Prudential Regulation Authority’s Proposed Changes to the UK Insurance Special Purpose Vehicle Regime

The UK insurance-linked securities (ILS) regime has been in force since December 2017, with the Risk Transformation Regulations 2017, which set out the corporate and regulatory legislative structure for the UK ILS regime, and the Risk Transformation (Tax) Regulations 2017, which set out the tax legislative structure. In the years following introduction of the ILS regime, the Prudential Regulation Authority (PRA) has made amendments to the regime, including issuing a Supervisory Statement on the authorization and supervision of insurance special purpose vehicles (ISPVs) (SS8/17). The Financial Conduct Authority has also published its final statement on authorizing and supervising special purpose vehicles (SPVs).

Since the ILS regime has come into force, the UK regulators have approved a number of ILS structures. With the experience gained from this and feedback from the market, the PRA has continued to review and develop the framework. In December 2022, the PRA published the Policy Statement “Insurance special purpose vehicles: Further updates to authorisation and supervision” (PS 12/22), which amended the PRA’s approach to authorizing and supervising the activities of UK ISPVs operating short-tail, wholesale, and general insurance structures.

However, there has continued to be limited uptake of the regime, and feedback from market participants notes that the existing framework does not support the establishment of UK ISPVs. As a result, the PRA has recently published a consultation paper (CP 15/24) that aims to align the UK ISPV regime with the global ILS market while continuing to offer policyholders a level of protection consistent with the PRA’s objective to enhance UK competitiveness.

One of the biggest obstacles to the development of the UK ILS market has been the requirement that aggregate maximum risk exposure (AMRE) be fully funded at all times (FFAAT). In CP 15/24, the PRA recognizes that the upfront investment required to be FFAAT limits firms’ ability to use UK ISPVs for multiyear risk transfer arrangements. As a result, the PRA is proposing that realized investment returns retained by the UK ISPV count toward covering the AMRE and notes that the AMRE may increase over time commensurate with the realization of investment returns that are retained in the ISPV. However, the PRA expects that a maximum of seven years of realized investment return allowance be provided for in contractual arrangements as there is an increasing risk over time of actual returns being less than those assumed in the contractual arrangements. The PRA also notes that the level of capital relief available to ceding (re)insurers at any point should be no greater than the UK ISPV’s AMRE.

Other barriers to the use of UK ISPVs include the lack of a grace period for the FFAAT requirement and uncertainty around use of limited recourse clauses (which limit an ISPV’s AMRE to the value of its assets). In relation to grace periods, the PRA recognizes that the lack of a grace period causes funding issues for renewals. As a result, the PRA has proposed an explicit 30-business-day contractual grace period at the beginning of a risk transformation transaction, bringing the UK in line with the current position in other key ILS markets such as Bermuda. To address the uncertainty around limited recourse clauses, the PRA has stated that such clauses may be relied on to comply with the FFAAT requirement on an ongoing basis. However, they should not be used to comply with the FFAAT requirement at the inception of a risk transformation transaction, nor should they be an alternative to a sound risk management and investment strategy.

In an effort to prevent cost and time inefficiencies, the PRA is proposing to remove the requirement for UK multi-arrangement ISPVs undertaking multiple risk transformation transactions as part of the same contractual arrangement to be structured as protected cell companies.

In addition to the proposed structural changes outlined above, the PRA has also proposed an “accelerated pathway” for certain UK ISPVs (such as Rule 144A cat bonds) where approvals will be issued within 10 working days from the submission of a completed application to the PRA, subject to certain criteria. Such criteria include (among other matters) that (i) the risk transferred is (a) nonlife and (b) has a clearly defined loss trigger per market standards; (ii) the UK ISPV has a maximum 15-year life; and (iii) the funding of the UK ISPV’s obligations are structured as debt securities only.

The PRA also intends to introduce a new Supervisory Statement setting out its expectations in respect of the use of SPVs (regardless of their jurisdictions of authorization) by UK (re)insurers. The Supervisory Statement will address how UK (re)insurers should manage risks in relation to limited recourse clauses and grace periods including the need to consider and model the possibility that the SPV may not meet its obligations under the risk transfer agreement and the potential that such risks are transferred back to the UK (re)insurer. Furthermore, the PRA notes that UK (re)insurers should not use SPVs to transfer risk from annuity or similar business. This is because the PRA is of the view that to offer acceptable pricing, the SPVs would need to invest in assets with significant credit and market risks, resulting in a higher risk of deterioration in asset values in the SPV. The PRA is also of the view that management of an SPV is unlikely to be able to respond to a deterioration in operating conditions as SPVs do not benefit from diversification with a wider range of risks.

Finally, the PRA is proposing amendments to the required senior manager function (SMF) roles for UK ISPVs. Under the current framework, a UK ISPV is required to have at least three designated SMF roles (a Chair, CEO, and CFO), although the PRA permits the same person to hold all three SMFs. In CP 15/24, the PRA states that for the most part, a CEO would be sufficient for all UK ISPVs. The PRA recognizes that in the case of certain complex structures, there may be a need for more than one person to hold an ISPV SMF 1 role and notes that it may also be appropriate in complex structures to appoint an SMF 3 (executive director).

The consultation period for CP 15/24 ends on February 14, 2025, and the proposed amendments to the UK ILS regime are expected to come into force by mid-2025. If the amendments are delivered as set out in CP 15/24, in particular as regards the removal of FFAAT requirement in certain circumstances, the introduction of grace periods and the reduction in authorization times for a UK ISPV, this is likely to result in a meaningful increase in the volume of UK-based ILS transactions.