The Prudential Authority is proposing a more comprehensive liquidity-risk framework for insurers, including a minimum liquidity ratio, enhanced stress testing, practical plans for addressing liquidity shortfalls, and monthly reporting.
Draft Prudential Standard FSI 6 would replace the existing liquidity-risk assessment standard, which the Authority says does not adequately address insurers’ resilience to sudden cash-flow pressures. The proposals aim to strengthen insurers’ ability to identify, manage, and prepare for liquidity shortages that could prevent them from meeting financial obligations on time.
The Standard would apply to insurers licensed under the Insurance Act, except microinsurers, Lloyd’s, and branches of foreign reinsurers. It would not impose its liquidity ratio, asset, stress-testing, or reporting requirements on brokers, intermediaries, or advisers in their own capacity.
Why the PA wants a new framework
Liquidity risk is different from solvency risk. An insurer may be solvent but unable to meet commitments when they fall due or may be able to do so only at significant and unexpected cost.
The existing FSI 6, issued in 2018, provides a framework for evaluating liquidity risk that includes a liquidity-shortfall indicator. The Authority says it does not adequately capture vulnerabilities arising from insurer-specific liquidity stresses, business-as-usual and stressed cash flows, margin and collateral calls on derivatives, and the sudden recall of funds received through securities-lending transactions. It also does not require a documented contingency funding plan.
The proposed framework draws on principles set out by the International Association of Insurance Supervisors. The Authority says it is intended to strengthen insurers’ resilience, protect policyholders, and promote financial stability.
A minimum ratio backed by stress testing and practical plans
At the centre of the proposal is an insurance liquidity ratio (ILR) measuring an insurer’s ability to meet short-term cash-flow obligations over 30 calendar days. Insurers would have to maintain an ILR of at least 100%, together with an appropriate buffer, and manage their businesses so that the calculated ratio did not fall below the applicable minimum.
The ILR would compare adjusted high-quality liquid assets (HQLA) backing obligations where the policyholder does not bear the investment risk with net cash outflows under stress. Recognised cash inflows would be capped at 75% of outflows. Cash flows on unit-linked liabilities where policyholders bear the investment risk would be excluded, although residual liquidity risks associated with that business would remain in scope.
A proposed accompanying determination divides qualifying assets into three levels. Level 1 assets would receive no haircut and be included at fair market value. Level 2a assets would be subject to a 15% haircut, and Level 2b assets to a 50% haircut. To qualify, an asset would have to be unencumbered and capable of being converted into cash within 30 days through a direct sale or repurchase agreement at minimal or no cost.
The ILR would not alter Pillar 1 capital requirements or the valuation of technical provisions. Liquidity risk, including ILR calculations and stress-testing results, would instead be addressed through the insurer’s Own Risk and Solvency Assessment (ORSA) under Pillar 2.
The ILR would be accompanied by stress testing over several periods. Insurers would have to use severe but plausible scenarios, including acute stress extending up to three months and protracted stress extending up to 12 months. The scenarios would cover market-wide disruptions, events specific to the insurer, and combinations of these factors. The Authority could also require insurers to run a standardised scenario to support comparisons.
Reverse stress testing would identify circumstances in which the insurer’s stock of liquid assets would be exhausted and the route by which the initiating events produced that outcome.
Each insurer would also need a board-approved contingency funding plan setting out practical measures to generate cash, obtain alternative funding, or reduce liquidity needs during stress. The plan would have to identify when actions could be activated, how quickly funds could be obtained, and who would be responsible. Annual testing would have to confirm that the plan could keep the ILR at or above the 100% minimum and mitigate related risks.
The requirement would therefore go beyond identifying possible emergency funding sources. Insurers would have to demonstrate that their proposed actions could be carried out within the time available and produce sufficient liquidity under stressed conditions.
Monthly reporting and stronger oversight
Insurers would submit a Liquidity Risk Return through the Umoja Portal every month, within 20 business days after month-end. Reporting would begin when the revised Standard took effect.
The return separates business-as-usual and stressed cash flows for shareholder and policyholder portfolios across periods from the next day to 12 months. It covers items including premiums, claims and policy benefits, withdrawals, reinsurance flows, investments, and operating expenses. It also provides space for other potential liquidity needs not already included in stressed cash flows, such as margin and collateral calls, securities-lending transactions, repurchase agreements, and operational-risk events.
The insurer’s board would carry ultimate responsibility for compliance and approve its liquidity-risk appetite, tolerance limits, policy, and stress scenarios. The head of actuarial function would give the board an opinion on the accuracy of the ILR calculations and the appropriateness of the assumptions, while the appointed auditor would obtain audit evidence on the HQLA portfolio and ILR calculation.
The ORSA would also have to assess dependence on funding from a parent company or other group entities and whether those arrangements were likely to remain effective during stress.
Costs and impact remain uncertain
The Authority conducted a quantitative impact study and sought industry input through a questionnaire, but the response rate was low. It says the findings may not represent the sector and limit the conclusions that can be drawn about the effect of the proposed framework. The sector’s implementation cost has yet to be determined.
Respondents raised concerns about system configuration, model enhancements, skilled personnel, detailed reporting, and audit costs. Some questioned whether the burden would be proportionate to the liquidity risks they faced and whether sufficiently reliable data would be available for business-as-usual and stressed cash-flow projections.
Views differed on allowing insurers to develop their own stress scenarios. Some respondents said this could reduce consistency and comparability, whereas others regarded flexibility as appropriate because business models differ. Concerns were also expressed that the ILR methodology could produce artificial shortfalls or misaligned incentives.
These views do not represent the insurance industry’s aggregate position. Some respondents supported the ILR as an additional benchmark and considered contingency funding plans beneficial for crisis preparedness. The Authority says it will use the public consultation to obtain additional quantitative data and insights to improve the robustness of its final impact assessment.
An earlier draft was released for informal consultation in May 2024, and the Authority says comments received then were incorporated into the revised proposal. The commencement date has not been announced. Comments on the current package must be submitted by 27 November 2026 using the prescribed Word template.
Click here to download the full consultation package.
