Hugh Savill, Director of Regulation, ABISo the new solvency look for insurers is all of four months old, and already the fashion world is trashing it.
Models on the catwalk mutter that they had hoped for something more glamourous after 12 years dressed in ICAS rags and feathers. Buyers moan that the £3 billion UK price tag is too expensive. British insurers worry that dashing continental regulators have tailored the Solvency II cloth to flatter the figures of their insurers, while the PRA cutters have stuck to the designs from Brussels – with a little gold braid of their own invention.
Call me old-fashioned, but four months is too early for a proper assessment of Solvency II. Everybody knows that good country clothes need to be worn for several years before you can really tell if they fit. And so far nobody outside the PRA knows how the new capital levels compare overall with Individual Capital Assessment (ICA). Solvency reports to be published next year will provide further transparency, and that should be most revealing.
There are early signs that the fit may be straining the fabric across the anatomy of the life insurance sector. We can see a rising trend to reinsure longevity risk outside the UK. Some companies report a 50% increase in the regulatory capital required for annuities.
On these grounds alone, Solvency II needs some alterations. A healthy annuity market is essential to the Government’s pension reforms. If investors are unwilling to commit capital to the long term savings market, instability will follow.
As ever, alterations will take time. In the UK, we must assume that the PRA is pleased with the higher calibration they have brought in on the back of Solvency II. At the EU level, change is constrained by a timetable which currently puts the first substantive review in 2018.
Finishing touches to this year’s range
Solvency II says that transitional measures “may be re-calculated every 24 months, or more frequently where the risk profile of the undertaking has materially changed.” We were pleased when the PRA produced a consultation document, but there is room for debate about what “material change” means. We believe it should be based on each company’s circumstances.
Further discussion is also needed of the process for changing internal models. This is a difficult balance to strike. Over-frequent changes will create confusion, but companies should not be trapped in solvency models inappropriate to their business model. So again we were pleased to see a consultation document from the PRA. We are hoping that both PRA and firms have learnt lessons from the painful exchanges over the levels of documentation and validation required for initial approval of internal models last year. However, the PRA’s proposal for a pre-application process is not promising.
And of course reporting requirements are still finding their shape and are yet to have their first time on the annual catwalk.
Next year’s look
Can we get ahead of the regulatory fashion? 2018’s EU review season is not far off, and we need to begin preparing now. Early sketches and swatches of material are already circulating at EIOPA. Upstart designers in Basel are flashing sketches of their controversial International Capital Standard range. Given the choice, which numbers would we like to see re-designed?
The Matching Adjustment is essential underwear for annuity business - unfortunately more restrictive than the generously styled ICA liquidity premium. In particular the requirement for fixed cash flows limits the value of the MA. The PRA’s reading of “fixed cash flows” has led them to insist that many assets be placed in special purpose vehicles. This does nothing to enhance consumer protection, and is a waste of money.
We are also hoping that the PRA will overcome their moral objections to a dynamic Volatility Adjuster. The ensemble may sound a little risqué in terms of financial stability, but has yet to cause wardrobe malfunction in markets where it is permitted.
The Risk Margin is currently the least popular garment in the entire Solvency II range. Those wearing it say that it is uncomfortably volatile, too high, and (back to country clothes) impossible to hedge.
In any event, new styles needs to be prepared with care. Nobody wants to be seen wearing the Emperor’s new clothes.
Hugh Savill is Director of Regulation at the Association of British Insurers (ABI)