The Association of British Insurers (ABI) welcomes the publication of an independent report from WTW (Willis Towers Watson), which analyses the potential impact of reforms being explored by the Prudential Regulation Authority (PRA) on the Government’s objectives for its Solvency II review – objectives that the UK insurance industry supports wholeheartedly.
After HM Treasury set out the next steps in the Solvency II review in July 2021, the PRA launched a Quantitative Impact Study (QIS) to assist with its analysis of the potential options for reform of Solvency II. Commissioned by the ABI, WTW has analysed selected responses from ABI members in order to inform the continued constructive dialogue between the industry, PRA and HM Treasury.
Overall, WTW found that the reforms set out in the QIS, if they became policy, would not satisfy the Government’s objectives for the Solvency II review on competitiveness, policyholder protection and increased investment in productive finance. In particular, they would:
- Prioritise unnecessary prudence to the detriment of UK competitiveness and growth;
- Lead to higher and more volatile annuity prices, ultimately leading to reduced income security for UK pensioners; and
- Hinder, rather than stimulate growth and investment in the UK, especially for infrastructure and long-term productive assets.
Key findings on specific elements of the Solvency II framework include:
- The Matching Adjustment, and the Fundamental Spread used in its calculation, are elements of Solvency II that are acknowledged to have worked as intended. However, the PRA’s QIS proposed changes to the Fundamental Spread conflict with the original design objectives of the Matching Adjustment. These proposals would reduce the size of the MA by 44% under Scenario A of the QIS and by 13% under Scenario B, increasing aggregate UK annuity liabilities by over £14.1bn and £4.3bn respectively, and as a consequence lock up additional capital that could otherwise be used to invest in growth and the transition to Net Zero. Furthermore, these proposals would introduce artificial balance sheet volatility into Solvency II, which the Matching Adjustment was specifically designed to mitigate.
- The industry and the PRA agree that the Risk Margin is too large and too sensitive to interest rates. These weaknesses have contributed to UK insurers offshoring longevity risk, often to jurisdictions with less penal regulatory regimes. The Risk Margin for annuity business would reduce by 56% under Scenario A and by 21% under Scenario B; however, both these fall short of the 75% reduction that the ABI believes is justified.
- A significant limitation of the QIS was the lack of information on how the capital that firms are required to hold might be impacted by the updated Matching Adjustment methodology. The PRA did not request information on capital requirements in the QIS to enable it to test the capital impacts of its proposals. The report considers this a limitation of the scope of the QIS as it hinders transparency of the impact on capital requirements of the QIS proposals and any knock-on impacts on the health and competitiveness of the UK insurance market.
- To satisfy the Solvency II review objectives, the report points out that we need to go beyond the balance sheet and take a more holistic view. The QIS focused on the level of insurer capital (Pillar 1). However, some of the PRA’s concerns are already addressed through the risk management, governance and disclosure requirements set out in Pillars 2 and 3 – with a much lower level of cost and disruption to industry.
David Otudeko, ABI Head of Prudential Regulation, says,
Solvency II reform is a once in a lifetime opportunity which could enable our sector to do much more to support economic growth and the transition to Net Zero, and provide our customers with the peace of mind they need. This report from WTW is an important piece of work to inform the ongoing cross-industry work with Government and regulators.”
Notes to Editors
Enquiries to:
Sarah Aspinall 020 7216 7412 Mobile: 07725 245297
Malcolm Tarling 020 7216 7410 Mobile: 07776 147667
Helen Mitchell 020 7216 7411 Mobile: 07834 328512
Laura Dawson 020 7216 7338 Mobile: 07725 245838
Myles Langstone 020 7216 7335 Mobile: 07834 626206
- The Association of British Insurers is the voice of the UK’s world leading insurance and long-term savings industry. A productive, inclusive and thriving sector, we are an industry that provides peace of mind to households and businesses across the UK and powers the growth of local and regional economies by enabling trade, risk taking, investment and innovation.
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