The Bank of England’s Prudential Regulation Authority (PRA) has now assessed the United Kingdom’s insurance-linked securities (ILS) and risk transformation regulations and has now published its supervisory guidance on the ILS rules, which raise a few questions on how practical their implementation will be.
The PRA has confirmed the regulatory approach to ILS it had previously set out in July and has also provided additional guidance on how it intends to manage the authorisation and supervision of Insurance Special Purpose Vehicles (ISPV’s).
In delivering its final approach and its expectations for how ILS business will be transacted in the UK, the PRA has put in place a few stipulations that may be seen as less than practical by ILS market practitioners.
The first piece of guidance that could be a potential issue for some market participants is the fact that the PRA says that all ILS vehicles must be fully-funded.
In order to grant approval for applications the PRA says that it must see that the, “ISPV can demonstrate that it will receive the relevant funding before the risk transfer to the ISPV becomes effective.”
In some domiciles the funding of the special purpose reinsurance vehicle can take place after the initial risk transfer has been effected, and reinsurance trusts are notorious for taking time to be funded, so this stipulation on funding of the ISPV could put the UK at a slight disadvantage.
Additionally, the PRA will expect that the ISPV can prove that it has the ability to meet expenses and operating costs, as well as the collateralisation required to fund the risk transfer.
However, logically thinking it is better for the ILS vehicle to be fully-funded so that it could pay claims, as should a loss occur on the first day it is on-risk then a lack of funding could prove problematic. So it is understandable why the PRA has taken this approach, but remains to be seen whether this could hinder use of the UK ILS regulations.
Another stipulation from the PRA is that it will not be moved on its timeline for approving new ILS structures, saying that 6 to 8 weeks remains its expectation. Sometimes the approval process could be quicker, but it seems the regulator will not commit to providing any faster turnaround than this, at this stage.
However, the PRA has also given itself a 6 month limitation on approvals, saying complex cases could take this long.
“The PRA will determine complete applications for authorisation as an ISPV within six months of receipt. The PRA anticipates that ISPV applications will range in complexity. The PRA considers that where applications represent a relatively straightforward proposal, and are supported by good quality documentation this should allow a determination to be reached within 6-8 weeks. In addition, where effective pre-application engagement has taken place 6-8 weeks is more likely to be feasible. The PRA will process applications as quickly as possible and approval may be possible more quickly in some circumstances,” the PRA explained.
This isn’t necessarily an issue, as once an ISPV is established it can enter into further transactions on a post-notification basis with the regulator, as long as they fit the purpose of the ISPV as it was described when set up.
But for anyone seeking to set up and issue a last-minute catastrophe bond or collateralised reinsurance vehcile in the UK in time for a renewal, it would be wise to make sure the application is in well in advance.
ISPV’s can also be used as multi-arrangement insurance special purpose vehicle’s (MISPV), which will enable service providers to establish UK domiciled collateralised reinsurance vehicles that they can offer to the market for cedents and investors to use for transactions.
Being able to post-notify of completed transactions was a vital piece of the regulation for this kind of use-case, so it’s encouraging to see it included in the PRA’s guidance.
The guidance from the PRA goes into much more detail on how it expects the ILS regulations to be put into practice. You can access the published supervisory and process statement documents here.
The question now is whether the ILS regulations could be put to work in time for the January renewal. The Parliament still needs to debate the rules, but now the regulatory guidance is out that will likely be scheduled.
At this stage it does seem unlikely that the UK could get an ILS transaction completed for January 1st, being only two months away, but it could be possible if any service provider has got its application for an ISPV in already.