Sam Woods, Deputy Governor for Prudential Regulation and Chief Executive Officer (CEO) of the UK’s Prudential Regulation Authority (PRA), has proposed changes to the design of risk margin in Solvency II rules, which he has suggested are currently too sensitive to the level of interest rates.
In a letter to Nicky Morgan MP, Chair of the UK Treasury Committee, Woods claimed that the risk margin in Solvency II guidelines was too high given the current low levels of interest rates, particularly for long-dated insurance contracts such as annuities.
Whilst transitional measures have off-set the risk margin for business written before Solvency II, Woods said that Prudential was becoming increasingly concerned by the significant proportion of longevity risk from newer annuity business that is being reinsured offshore in response to the level of risk margin.
However, he also acknowledged that supervisory reviews had not “brought to light significant immediate concerns about the way in which that reinsurance is being conducted.”
Similarly, he stated that “it does not appear that Solvency II is having a detrimental impact on policyholders via annuity prices, the dominant drivers of which continue to be risk-free interest rates and corporate bond spreads.”
Woods proposed that reviewing the supervisory approach regarding the use of future risk mitigation and transfer mechanisms may offer a solution to the issue of risk margin, but said that such an approach would be complicated by uncertainty surrounding the UK’s situation following Brexit.
He stated: “In the context of the ongoing uncertainty about our future relationship with the EU in relation to financial services we do not yet see a durable way to implement a change with sufficient certainty for firms to be able to rely on it for pricing, capital planning and use of reinsurance.”
In February 2018, Woods revealed at the annual conference of the Association of British Insurers (ABI) that PRA and the UK Treasury were consulting on an extensive Solvency II reform package that more closely considered the effects of regulation on policyholders.
