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 section after it revealed the outcomes of its April 2022 session. This coincided with its Autumn assertion, signifying the significance attributed to Solvency II reforms inside 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 belongings in the actual financial system. Aviva estimates it might make at the least £25 billion price of capital funding over the subsequent 10 years throughout the UK if the reforms go forward. The ABI view is that the modifications would enable trade 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 vary legal guidelines inherited from the EU imply that it could create a Solvency II regime that’s higher tailor-made to the UK insurance coverage market.  Threat margin reforms undoubtedly replicate widespread settlement that the present guidelines are poor.

Modifications proposed by the PRA to elementary unfold (FS) methodology haven’t, nonetheless, made it into the ultimate package deal.  PRA considerations 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 path for reform, it may very well be a while till the element is understood. Some reviews recommend it may very well be the top of 2024, or presumably 2025, earlier than the modifications come into drive.

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 chance margin is broadly criticised for its unnecessarily burdensome impact on life insurers.

Nonetheless, while there’s normal settlement that reforms to Solvency II might assist set up a extra applicable regime for UK insurers, there was much less settlement on how precisely it wants to vary. The PRA, specifically, has argued for warning in making modifications to the Solvency II regime that launch capital for funding however don’t meet with the necessity for prudence, per its security and soundness and policyholder safety goals. In a speech given in July 2022, Sam Woods of the PRA said as follows:

“Brexit offers us a chance 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 have to be clear that this isn’t a free lunch. If modifications merely loosen laws which have 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 threat margin;
• reforming the FS of the matching adjustment;
• rising funding flexibility for matching adjustment portfolios; and
• lowering 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 chance 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 assist for the goals of the Solvency II overview however stops in need of saying it helps the end result.

HMT package deal of reform

The Treasury’s reform package deal carries over many of the proposals put ahead in its session paper, with some notable variations.

Threat margin

Unsurprisingly, modifications to the chance margin are going forward, together with a 65% discount for long-term life insurers beneath latest financial situations. The Authorities anticipates that this variation will, amongst different issues, unencumber vital quantities of capital, eradicating a barrier to decrease product costs and better annuity yields and scale back the volatility of life insurers’ steadiness sheets.

For normal insurance coverage enterprise, the discount can be round 30%.

Basic unfold

The “most difficult component of the controversy” was on the assemble of the FS. The PRA needs to vary the present methodology to replicate varied considerations, together with that the FS doesn’t, in its view, enable absolutely for uncertainty round credit score threat. The Treasury has rejected the PRA’s proposals on the premise that it has been not possible to achieve a consensus, deciding to go away the design and calibration of the FS because it stands. It should, nonetheless, enable the

PRA to make use of three new measures geared toward safeguarding policyholders:

• the introduction of recent stress check necessities;
• requiring nominated senior managers with formal regulatory duties beneath the SMCR to signal an attestation that the agency’s dedication of the FS, as recognised in its accounting data, correctly displays all retained dangers; and
• permitting insurers to use the next FS on a voluntary foundation (which might presumably be performed in response to a senior supervisor having considerations about signing the attestation).

The sting within the tail for companies of preserving the present FS methodology would be the introduction of a brand new formal attestation requirement. There isn’t any affirmation but of how usually this attestation can be wanted and of what it might want to cowl. Nonetheless, the non-public legal responsibility that attaches to the senior supervisor who’s liable for giving the attestation implies that processes will have to be established to safeguard their place and that of the agency. Cautious consideration will have to be given, for instance, to how the attestation is drafted and applicable diligence ought to be performed to acquire the requisite stage of consolation within the statements which are being made.

It’s also doable that the present reforms are introducing political threat into the system. Particularly, if a brand new authorities have been fashioned, 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 problem, it’s not tough to think about the PRA at the least elevating the problem.

Growing funding flexibility

The Authorities is taking ahead proposals to carry among the present restrictions on belongings that may be introduced into companies’ matching adjustment portfolios. Particularly, necessities that money flows from matching adjustment portfolios should be fastened can be changed by a requirement that money flows are “extremely predictable”. Further flexibility to incorporate belongings with prepayment threat or building phases may even broaden matching adjustment eligibility.

These modifications, along with the modifications to the chance margin, are anticipated to unencumber capital that may very well be used to extend insurer funding in long-term productive belongings, most notably in infrastructure. Certainly, some main UK life insurers have already publicly mentioned that that is what they intend to do. It’s also hoped that there can be much less want for asset restructuring to fulfill matching adjustment standards.

Lowering reporting and administrative burdens

As a part of its efforts to “slash crimson tape lingering from the EU”, the Authorities is introducing sure modifications geared toward lowering the executive burden on companies and making a extra beneficial surroundings for smaller insurance coverage companies.

These embody eradicating necessities for UK branches of abroad insurers to calculate department capital necessities and to carry belongings domestically to fulfill 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 assist of this variation is {that a} department capital requirement shouldn’t be wanted if the “mum or dad” agency is correctly capitalised beneath its dwelling state’s regulatory regime. Extra typically, the PRA has additionally indicated, following its session earlier this yr, that it expects to have the ability to scale 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 package deal of reforms embody the next:

• Regardless of solutions in April’s session paper that the Authorities would possibly look to limit the usage of some belongings which are 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 don’t have an in depth image of what the ultimate reforms will seem like. As at all times, the satan could also be within the element (for instance, is a few elaboration of what “extremely predictable” means to be provided?) though it appears unlikely that vital inroads can be made into the commitments made by the Treasury.
• What does appear clear is that the Authorities shouldn’t be content material to let the PRA make all the principles wanted to implement these reforms, and subsequently it intends to legislate on sure features of the proposed reforms that it feels strongly about, reminiscent of the chance margin.
• It should nonetheless be fascinating to see how the PRA responds to the Treasury’s package deal of reforms given its clear reservations over among the modifications.