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PRA review aims to tailor Solvency II for the UK market

11th February 2021 - Author: Matt Sheehan

The Prudential Regulation Authority (PRA) has confirmed that a post-Brexit review of Solvency II guidelines will aim to tailor the rules specifically for the UK re/insurance market.

accounting imageThe UK Government has committed to a review of the European Union’s Solvency II regulatory requirements for re/insurance firms now that it is no longer a member state of the EU.

The PRA has previously suggested that the review could result in changes to the design of risk margin in Solvency II rules, which are currently seen as too sensitive to the level of interest rates.

And now, Anna Sweeney, Executive Director of Insurance at the PRA, has confirmed that “the top level goal of the review is instead to tailor a regime based on those principles to the UK market.”

That said, the PRA maintains that it is broadly looking to uphold the principles of Solvency II, as it sees little appetite to fully dispense with the rules given how much UK re/insurers have already invested in implementing the regime.

“Tailoring will mean reforms to specific aspects of the regime that are not well-designed or imperfectly calibrated for the UK, and are currently distorting incentives and behaviour,” Sweeney explained, adding that the risk margin is probably the most prominent example.

“The risk margin formula is too sensitive to interest rates, and when rates are low it is higher than it need be to fulfil its purpose,” she said. “And this has driven a misallocation of capital, away from longevity risk, a misallocation which is relentlessly increasing as volumes of business not covered by transitional measures grow.”

Moreover, Sweeney noted that the PRA is not looking to either decrease or increase the total capital in the sector, claiming there is no persuasive evidence that currently levels are too high or too low.

“I recognise that there is an opportunity cost to higher regulatory capital: capital that supports the risks in existing business cannot also be used to support acquisitions or expansion into innovative fields. But price is not the same as value,” she went on, concluding: “I do not believe that we have that balance badly wrong at the moment.”

However, analysts at RBC Capital Markets believe that Sweeney’s statement “points to a reduction in capital requirements” following the Solvency II review.

“While she mentions no change in capital requirements this is common for a regulator to give the other side when launching a consultation,” RBC noted, adding that responses to the Treasury’s call for evidence are expected to “uniformly stress why a reduction in the risk margin is appropriate for UK insurers.”

In previous comments, RBC has similarly argued that the PRA will reduce the risk margin, which has resulted in off-shoring £9bn of profits since 2016.

“We expect a change in 2022 which would allow UK insurers to once again retain longevity risk, as they did pre-2016, meaning they would not have to pay away a margin to non-European reinsurers,” RBC stated. “A winding back of the rules also means a one-off gain to book values in respect of business written pre-2016. This gain could be used to strengthen balance sheets, pay dividends, or be reinvested in
businesses, creating future earnings for years to come, in our view.”

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