Solvency II reforms confirmed: Budget 2022

HM Treasury has today published its plans for reforming Solvency II, which it hopes will 'unlock tens of billions of pounds' in investment by UK insurance companies.

Related topics:  solvency II,  autumn statement,  solvency uk,  insurance
Commercial Reporter
17th November 2022
HMRC Government

The consultation, launched in April, proposed to reform the capital requirements for insurance companies, which the government said would reduce 'red tape' from the EU and allow insurers to invest in infrastructure and green projects.

It asked how a reduction in insurers’ risk margin would impact policyholders and their level of protection, along with their effect on insurers’ decisions surrounding investment and pricing.

Driving the reformed legislation, to be known as Solvency UK, was the need for the UK’s financial services regulatory framework ‘to adapt’ to our new position outside the European Union.

Four proposals were considered as part of the consultation:

1.     Releasing capital by changing the calculation of the risk margin and cutting the risk margin substantially, including by 60-70% for long-term life insurers in recent economic conditions

Almost all respondents to the consultation said the current risk margin was ‘far larger than is necessary to fulfil its purpose’ of protecting policyholders.

The review said there was also broad consensus that cutting the risk margin for long-term life insurance business by 60-70% would increase insurers fund and improve balance sheet stability.

The government’s response to consultation will include legislating as necessary to reduce the risk margin for long-term life insurance business, including Periodic Payment Orders, by 65% and for general insurance business by 30%, under recent economic conditions and to enable a modified cost of capital approach to its calculation.

Policyholders will remain protected by the requirement for insurers to hold enough capital to withhold a 1-in-200-year shock.

2.     Reforming the fundamental spread of the matching adjustment

As there has been no consensus on the best approach for reform on this proposal, it has decided to leave the design and calibration of the fundamental spread as it stands. However, it will increase the risk sensitivity of the current fundamental spread to allow allowances to be made within major credit ratings.

3.     Unblocking long-term productive investment by making it easier to include a wider range of assets in matching adjustment portfolios

The proposal regarding eligibility for matching adjustment will be broadened as a result of the consultation to allow the inclusion of assets with highly predictable cashflows.

4.     Reforming reporting and administrative requirements to reduce EU-derived burdens

The government will work the Prudential Regulatory Authority to reduce the burden of reporting and administrative requirements – including streamlining approval requirements for firms’ internal models and allowing the PRA to exercise more supervisory judgement in assessing firms.

In July, the Association of British Insurers criticised elements of the planned reforms as needing 'further work', noting:

“The current proposals would not achieve the suggested release of 10 to 15 per cent of capital for reinvestment. Life insurance firms would have to hold more capital than currently required, preventing them from being able to provide the funds that are needed for investment across the UK.”

“Increases in capital are also not costless. Rather they are paid for by customers through lower returns and by society through less investment in productive assets.”

Simon Youel, head of policy and advocacy at Positive Money, commented:

“September’s pension fund chaos was a warning sign of the fragility of our financial sector. Despite the Chancellor’s rhetoric about prioritising ‘stability’, this government is signalling it intends to push ahead with its reckless deregulatory agenda for the City of London.

“The government has swallowed the insurance industry’s spin that deregulation via Solvency II reform will unlock tens of billions of pounds to invest in the economy. Not only is there little reason to think that insurers will take advantage of deregulation to suddenly change course towards productive or socially useful investment rather than increasing share buybacks or dividends, it’s also unclear how much capital they actually have to spare.

“We shouldn’t be relying on risky deregulation to increase investment in energy and infrastructure, which will only cost the public more in the long-run. We need public investment to take a leading role in upgrading our economy.”

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