A model of this text was first revealed on Thomson Reuters Regulatory Intelligence.
The Treasury’s plans to reform Solvency II have entered their subsequent part after it revealed the outcomes of its April 2022 session. This coincided with its Autumn assertion, signifying the significance attributed to Solvency II reforms throughout the Authorities’s wider plans to create a vibrant post-Brexit financial system.
A reassessment and loosening of sure features of the present regulatory framework are anticipated to launch vital quantities of capital, enabling insurers to spend money on illiquid property in the actual financial system. Aviva estimates it might make at the least £25 billion value of capital funding over the following 10 years throughout the UK if the reforms go forward. The ABI view is that the adjustments would enable business to speculate over £100 billion over the identical interval in productive finance, together with UK social infrastructure and inexperienced power provide.
The Treasury argues that post-Brexit freedoms to alter legal guidelines inherited from the EU imply that it might create a Solvency II regime that’s higher tailor-made to the UK insurance coverage market. Threat margin reforms undoubtedly mirror widespread settlement that the present guidelines are poor.
Modifications proposed by the PRA to basic unfold (FS) methodology haven’t, nevertheless, made it into the ultimate bundle. PRA issues that Solvency II reforms should preserve the general integrity of the regime have clearly been overruled by the Authorities on this event. It will likely be fascinating to see how the PRA reacts over the approaching months and years, together with in its interactions with future governments.
Whereas the Treasury’s proposals point out a transparent route for reform, it might be a while till the element is understood. Some studies recommend it might be the top of 2024, or probably 2025, earlier than the adjustments come into power.
Background
There was long-standing debate on the suitability of sure features of the present Solvency II regime for the UK insurance coverage market. For instance, the present methodology for calculating the danger margin is broadly criticised for its unnecessarily burdensome impact on life insurers.
Nevertheless, while there may be basic settlement that reforms to Solvency II might assist set up a extra acceptable regime for UK insurers, there was much less settlement on how precisely it wants to alter. The PRA, particularly, has argued for warning in making adjustments to the Solvency II regime that launch capital for funding however don’t meet with the necessity for prudence, in line with its security and soundness and policyholder safety goals. In a speech given in July 2022, Sam Woods of the PRA acknowledged as follows:
“Brexit provides us a possibility to rewrite the insurance coverage laws we inherited from the EU – and in doing so assist drive additional funding within the financial system. However we should be clear that this isn’t a free lunch. If adjustments merely loosen laws which had been over-cooked by the EU, with out tackling different areas the place laws are too weak, then we’re placing policyholders in danger.”
In an effort to construct consensus, the Treasury launched a session paper on 28 April 2022 calling for suggestions on 4 key areas for reform:
- a considerable discount within the danger margin;
- reforming the FS of the matching adjustment;
- rising funding flexibility for matching adjustment portfolios; and
- decreasing pointless reporting and administrative burdens.
Concurrently, the PRA issued a dialogue paper (DP2/22) setting out its views on the Treasury’s proposed reforms to the danger margin and matching adjustment. In a suggestions assertion (FS1/22), additionally issued on the identical day as the federal government’s Autumn Assertion, the PRA notes its help for the goals of the Solvency II assessment however stops wanting saying it helps the result.
HMT bundle of reform
The Treasury’s reform bundle carries over a lot of the proposals put ahead in its session paper, with some notable variations.
Threat margin
Unsurprisingly, adjustments to the danger margin are going forward, together with a 65% discount for long-term life insurers beneath current financial situations. The Authorities anticipates that this modification will, amongst different issues, liberate vital quantities of capital, eradicating a barrier to decrease product costs and better annuity yields and cut back the volatility of life insurers’ stability sheets.
For basic insurance coverage enterprise, the discount might be round 30%.
Basic unfold
The “most difficult component of the talk” was on the assemble of the FS. The PRA needs to alter the present methodology to mirror varied issues, together with that the FS doesn’t, in its view, enable totally for uncertainty round credit score danger. The Treasury has rejected the PRA’s proposals on the premise that it has been unattainable to achieve a consensus, deciding to depart the design and calibration of the FS because it stands. It should, nevertheless, enable the
PRA to make use of three new measures aimed toward safeguarding policyholders:
- the introduction of recent stress check necessities;
- requiring nominated senior managers with formal regulatory obligations beneath the SMCR to signal an attestation that the agency’s willpower of the FS, as recognised in its accounting information, correctly displays all retained dangers; and
- permitting insurers to use a better FS on a voluntary foundation (which might presumably be performed in response to a senior supervisor having issues about signing the attestation).
The sting within the tail for corporations of preserving the present FS methodology could be the introduction of a brand new formal attestation requirement. There is no such thing as a affirmation but of how usually this attestation might be wanted and of what it might want to cowl. Nevertheless, the non-public legal responsibility that attaches to the senior supervisor who’s accountable for giving the attestation signifies that processes will should be established to safeguard their place and that of the agency. Cautious consideration will should be given, for instance, to how the attestation is drafted and acceptable diligence ought to be carried out to acquire the requisite stage of consolation within the statements which can be being made.
It is usually attainable that the present reforms are introducing political danger into the system. Particularly, if a brand new authorities had been shaped, can anybody say with certainty that the PRA wouldn’t persuade them that the present reforms have unduly weakened the regulatory regime general? Given its clear stance on this concern, it isn’t troublesome to think about the PRA at the least elevating the difficulty.
Rising funding flexibility
The Authorities is taking ahead proposals to raise among the present restrictions on property that may be introduced into corporations’ matching adjustment portfolios. Specifically, necessities that money flows from matching adjustment portfolios have to be mounted might be changed by a requirement that money flows are “extremely predictable”. Further flexibility to incorporate property with prepayment danger or building phases may also broaden matching adjustment eligibility.
These adjustments, along with the adjustments to the danger margin, are anticipated to liberate capital that might be used to extend insurer funding in long-term productive property, most notably in infrastructure. Certainly, some main UK life insurers have already publicly stated that that is what they intend to do. It is usually hoped that there might be much less want for asset restructuring to satisfy matching adjustment standards.
Lowering reporting and administrative burdens
As a part of its efforts to “slash purple tape lingering from the EU”, the Authorities is introducing sure adjustments aimed toward decreasing the executive burden on corporations and making a extra beneficial setting for smaller insurance coverage corporations.
These embody eradicating necessities for UK branches of abroad insurers to calculate department capital necessities and to carry property domestically to satisfy these necessities. This is a matter that got here to the fore as a consequence of teams restructuring to mitigate the impression of Brexit. The argument in help of this modification is {that a} department capital requirement is just not wanted if the “mother or father” agency is correctly capitalised beneath its residence state’s regulatory regime. Extra usually, the PRA has additionally indicated, following its session earlier this yr, that it expects to have the ability to cut back the reporting burden for insurers considerably as a part of the reforms.
The Treasury additionally intends to extend the thresholds for the dimensions and complexity of insurers earlier than they turn into topic to the UK’s on-shored model of Solvency II.
Additional observations
Further factors raised by the Treasury’s bundle of reforms embody the next:
- Regardless of recommendations in April’s session paper that the Authorities would possibly look to limit using some property which can be launched from the matching adjustment beneath these reforms (eg, to require their funding in infrastructure), nothing in its response suggests it will occur.
- Till the drafted guidelines and laws have been launched, we wouldn’t have an in depth image of what the ultimate reforms will seem like. As all the time, the satan could also be within the element (for instance, is a few elaboration of what “extremely predictable” means to be supplied?) though it appears unlikely that vital inroads might be made into the commitments made by the Treasury.
- What does appear clear is that the Authorities is just not content material to let the PRA make all the principles wanted to implement these reforms, and due to this fact it intends to legislate on sure features of the proposed reforms that it feels strongly about, equivalent to the danger margin.
- It should nonetheless be fascinating to see how the PRA responds to the Treasury’s bundle of reforms given its clear reservations over among the adjustments.
