their product oversight and governance responsibilities, including the design of products, the identification of suitable target markets and the ongoing review of the suitability of inforce policies.

Digitalisation

The Central Bank will continue to focus on understanding, anticipating and adapting to the rapidly evolving financial services industry that operates in and from Ireland. 

Adoption of digital business models are necessary for insurers to remain competitive and could be an opportunity to increase efficiencies across the entire insurance value chain, and to enable insurers to become more responsive and consumer-focused. On the other hand, the adoption of new technological innovations (e.g. artificial intelligence) may give rise to new risks, and present ethical questions in relation to how vulnerable consumers are treated. A digitalisation survey will be issued later this year, with the aim of building a more comprehensive picture of innovation across the sector.

Outsourcing of IT processes, which may help enable digital transformations, must be accompanied by sound risk management practices. Boards and senior management are reminded that they remain ultimately accountable for the effective oversight and management of outsourcing risk within their business. Records of recent operational incidents maintained by the Central Bank have highlighted the vulnerability of personal data to cyber attack, particularly where outsourcing is utilised.  Firms should take particular care to implement robust, effective measures to secure and protect this data, whether the controls are implemented by the firm or an outsource service provider.

Outsourcing may also give rise to risks to the wider financial system, particularly where there is a significant reliance on a few large technology providers. These concerns are also reflected in the forward looking EU policy agenda, and in particular the Digital Operational Resilience Act, or DORA.  Some of the largest ‘big tech’ firms will be subject to some degree of supervisory oversight for the first time, by virtue of their growing footprint in the financial services sector, as providers of cloud services and data analytics platforms. It is perhaps notable that at the EUROFI Conference in Prague last month, a number of technology firms, including cloud service providers, attended for the first time.

Climate Risk

In respect of climate change and sustainability, many of you will have noted the emphasis which the Central Bank is already placing on this issue. It is acknowledged that assessing the potential impacts of climate change presents unique challenges:  they are likely to be far reaching, non-linear, and whilst affected by actions today, will occur over a much longer period than typical business planning time horizons. Individual firms are at different stages of development in relation to their management of climate change risk. This is an iterative process that will improve over time.  With that said, there is still scope for the majority of firms to be more ambitious in their consideration of climate change risk (particularly life firms, which appear less developed than non-life firms).

Some examples of better practices observed in recent reviews of ORSA reports included:

• Considering both first order (e.g. increased frequency/severity of physical risk events or reduction in asset values) and second order climate change risks (e.g. availability of reinsurance or potential changes to business model);
• Carrying out appropriately severe stress and scenario tests; and
• Considering climate change impacts beyond the current planning period - (re)insurers that consider climate change risk over different time horizons are likely to have a better understanding of potential risks and how they may emerge in the future.

To assist in the assessment of climate change risks, the Central Bank has recently commenced a public consultation on proposals to introduce guidance on climate change risks for the insurance sector¹⁰, which expands upon the letter issued by the Governor in November of last year¹¹.  In the coming year, climate related work is likely to focus on developing capabilities and understanding of climate risks within our own supervisory teams, and on expanding upon the data and tools to enable assessment of potential direct and indirect climate risk exposures across the sector.

Conclusion

In conclusion, I would reiterate that life assurance plays a very important role in society by facilitating customers to plan and save for the future. The direction and ambition for the industry over the coming years should be to meet these various challenges – inflation, digitalisation, climate change - in a manner that is responsive and forward-looking.

Thank you.