20th May 2018

LMA and IUA respond strongly to PRA consultation paper on credit risk mitigation

The Lloyd's Market Association(LMA) in a response to the Prudential Regulatory Authority(PRA)’s consultation paper “Credit risk mitigation: eligibility of guarantees as unfunded credit protection”, warns of a risk to the UK financial services sector if the efficiency of credit insurance is reduced in helping banks to mitigate risks. The PRA’s consultation is looking at some of the key credit risk mitigation(CRM) eligibility criteria of unfunded bank guarantees, including non-payment insurance, in terms of timeliness of payment, enforceability, clarity and incontrovertibility. The LMA’s comprehensive response highlights the vital role that non-payment insurance, used as CRM, plays in the banking sector and in supporting global trade and the UK economy.
Non-payment insurance products paid over $2.6bn in claims to regulated financial entities between 2007-2017, with no claims made going unpaid except those where operational failure on the part of the insured made the claim invalid. These products support a wide range of lending, with global exposures insured on a transactional basis currently estimated at $100bn to $150bn.
James Bamford, Global Practice leader Political Lines at Talbot Underwriting, and chairman of the LMA Political Risk, Credit and Financial Contingencies Panel, comments “Disruption to this market could create a series of negative effects for banks, such as damaging financial stability, reducing resilience to volatility, increasing costs, reducing lending capacity and ultimately reducing global trade flows.”
The LMA’s key recommendations to the PRA are as follows:
-PRA should consider the wider economic impact on costs, lending and global trade flows if existing CRM techniques are disrupted.
-PRA to confirm that credit insurance products can meet the Capital Requirements Regulation(CRR) where the lender has the right to pursue the guarantor in a timely manner once the claim has been validated, in line with the PRA’s interpretation of timeliness for other CRR qualifying products.
-Insurance contracts that contain systemic risk exclusions can remain consistent with the incontrovertibility requirements of the CRR.
-PRA to confirm that, until a revised Supervisory Statement has been issued, banks may continue their current approach to non-payment insurance as CRM.
David Powell, the LMA’s head of Non-Marine Underwriting, added “The LMA is concerned that the proposals set out in the consultation paper could damage the on-going use of non-payment insurance as a robust and effective transfer of risk for banks. Working closely with the IUA, leading political risk and credit insurance brokers and other banking and insurance stakeholders, we have developed a comprehensive response which seeks to address the PRA’s concerns and ensures the ongoing successful operation of this insurance marketplace which is vital for our economy.”
Credit risk insurance policies are likely to become more expensive and less readily available if proposed new regulatory changes are pursued, the International Underwriting Association (IUA) has warned. Planned reforms could cause some London Market insurers to conclude the product is no longer viable, which may have a subsequent impact on bank lending.
Responding to the consultation paper published by the PRA, the IUA stated that the changes failed to recognise the importance, flexibility and effectiveness of credit risk insurance provided to banks and other financial institutions. The association called on the regulator to reconsider its proposals and review their potential impact on the London insurance market, the UK economy and wider global trade flows.
“The credit insurance product has historically worked well, continues to do so and is valued by clients,” comments Chris Jones, IUA director of legal and market services. “Our research on this issue has revealed widespread concern that the regulatory proposals will make the market less attractive and that alternative forms of security are in some circumstances problematic and limited.
Insurers and reinsurers represent an excellent source of security, coupled with proven claims handling and payment performance. If the market for credit risk insurance is disrupted there is a danger that banks will transfer their lending to other jurisdictions which would be hugely detrimental to London banking, insurance and the UK financial services sector generally.”
The PRA’s consultation paper interprets the obligation for insurers to pay out in a timely manner as settling claims within days of a credit default occurring. It is, however, not uncommon for many weeks to pass before a bank even informs its insurer of a potential claim. This delay may be for quite valid operational reasons as, for example, a bank evaluates the extent of a borrower’s financial difficulties before deciding whether an insurance claim is required.
Necessitating claims to be settled within days of a borrower failing to make a payment would not allow time for usual investigation and claims assessment processes to be followed.
“The proposed changes would result in insurers becoming de facto liquidity providers,” said Jones. “In order to process claims quickly, insurers would be quite reliant on receiving information from the lender in good time–a process over which they have limited control.
Our feedback suggests that banks do not rely on credit insurance as a primary source of repayment in the immediate term. There seems little value in turning an insurance claim based on indemnity principles into a stop-gap payment.”

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