PRA has issued a follow-up note for PRA-regulated insurers with regard to the PRA letter on its position regarding IFRS 9, capital requirements for firms, and loan covenants. On March 26, 2020, Sam Woods of PRA issued this letter to Chief Executive Officers of UK banks. Since then, some insurance firms have sought clarification on how the points in that letter should be interpreted in context of their internal assessments of loan creditworthiness and treatment of unrated assets.
The note highlights that the expectations of PRA for insurers' use of unrated assets have been set out in the supervisory statement (SS3/17) on Illiquid, unrated assets under Solvency II, which was updated on April 02, 2020. Paragraphs 2.8A to 2.8L of the SS3/17 set out relevant expectations regarding risk identification and application of judgments and methodologies. The accompanying policy statement (PS9/20) on income-producing real estate loans and internal credit assessments for illiquid, unrated assets further refers to the published measures to alleviate operational burdens arising due to the COVID-19 outbreak. In this context, while Sam Woods’ letter does not address insurers’ internal credit ratings, some points in the letter can be considered to have applicability beyond the insurers that are using IFRS 9 to account for financial instruments.
Insurers are advised to read the letter in its entirety. Paragraph 5 of the Annex to the letter includes further examples of considerations that insurance firms may find helpful when forming their judgments on the impact of COVID-19 outbreak on their internal credit assessments. Similarly, regarding breaches to loan covenants arising directly as a result of COVID-19, the letter further noted that in the current uncertain environment such breaches may not necessarily be reflective of long-term credit risk. Nevertheless, it should be noted that firms will need to use their judgment to determine which covenant breaches do reflect increased credit risk and which do not. As set out in the letter, it remains important that firms’ assessments of covenant breaches fully take into account the differences between normal covenant breaches and those that might occur directly because of the COVID-19 pandemic.
Kewywords: Europe, UK, Insurance, COVID-19, IFRS 9, Capital Requirements, Solvency II, Credit Risk, Loan Convenant, Credit Ratings, Financial Instruments, PRA
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