PRA reviews insurer third-party concentration risks

KPMG has today published analysis of the Prudential Regulation Authority’s Insurance supervision 2023 priorities letter, highlighting a renewed focus on counterparty and concentration risks linked to reinsurance and third‑party arrangements. The KPMG report notes that the PRA will scrutinise how rapidly growing reinsurance use and outsourced services could create concentrated exposures across individual insurers and the wider sector.

Key findings from the KPMG and other consultant briefings on the PRA’s 2023 priorities include: • The PRA’s priorities letter, issued on 10 January 2023, sets out supervisory expectations for insurers across financial and operational resilience, climate risk, and governance and risk management. • The PRA flags potential offshored counterparty concentration risk arising from rapidly growing levels of reinsurance, particularly where exposures are focused on a small number of counterparties. • The PRA expects UK authorised firms to consider and comply with the Prudent Person Principle in relation to risks from their reinsurance activities.

• The PRA will examine whether policy action is needed on reinsurance structures and limits to mitigate systemic risks to policyholders as part of its work on counterparty and concentration risk. • The PRA highlights concentration risks in funded reinsurance used in bulk purchase annuity business, warning that specialised fully funded reinsurers may increase carriers’ overall risk profiles. • The PRA reiterates expectations on outsourcing and third‑party risk management, including that important business services must remain within impact tolerances even when relying on external providers, and that insurers should review their exposure to third parties.

KPMG reports that the PRA’s 2023 supervisory agenda continues to emphasise financial and operational resilience, alongside financial risks from climate change and governance and risk management. Within this, KPMG notes that the regulator is sharpening its focus on how reinsurance and outsourcing choices affect firms’ resilience under stress. According to the priorities letter, the PRA expects UK authorised firms to assess their compliance with the Prudent Person Principle for risks associated with their reinsurance activities, including how these arrangements affect overall risk profiles. The letter states that insurers should consider the resilience of their reinsurers over the full duration of exposures and the potential impact of a mass recapture event where large concentrations to a small number of counterparties exist.

KPMG’s summary adds that the PRA will examine the need for policy action on reinsurance structures and limits, with the stated aim of mitigating systemic risks to policyholders as part of its work on counterparty and concentration risk. Skadden’s commentary on the priorities letter notes that these concerns centre on concentration risk in funded reinsurance for bulk purchase annuities, with the PRA warning that use of specialised fully funded reinsurers may increase a carrier’s overall risk profile.

PwC reports that the PRA also draws attention to its expectations on outsourcing and third‑party risk management as set out in its Supervisory Statement, linking these to the broader concentration risk agenda. KPMG highlights that firms should continue to comply with the PRA’s outsourcing and third‑party risk management policy by ensuring that important business services remain within impact tolerances even when they rely on outsourcing or third‑party providers.

Hymans Robertson notes that the PRA’s priorities letter indicates insurers should review their exposure to third parties to manage outsourcing and third‑party risk exposure. ProcessUnity’s analysis of the PRA’s outsourcing guidelines states that the rules develop expectations around concentration risk by requiring firms to consider fourth‑party dependencies, where different suppliers rely on the same subcontractor.

The Bank of England’s letter states that the PRA sees potential for offshored counterparty concentration risk to arise from rapidly growing levels of reinsurance, and that these concentrations can emerge at both firm and sector level. The letter adds that insurers need to consider the reinsurer’s resilience over the whole duration of exposures and the potential impact of a mass recapture event in cases of large concentrations to a small number of counterparties.

--- Sources: https://www.bankofengland.co.uk/prudential-regulation https://www.hymans.co.uk/media/uploads/PRA_regulatory_priorities_2023_Final_Version.pdf https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/letter/2023/insurance-supervision-2023-priorities.pdf