Prudential Regulation Authority Rulebook

2.1

For the purpose of this SS, the ‘risk appetite’ is intended to mean the amount and type of risk that an insurer is willing to take in order to meet its strategic objectives.

2.2

The PRA expects an insurer’s risk appetite to be approved by the board, and to be documented in terms that are clearly understandable in a risk appetite statement, along with the rationale for the terms in which the risk appetite is expressed, and for how this appetite has been determined. The PRA expects the insurer’s risk appetite statement to identify the reasonably foreseeable circumstances under which the statement might be reviewed and changed. Any revision to this statement is expected to be signed off by the board.

2.3

The insurer’s risk appetite statement is expected to include the risk appetite for the levels of capital that are to be maintained in reasonably foreseeable market conditions (eg as assessed through stress and scenario tests, or through some suitable alternative approach, to provide no more than a 1 in X probability that Solvency Capital Requirement (SCR) coverage might fall below 100%). This appetite is expected to take into account factors such as the following, where relevant:

• sensitivity of the balance sheet to changes in the key risk drivers, including changes in market and underwriting conditions, and the emergence of large claims;
• non-linearities and discontinuities that may arise in the balance sheet due to combinations of adverse events and the potential loss of matching adjustment (MA) or volatility adjustment (VA) approval in stress scenarios;
• quality of capital resources;
• inherent uncertainty in the technical provisions (including in the application of the MA or transitional measure on technical provisions (TMTP)), risk margin, the value of any illiquid assets, and the SCR, due to limitations and approximations in the insurer’s regular solvency monitoring;
• levels of uncertainty in forecast earnings;
• the results of stress and scenario testing (including reverse stress testing);
• capital levels that are considered to be required to maintain credit ratings and market reputation;
• potential impact of firm failure on policyholders (including substitutability of insurance cover); and
• recovery options that may be available to the insurer, including consideration of when each option may not be available.

2.4

The PRA also expects the risk appetite statement to include, in a proportionate manner, the insurer’s appetite for the level and volatility of future dividend payments that it would be willing to make, in the context of, among other things: (a) its financial and business plans; (b) the levels of capital held by the insurer; and (c) the volatility of its earnings.

2.5

Syndicates at Lloyd’s may have mixed capital, and will share in the Lloyd’s Central Fund. In addition, they are structured as annual ventures. As a result, alternative considerations may be relevant, but the PRA expects such considerations to reflect the spirit of the above issues as appropriate.

2.6

The risk appetite statement should encompass all the material risks that are relevant to the insurer, including those listed in Conditions Governing Business 3.1(2)(c) that are considered to be material. It should include the risk tolerance limits (ie the limits on the amount of risk) that have been set for the various types of risk (including market risk, underwriting risk, operational risk and liquidity management risk) that the insurer is willing to bear. Many of these limits are likely to be expressed in quantitative terms, but the appetite for some types of risk (eg reputational risk) may be expressed qualitatively.

2.7

The PRA expects any significant change to an insurer’s risk appetite only to be made by the board following an overall discussion on the risks and capital requirements of the business. Most insurers review their strategy and business plans on an annual basis, in the context of the insurer’s risk profile, a process which inherently includes reviewing the risk appetite, and a review may also be appropriate following some major external event. The PRA does not however expect the risk appetite to be changed solely to justify, or regularise, particular actions, such as the assumption of a new risk, a change in investment policy, or a dividend payment.

2.8

The level of detail to be included in the risk appetite statement should be commensurate with the nature, scale and complexity of the risks borne by the insurer.

2.9

The PRA expects this risk appetite statement to be communicated appropriately within the insurer, so as to set a framework for the management and reporting of relevant risks that can be clearly understood by individuals performing key functions at the insurer, and to be expressed in sufficient detail to be clearly relevant to them.

2.10

The PRA expects communications to external stakeholders, such as shareholders/capital providers, customers and their agents, rating agencies, and regulators, to be consistent with the risk appetite statement.