We set out the findings of our multi-firm review of general insurance brokers, where we identify areas for improvement which firms can learn from. Regulated firms (not just general insurance brokers) should read this and consider whether changes are needed in their own arrangements.
Why we conducted this review
We worked with firms across the general insurance broking sector as part of our response to the Covid-19 pandemic. We found inconsistencies in their approaches to assessing adequate liquidity for orderly wind-down. So in the first half of 2022, we reviewed a sample of general insurance brokers, predominantly London market and commercial general insurance brokers. Our purpose was to understand which of these approaches and practices either increased or weakened the credibility of these firms’ wind-down arrangements. We have provided direct, specific feedback to the firms assessed in this review.
The potential for harm in failure is particularly acute if a firm’s wind-down is disorderly. This can cause harm – for example through loss of client money, loss of confidence and participation in the general insurance brokerage markets, where services provided are not easily replaced by other firms, or if a firm cannot pay redress.
Effective wind-down planning enables a firm to cease its regulated activities with minimal adverse impact on its clients, counterparties, or the wider markets. It also allows a firm to assess if it would have adequate resources (capital, liquidity, knowledge, and staff) to wind down in an orderly manner, especially under challenging circumstances. We strongly encourage firms to ensure that they have adequate wind-down planning in place.
This multi-firm review is part of our strategy until 2025[1], where we commit to reducing harm from firm failure.
Who this applies to
We believe that most firms would benefit from comparing their wind-down planning arrangements with our findings and the regulatory material referenced.
Although our observations came predominantly from a review of London market and commercial general insurance brokers, they are likely to be relevant for general insurance intermediaries in different sectors and regulated firms more broadly.
Our approach
We selected a sample of 10 general insurance brokers and assessed the credibility and operability of their modelling of the minimum liquidity required for orderly wind-down. We did this by reviewing their risk management frameworks, stress testing and reverse stress testing and their underlying modelling assumptions. We undertook interviews with key members of staff from the senior management, risk and compliance functions.
Where relevant, we also made observations on general wind-down planning. This included instances where firms were part of a wider Group which had consolidated Group wind-down plans. We considered how those structures might affect our ability to effectively supervise the wind-down planning of entities within the Group.
The rules, guidance and prior communication we considered
Alongside existing regulatory material, including formal guidance and rules, these observations will help firms make their own assessments to ensure that they are adhering to Principles for Business, the Threshold Condition on Appropriate Resources and our guidance on wind-down planning.
Firms authorised by us must comply with the Threshold Conditions described in our Handbook[2]. This includes the requirement in COND 2.4[3] to hold adequate resources for the activities that the firm carries on, or seeks to carry on.
Firms must also comply with Principles for Business requiring a firm maintain adequate financial resources (Principle 4, PRIN 2.1[4]). We published finalised guidance on assessing adequate resources[5] which explains that one of the roles of adequate resources is to enable an orderly wind-down.
It is up to the firm to choose the structure of their wind-down arrangements given the nature, size and complexity of their business models. A Group wind-down plan may be appropriate for example if it covers all the regulated entities within the Group and all necessary aspects of the wind-down planning, including any interactions between the entities within the Group. To assist firms with wind-down planning, we have published a Wind-down Planning Guide[6] and a review of our observations of wind-down planning[7].
Our Handbook contains other relevant rules or guidance (for example SYSC 4 and 7[8]), and firms should use them to assess the credibility of their risk management and wind-down planning, including liquidity modelling.
We also emphasised the importance of financial resilience and orderly wind-down in our 2020 and 2022 letters sent to the sector.
What we measured
When considering the general insurance broker sector, we distinguish our concerns between:
- lack of wind-down planning – considerations of the risks which could cause wind-down and the resources required to do so in an orderly fashion; and
- lack of formal wind-down plans – the formal wind-down plan as a document, setting out the necessary steps to wind down
While both are important in helping firms to properly manage their risks, a lack of robust wind-down planning may be especially problematic. In these cases, firms will not be able to demonstrate that they hold appropriate financial resources to ensure an orderly wind-down. This could suggest they are not meeting Principles for Business requiring a firm to maintain adequate financial resources (Principle 4, PRIN 2.1[5]) or the Threshold Condition on Appropriate Resources (COND 2.4[10]).
What we found
Most firms in our review had both wind-down planning arrangements and formal wind-down plans in place. However, some of these had not been updated for some time. We observed mixed results and, because few firms consistently demonstrated good practices, our findings show that firms need to further improve their wind-down planning and formal wind-down plans.
Firms which have robust, credible and operable wind-down plans in place, based on robust wind-down planning, are best placed to demonstrate that they have (i) identified the resources needed for an orderly wind-down, and (ii) ensured those resources are in place and readily available. Those firms have an up-to-date, comprehensive understanding of the likelihood of wind-down being triggered, and the harm this may cause.
Firms with good practices
We observed these firms have:
- clear identification and regular reviews of the risks inherent in their business models
- strong consideration of the harms which could flow from those risks, and the steps needed to mitigate them
- detailed and well thought-out cashflow projections and assumptions for wind-down, which helped with operable, credible planning
- stress testing and reverse stress testing, embedded in the risk management framework, which improved modelling and wind-down planning by providing a broader view of the likelihood of risks crystallising
- strong risk management frameworks which included risk metrics and forward-looking management information. This empowered firms to be able to adequately identify and manage the risks they are exposed to
Where these elements were not present, firms did not appropriately identify and mitigate risks of harm, and there was a greater likelihood of a disorderly wind-down. We go into detail on this in the next chapter.
Key observations
We found a number of good practices which give credibility to firms’ assessments of adequate liquidity for wind-down.
Firms should use a risk register to highlight the key risks inherent in the business, to identify the risk controls and monitor their effectiveness. Having a thorough and regularly updated risk register, which covers all the risks relevant to the firm, is essential to adequately identify, measure, monitor and manage those risks. This can help to promptly identify if a risk has moved outside of tolerance and to ensure the firm takes any necessary remedial action.
Knowing when to consider winding down the business is crucial to having credible and operable wind-down arrangements. A sound approach to identifying that trigger point is to consider the results of reverse stress testing. This allows an assessment of what may make the business proposition unviable and initiate wind-down.
For both stress testing and reverse stress testing to be able to produce meaningful results, they need to be specific to the business model and its inherent risks. Stress scenarios which are specific to the firm, and which cover its key risks, can feed into the firm’s risk management and wind-down planning by using the results of those stresses to set the triggers for each of the firm’s key risk and early warning indicators.
It is good practice to regularly review and update the potential impact of key risks crystalising. This is because the impact of these risks will often change over time due to the evolving nature and size of firms. Similarly, the key risks for the firms should also be reviewed and updated. These updates will also require reassessment of the potential management actions and mitigants in response to these potential crystalising risks.
Even a firm which is profitable and operating normally can face an extreme but plausible economic, competitive or political scenario that could lead to it failing and so having to wind down. Having a robust, credible and up-to-date wind-down plan can minimise the risk of disorderly wind-down. So it is vital to ensure that the wind-down plan is regularly reviewed and updated.
Firms with poor practices
The poor practices we found reduce the credibility of firms’ own assessments of adequate liquidity for wind-down.
Weaknesses in embedding the firms’ risk management frameworks
- Lack of risk metrics and monitoring – these are essential to help ensure that firms are operating within their defined risk appetite and risk tolerances and can swiftly identify where they are not, so that they can take action.
- Poor forward-looking management information – this is the foundation for sound discussions, decision making and planning. The quality of any discussions and potential decisions depends on the quality of the information used in them. Not having good quality, forward-looking information will significantly hinder the firm’s ability to make sound decisions, potentially causing issues and risks to crystallise.
- Inadequately quantifying risk probability or potential impact – firms need to be able to quantify the impact of any potential risks and so decide how best to mitigate it.
Inconsistent or incoherent reporting of risks at different levels of the organisation
If the risks highlighted at any level within an organisation do not reflect the critical risks faced by the firm at that level, then the staff responsible for acting to mitigate the impact of those risks may not be held to account. Without appropriate action, those risks are more likely to occur and without appropriate monitoring, the firm may not be aware when a risk materialises. The consequence is that the firm faces increasing chances of unforeseen risks crystallising and potentially causing disorderly wind-down.
Lack of information on how firms assess the effectiveness of their risk monitoring and mitigation work
This can include undertaking reviews (deep-dives) into key risks and how they have been managed over time. Undertaking such regular reviews will help firms to continually improve the way they identify, monitor and manage their risks, ensuring these are timely and accurate.
Failure to use the assessment of relevant risks to inform stress testing or to develop stressed but plausible scenarios for wind-down
If the firm’s stress testing and reverse stress testing are not aligned with its risk management framework, any results from such stress testing or reverse stress testing may not be meaningful or helpful to the firm in understanding the risks in their business model.
Additionally, if the stress test scenarios for the purposes of wind-down planning are not plausible and sufficiently severe (and they do not trigger wind-down), they will not be useful in explaining what may happen during wind-down. This could lead to a wind-down plan which is not realistic and/or achievable.
Limited granularity in firms’ cashflow modelling
In some cases this was due to lack of detail, in others the analysis was too superficial to provide a complete picture of what the firm expects its cashflows during wind-down to be. It is crucial to develop detailed cashflow projections during wind-down to ensure that firms know the cash they expect to receive or have to pay out during wind-down. This includes any additional liquidity they may need to cover wind-down specific costs.
Little detail on the assumptions within firms’ cashflow modelling
This makes it hard to assess its credibility and operability. It is vital that firms fully capture those assumptions in planning to provide a realistic view on what they assume will happen during wind-down.
Insufficient prudence in the assumptions underlying firms’ cashflow modelling
This includes the risk of delays in receiving cash inflows (following the sale of business units). It also includes a lack of consideration of second-order effects (such as reputational impact and potential further impacts upon valuation of business units, retention of staff and renewal of clients). These may increase the impact of a risk crystalising. Any cashflow modelling under wind-down needs to be supported by realistic and reasonable assumptions which are discussed, challenged, and updated as part of the regular update of the wind-down plan. Not having realistic assumptions increases the risk of the firm struggling to achieve the actions in the wind-down plan, potentially having insufficient resources and facing a disorderly wind-down.
Insufficiently considering the potential for harm in wind-down and ways of minimising this
Wind-down plans should minimise harm to consumers, markets, and the firm itself. To achieve that, firms must consider the potential harm they can cause to all relevant stakeholders by having to wind down. Any management or mitigating actions, as part of the wind-down planning arrangements, should be designed with the objective of minimising that potential harm.
Expectations around complex structures and group exposures
We expect firms to ensure that they have adequate resources. They should have in place arrangements which allow them to clearly evidence that they meet this requirement. We observed the following:
Where there is a lack of consolidation at the authorised entity level, this can present challenges (i) for firms in ensuring they have adequate governance, risk management and wind-down arrangements in place, and (ii) for us in being able to effectively supervise those arrangements. These challenges are further exacerbated where firms grow quickly, including via acquisitions and where they lack strong senior management.
It is important for firms to consider whether their wind-down plans are dependent on their wider groups or any other third parties. This will ensure that they identify and mitigate any risks to orderly wind-down from such exposures. We also know there are firms who may rely on their immediate parents to provide liquidity – however, we expect that any liquidity to achieve orderly wind-down is sitting with the firm and not with the immediate parent.
Actions for firms
We are sharing these findings to help firms consider the appropriateness of their current arrangements, and to help them comply with existing expectations and requirements. We expect a firm’s wind-down planning to be proportionate to the nature, scale and complexity of its activities.
We have set out clearly in our three-year strategy and the letters sent to the sector our ongoing focus on financial resilience and the reduction of harm from firm failure. Firms should be financially resilient, have strong arrangements to protect their clients, including safeguarding clients’ money, and be able to recover quickly from disruptions.
We will continue to assess firms’ resilience against our standards, and we will measure success by a low and stable proportion of firms not meeting financial resource requirements.
Firms should review these findings, refer to our finalised guidance on assessing adequate financial resources[6] and other relevant regulatory material, including that referenced above, and consider whether they should apply any of the expectations and observations in these documents to their assessment of liquidity required for wind-down, and to their wider wind-down planning.
Although our review focused on liquidity required for wind-down, firms may find some of our observations helpful when assessing the adequacy of capital for wind-down and for liquidity, capital and revenue generation when performing ‘going-concern’ stress testing and modelling.