PKF Partner Paul Goldwin reviews how brokers maintain financial stability and survive through turbulent times.
The COVID-19 pandemic and its potential effect on insurance intermediaries has led the Financial Conduct Authority (FCA) to put financial resilience at the top of their agenda.
Depending on their size, financial strength and the sectors that they operate in, COVID-19 has had a mixed impact on insurance intermediaries:
The larger firms, with good financial reserves and a well-diversified book of business have generally coped well and, in many cases, better than expected. They weren’t only buoyed by significant cost savings, particularly in their travel and entertaining budgets, but also by the general hardening of insurance rates.
The smaller firms, especially in sectors like travel, hospitality, etc, and saddled with thinner capital resources have struggled. However, thanks to Government incentives such as the furlough scheme, tax deferrals, bounce back loans or the Coronavirus Business Interruption Loan Scheme (CBILS) they’ve survived.
That said, the problem hasn’t gone away for many firms. While 2020 was a year of survival, 2021 and beyond will prove even more challenging. With Government props evaporating, banks calling in loans and the Revenue claiming deferred taxes, insurance brokers will be facing a perfect storm.
In an attempt to identify firms in financial distress and to reinforce its message, the FCA has been engaging with the market via its COVID-19 Impact Survey.
Following 3,370 responses from insurance intermediaries, the FCA published the survey’s results on 7 January 2021 that confirmed their worst fears:
Although most brokers had sufficient cash to see them through the pandemic, their margin of safety was low -with an average of only 3% of available cash over their cash requirement;
Forty-four per cent of insurance brokers furloughed their staff; 19% had received a loan; but only 14% had entered into a delayed payments scheme with their creditors; and
Sixty per cent of firms were expecting to be badly affected by COVID-19. However, 75% of these thought their net income would be affected by the lowest range of between 1% and 25%.
The FCA’s position
The FCA’s been expecting many firms to fail and, in readiness for this, has been engaging closely with the market since the start of the pandemic.
To put it simply the FCA expects firms to:
have sufficient capital to get through this period and therefore to be financially resilient;
figure out what they need, compare this to what they’ve got and, if there’s a deficit, to decide how they’re going to deal with it;
contact them if they don’t have sufficient capital and, if that’s the case, to work out a closing down strategy that avoids impacting either their clients or the market; and
not use their clients’ money to keep their businesses afloat.
The FCA has provided insurance intermediaries with several recommendations on what firms should concentrate on and thus retain their financial resilience:
1. Firms should always plan ahead and employ sound management of their finances rather than following a ‘wait and see’ approach. At a practical level this means:
Preparation and adherence to detailed budgets and working capital projections based on realistic and reasonable assumptions; and
Scenario stress testing of budgets to ensure they build in sufficient headroom/buffers to account for all eventualities.
2. Firms should assess their current capital requirements against their current capital availability and above all, making sure that they meet their regulatory capital requirements at all times. In practice, this means:
Preparation of detailed Capital Resource Requirement (CRR) monitoring and feeding their working capital budgets into their CRR calculations;
Scenario stress testing and taking account of the effect of various alternative scenarios on buffers/headroom; and
If a buffer/headroom is being used up, leaving the firm with very little margin for error, they are expected to inform the FCA so that they can start putting a plan in place to help bolster their capital.
3. Wherever possible, firms should attempt to conserve capital, by carefully planning on how to meet potential demands on their liquidity. In addition, they should adopt a forward-thinking approach when deciding on dividend distributions, bonus payments, etc and, where there’s any sign of a decline in trading leading to potential losses, absolutely not draw on profit and loss reserves which could prove to be a valuable safety net in future.
The message is clear – firms must ensure they’re financially resilient or be prepared to demonstrate that they can leave the market in an orderly manner.
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