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Solvency II: Take Two

Steven Findlay.jpgHM Treasury’s Review of the Solvency II regime offers a once in a generation opportunity to improve the UK’s prudential regime for insurers and make it more appropriate for the UK. The ABI is currently gathering evidence and developing its response to Treasury’s Call for Evidence, for submission in January.  

ABI Annual Conference 2021 takes place on 23 February and is thus very timely from a prudential regulation perspective. The prudential regulation session, this year entitled Solvency II: Take Two will allow senior government, regulatory and industry representatives to reflect on Treasury’s Call for Evidence and discuss next steps for the review. This will be one of the first opportunities to hear reflections on the evidence gathered so far and any initial conclusions from policymakers.  

In this Q and A, Steven answers a variety of questions on industry priorities for the review and the opportunities it presents from a public policy perspective. If you have not yet registered for ABI Annual Conferencefull details can be found here. 

Why has HM Treasury launched a review of the Solvency II regime 

iStock-670968628.jpgThis is something the ABI has called for since the Brexit referendum took place in 2016, to ensure we have a UK framework that is optimal for the UK market. Many will remember the Treasury Select Committee’s review of EU regulation following the referendum and while some changes were made as a result of this, it also became clear that more fundamental changes would only be possible once the UK had exited the EU and the transition period had ended 

From 1 January next year the UK government will be the ultimate owners of the prudential regime, rather than it being agreed EU-wide. So Treasury has launched this review to see where the regime could be made more appropriate for the UK in terms of public policy objectives.  

The HMT has three main objectives for this review: to spur a vibrant, innovative, and internationally competitive insurance sector; to protect policyholders and ensure the safety and soundness of firms; and to support insurance firms provide long-term capital to underpin growth, including investment in infrastructure, venture capital and growth equity, and other long-term productive assets, as well as investment consistent with the Government’s climate change objectives. 

We support all three of these objectives, but at times they can come into conflict with each other, so it is essential that the final regime is appropriately balanced and not only constructed with the objective of firms’ safety and soundness in mind. This will also be essential to consider as part of HM Treasury’s Future Regulatory Framework Review.  

What is the ABI hoping to achieve from this review?  

The ABI wants to achieve a regime that is more appropriate for UK insurers in terms of the level of capital they hold, their approach to risk management and their reporting requirements. 

The EU Solvency II regime is necessarily highly prescriptive, given it is attempting to harmonise regulation across a multitude of member states. By contrast, regulation in the UK is less prescriptive and more principles-based, so returning to a more principles-based regime is key.  

But this should not just be about change for the sake of it. I see our interests as clearly aligned with HM Treasury policy objectives of improving international competitiveness to ensure the UK remains a word-leader in insurance, and freeing up more of firms’ sizable balance sheets to invest back into the real economy.  

The UK economy is facing serious challenges and while changes to insurance regulation cannot solve them all, they can go some way in contributing to a wider system of financial regulation that challenges unnecessary levels of conservatism and allows greater amounts of capital to be allocated to economic recovery, productive finance and growth.  

Since 2016 many lessons have been learnt about how Solvency II behaves through the economic cycle. It is very clear there are aspects of the regime that are far from perfect and some which are fundamentally flawed. Changes to these aspects in the interests of insurers, but also in the interest of UK policyholders and the UK economy, is the ABI’s primary objective.  

What are the ABI’s top priorities?   

The ABI’s top three priorities are to secure reforms to the Risk Margin to improve the affordability and availability of insurance; enable access to a wider range of long-term assets, through MA reform; and the simplifying and streamlining reporting and approvals, along with greater proportionality, to reduce the cost and delay in regulatory engagement. It is therefore very much welcome that these three aspects are front and centre of Treasury’s Call for Evidence 

On Risk Margin, the ABI, Treasury and PRA are all aligned on the view that the Risk Margin is fundamentally flawed and in need of reform. The Risk Margin is both too large (at more than £50 billion in aggregate) and too volatile to movements in interest rates. In fact, the Risk Margin undermines all three of HM Treasury’s core objectives for the review – it makes UK life business look very expensive (international competitiveness), it makes firms behave in a procyclical manner (safety and soundness), it leads to transfer of risk overseas (policyholder protection) and undermines firms’ ability to invest in socially useful assets (investment in real economy).  

Meanwhile, the Matching Adjustment constrains insurers’ investment potential by requiring firms to repackage and restructure a variety of assets in a very complex way that is both very expensive and resource intensive. Removing some of this complexity would allow firms to invest in a wider range of asset and put insurers balance sheets to better use for the UK economy 

Finally, current reporting requirements are duplicative, highly prescriptive and underused by regulators. This represents a huge cost for insurers and one that very often does not have commensurate benefit in terms of policyholder protection.  

Will the UK now be looking to international standards rather than European standards?  

The ABI is a supporter of international standards. We believe there are aspects of international regulation, including the Insurance Capital Standard (ICS), that could be more appropriate to apply in the UK than the current EU Solvency II regime. For example, if the ICS Margin Over Current Estimate (MOCE), the international version of the Risk Margin, were adopted in the UK, this would cut Risk Margin by at least half.  

That said, the ICS is still under development and will not be ready for implementation until 2025 at the earliest. It is essential that the UK adopts a regime that reflects the ways in which UK firms manage risk and capital, integrating international standards where most appropriate and especially where these were designed with UK priorities in mind.  

In the context of HM Treasury’s international competitiveness objective, it will also be important for HM Treasury to consider the regulatory regimes applied in non-EU jurisdictionsThe EU Solvency II regime is highly conservative and it will be important to consider how different jurisdictions go about balancing their obligations relating to competitiveness, policyholder protection and the role insurers can play in supporting the real economy, potentially in a manner that is better suited to the UK.  

How can the Solvency II Review further enable firms to take steps to tackle climate change and help support UK economic recovery from Covid-19?  

climate change 2.jpegClimate change and Covid-19 are the two of the most difficult challenges the world currently faces. Insurers are already proactively taking steps to reduce or mitigate the impact of climate change, whether that is in relation to assets or liabilities or through support of the TCFD recommendations. Insurers are also big investors in the UK economy, supporting government borrowing, investment in infrastructure and UK plc. But firms could do more if Solvency II were improved to facilitate this 

Reforms the Matching Adjustment (MA) represent one of the key opportunities in this review to help broaden the universe of assets that insurers can invest in. This would include assets that support the Government’s 2050 net zero emissions target, such as green energy and new technologies, as well as assets that support the UK economy, including UK SMEs, property and infrastructure.   

UK insurers are naturally cautious investors, but they also have very large balance sheets with assets in excess of £1.7 trillion. Inappropriately high capital requirements and onerous regulatory requirements such as some associated with the Matching Adjustment, prevent a greater proportion of these assets being allocated to green projects and the real economy.  

It’s useful to consider that if UK insurers were to reallocate just 1% of their current investment portfolio to assets supporting the mitigation of climate change, this would provide £17 billion for new green investment. A United Nations report from August this year points to a projected global funding gap for sustainable infrastructure of $16 trillion between now and 2040 while insurers globally hold assets of $33 trillion dollars. That’s certainly food for thought.  

What are you most looking forward to from the ABI’s Annual Conference?  

The ABI Annual Conference is always a wonderful opportunity to discuss highly important issues with policymakers and colleagues from across the industryAlthough we cannot meet in person this year, I’m confident that this opportunity will be the same in 2021 as in previous years, this time with technology facilitating new ways of networking and getting the discussion going.  

The annual conference, and from my perspective the prudential regulation session in particular, will allow a very important discussion to take place on the Solvency II review at a very opportune time.  

Last updated 02/12/2020