U.K. insurance special purpose vehicles proposed changes by the PRA

Insurance special purpose vehicles (or ISPVs) are intended to support risk transfer from U.K. cedants to other market participants (for example, by the issuance of insurance-linked securities, such as catastrophe bonds) and can be seen as an alternative to other forms of financing and risk transfer, such as reinsurance. The U.K. regime (and Solvency II) has long contemplated the use of ISPVs by U.K. cedants, but the background to CP 15/24 is that the existing iteration of the U.K. ISPV regime has not been widely taken up by U.K. insurers, with feedback from market participants being that the U.K. regime does not positively support the establishment of U.K. ISPVs. The purpose of CP 15/24 is to amend the existing policy framework to allow U.K. non-life insurance undertakings to play a bigger role in the global insurance-linked security market.

What are the proposals?

The PRA is proposing to relax the rules that apply to ISPVs in order to create a more flexible regime that can support greater use of ISPVs. In particular:

1. A key requirement of the U.K. ISPV regime is that an ISPV must be fully funded at all times (FFAAT). The current U.K. ISPV regime does not permit retained earnings from the ISPV’s investments to contribute to the satisfaction of the FFAAT requirement, meaning that investment growth cannot be taken into account in meeting the FFAAT requirement. The PRA is now proposing to change this rule so that up to seven years’ retained earnings can be utilised to meet the FFAAT requirement, and therefore to increase the aggregate maximum risk exposure (AMRE) of the ISPV. This could enable investors to potentially make a smaller upfront investment in the U.K. ISPV, while still satisfying the FFAAT requirement, reducing the upfront cost associated with accessing the ISPV regime and making ISPVs more attractive.
2. The proposed changes would permit a U.K. ISPV to undertake more than one risk transformation transaction (that is to say, have more than one contract for risk transfer) without being structured as a protected cell company (PCC). This would enable U.K. ISPVs to enter into more than one risk transfer arrangement from the same vehicle, without triggering the need to structure the vehicle as a PCC having a separate cell for each risk transfer contract. This would create additional flexibility to, for example, create different tranches of risk transfer from within the same undertaking.
3. The PRA is proposing that the U.K. ISPV regime be modified to include a grace period concept in relation to the FFAAT requirement. The PRA is proposing a 30 business day contractual grace period, kicking in at the commencement of a risk transformation transaction. This appears principally to reflect a need to keep step with other similar regimes around the world which provide an explicit grace period.
4. The PRA is proposing to clarify the role of limited recourse clauses in contractual arrangements with ISPVs. These limited recourse clauses aim to ensure that the ISPV is not obliged to pay more than the value of its assets at the relevant time, thereby satisfying the FFAAT requirement. The PRA intends to clarify that limited recourse clauses can be used to support satisfaction of the FFAAT requirements, but also to clarify that limited recourse clauses should not be used as an alternative to sound risk and investment management practices.

In addition:

a) The PRA is proposing certain technical changes to the authorisations and supervisory processes that apply to ISPVs, all of which are aimed at improving the uptake of ISPVs. Under the accelerated pathway, in collaboration with the FCA, the PRA proposes to consider completed applications and, where satisfied, issue approvals within ten working days (rather than the current four–six-week process) of being submitted to the PRA.

b) CP 15/24 includes some clarifications of the PRA’s expectations of U.K. insurers who cede risks to special purpose vehicles, wherever they are located (i.e. whether they are ISPVs authorised pursuant to the U.K. ISPV regime or otherwise). A key clarification is that the PRA does not expect U.K. (re)insurers to use SPVs to transfer annuities or similar long-duration liabilities. At the heart of this appears to be a concern that the investment risk embedded in meeting long-dated annuity (or similar) obligations is not compatible with the ISPV model, noting that a (re)insurer who transfers risk to an ISPV will seek to reflect the risk transfer in its capital requirements.

We think it is worth clarifying that the PRA’s comments on the use of ISPVs in relation to annuities do not amount to a “ban” on the use of captive insurers, for example, by pension schemes seeking to access reinsurance markets: the PRA is concerned in CP 15/24 with specific risk transfer tools (namely ISPVs) which U.K. (re)insurers can use to reduce their own capital requirements. It is also worth noting that the PRA has separately issued a policy statement (PS 13/24) on the use by U.K. (re)insurers of funded reinsurance, particularly in the context of annuities, making the point that the PRA acknowledges the role of reinsurance in relation to U.K. annuity business.

Next steps

CP 15/24 is open to responses until February 14, 2025.