HM Treasury has published a long-awaited public consultation on post-Brexit reforms to the capital regime governing insurance companies, providing detail on how it plans to unlock tens of billions of investment while still providing protection to policyholders.
The consultation, which was launched on Thursday and will close on July 21, proposes a series of changes from the Solvency II rules the UK inherited from the European Union. The government claims its proposals will make it easier for firms to invest in long-term assets such as infrastructure.
“Our reforms will unlock tens of billions of pounds of investment in the UK economy, spur innovation in the market while protecting policyholders – and will cement the UK’s position as a global hub for financial services,” said John Glen, economic secretary to the treasury, in a statement.
The key pillars of the reform include an easing of capital requirements via a significant reduction in the risk margin, an additional capital buffer already held by insurance companies, including a cut of around 60%–70% for long-term life insurers. As of the end of 2021, the risk margin for life business was in excess of £32bn, according to figures from the UK's Prudential Regulatory Authority.
The treasury also proposes changes to better reflect credit risks in the so-called fundamental spread used to calculate the matching adjustment, which the government said incentivises insurers to match long-term life insurance products against assets with similar characteristics.
The treasury said the package of reforms would also reduce firms’ reporting requirements and administrative burden.
In its response to the detail of the consultation, the PRA acknowledged the proposed reforms would raise the risk of insurance company failure but agreed with the case for reform of the risk margin.
It stressed, however, that this must be carried out in tandem with the strengthening of the fundamental spread to better reflect credit risks, to ensure that the overall package continues to advance the PRA’s statutory objectives and is within its risk appetite.
“If this outcome is achieved, the PRA considers that the risk margin could be recalibrated to reduce its impact in current economic conditions by around 60% for life insurers and around 30% for general insurers, while continuing to ensure the UK regime provides an appropriate level of safety and soundness and policyholder protection,” it said.
The PRA said such reforms could reduce life insurers’ overall capital levels by around 10%–15%.
Analysts at Morgan Stanley said the proposals would have the biggest impact on UK annuity providers, boosting their capital positions and capital generation.
“The proposal for increasing investment flexibility would broaden the universe of illiquid assets that insurers can include in matching adjustment portfolios, which could provide a boost to capital generation, particularly given the demand for these illiquid assets (in particular green assets) has increased beyond the insurance industry,” said the analysts.
“By reducing reporting and administrative burdens, the proposed changes to internal models post M&A would likely benefit back-book acquirers such as Phoenix, and could accelerate capital releases post M&A, although the proposed simplification of the transitional measure on technical provisions (TMTP) calculation would reduce the administrative burden of insurers' legacy books, which could impede demand for back-book disposals.”
The first battle
Voices within the UK insurance industry have long called for change to a regime they deemed overly burdensome and ill-suited to UK firms.
Charlotte Clark, director of regulation at the Association of British Insurers, told IFR the industry has been urging the government to free up insurers' capital, so firms can further support the net zero transition and the UK's levelling-up agenda while maintaining high levels of policyholder protection.
"We will consider what has been published today by HM Treasury and the Prudential Regulation Authority in more detail to ensure what is being proposed meets the common objectives of both the insurance and long-term savings sector and the government’s intentions in undertaking this review," she said.
"Only meaningful reform can enable our industry to provide much-needed investment in green infrastructure, particularly at a time when energy security is increasingly vital."
Speaking at an Atlantic Council event on Thursday, Tracy Blackwell, chief executive of Pension Insurance Corporation, said efforts to reform Solvency II represent a first test case for broader efforts to reform UK financial regulation in the wake of Brexit.
She suggested the relatively slow progress so far reflects the different objectives of the government and the regulator.
"This is all being played out in real time, so I liken it to Solvency II being the battle, while future regulatory framework is the war," she said.
"Where it is going to land and where it is going to end up in terms of who is accountable, how that accountability is measured and discussed and given, is all new because we haven't had to do that for a very, very long time."