UK insurers must take a closer look at how they value the illiquid assets and complex financial products in their investment portfolios, after a review by the PRA found some insurers' practices "insufficiently robust and complete".
The warning from the regulator follows a survey conducted over the summer of insurers' procedures relating to valuation uncertainty. The PRA observed poor standards of financial asset valuation governance and control, including: insufficient independence in valuing assets; inadequate documentation of policies and procedures; poor control over valuation models, such as a limited understanding of model assumptions and limitations; and inconsistent governance between internally and externally managed funds.
Consultants say the PRA's scrutiny of asset valuation processes is due in part to the need for insurers to upgrade their reporting standards in preparation for Solvency II.
The growing trend for insurers to invest in illiquid assets such as infrastructure and corporate loans has also pushed the issue of asset valuations up the PRA's agenda.
The PRA is also concerned with the inconsistent governance of internally and externally managed funds. Third-party asset managers may not share the same valuation assumptions as an insurer's in-house team or report at the required level of granularity.
The PRA has flagged issues with firms' valuation models. Some firms may not have an adequate grasp of what portion of the spread on some of their assets is applicable to illiquidity and what portion is applicable to credit risk. Firms may be also underestimating the credit risk inherent in their illiquid portfolios, say consultants.
The supervisor has published a note on its website reminding firms to review their compliance with GENPRU 1.3.33, a section of the PRA's handbook detailing the governance process that should be undertaken when assessing difficult-to-value assets.
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