PRA finalises how it will authorise and supervise insurance linked securities regime

The new rules and supervisory statement will be formally adopted once the 2017 Risk Transfer Regulations, which were laid before parliament last month, come into force.

The PRA's final approach mostly corresponds to the draft that it published in July. It also includes some additional guidance on the requirement that the ISPV be fully funded, the circumstances in which ISPVs may be authorised before receiving funding, and interaction with the Senior Insurance Managers Regime (SIMR), among other matters.

The final rules also do away with the need for a multi-arrangement ISPV (MISPV) to pre-notify the PRA each time they create a new 'cell', following concerns from the industry that this requirement could prove unduly burdensome and would not support a competitive environment for ILS activity. Instead, the PRA will authorise MISPVs based on a 'scope of permission', which would set out the parameters within which future cells could be established.

A UK framework governing the tax and regulatory treatment of ILS is expected to be in force in time for the 2018 renewal season, subject to the passage of the necessary regulation through parliament. The regulations provide for a tailored and proportionate approach to the authorisation and supervision of ISPVs, while additional Risk Transformation (Tax) Regulations set out the associated tax regime.

ILS, of which 'catastrophe bonds' are one common type offer insurers an alternative to traditional reinsurance as a form of risk mitigation by allowing insurers to transfer large and complex risks to the capital markets, rather than a reinsurer. The regulations, and associated rules, will allow the UK to share in a global market which is estimated to be worth as much as $87 billion by 2019, according to research previously cited by the Treasury.

Under the new regime, those wishing to apply for authorisation to engage in ILS activity will do so by way of a newly-regulated activity of 'insurance risk transformation' using a type of 'protected cell company' (PCC) corporate structure. This structure is made up of an administrative 'core' and a number of 'cells' corresponding to the individual insurance risk transfer contracts, making it administratively efficient to manage multiple deals through a single ISPV.

The PRA will lead the authorisation process, although Financial Conduct Authority (FCA) approval will also be required before finalisation. Both the legal entity, and certain individuals occupying senior management roles, will require authorisation.

ISPV contractual arrangements will have to be consistent with articles 319-321 of the Solvency II Delegated Regulation. These require the ISPV to be fully funded and for there to be an effective transfer of risk, as well as setting out the rights of the providers of debt or financing mechanisms. MISPVs will also have to complete a regulatory business plan (RBP) before applying for authorisation, which must set out the maximum number of cells permitted, maximum aggregate risk exposure, classes of business and loss trigger type, among other matters.

The PRA expects to take a maximum of six months to authorise applications. It also intends to allow prospective ISPV applicants to "discuss their proposals" before applying, "given the often time-sensitive nature of insurance-linked securities transactions". This will allow firms to discuss the scope and structure of their ISPV, as well as its proposed investment strategy, with the regulator, according to its policy statement.

The PRA has also published a dedicated webpage for firms seeking to apply for authorisation to carry out insurance risk transformation. This webpage includes background information and links to all the relevant regulatory documents.