Sam Woods, Chief Executive Officer of the Prudential Regulation Authority, sees no appetite to tear up the basic principles of Solvency II given the huge investment made in their adoption.
The PRA had previously suggested that the Solvency II 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.
During a speech given at the Association of British Insurers, Woods described Solvency II as having broadly served the UK well – as evidenced by the resilience of the country’s firms during the pandemic to date.
However, in Woods’ view the regime is somewhat over-specified and in need of tailoring, particularly on the Life side.
“It is common ground between us that the risk margin is not correctly calibrated, resulting in levels of offshore reinsurance of longevity risk in the provision of UK retirement income that will become increasingly uncomfortable over time if we take no action,” Woods said.
“The risk margin will come down from current levels, and become less volatile. But for us risk margin reform in isolation is not synonymous with discontent about the overall levels of capital in the system.
“We have not seen persuasive evidence that this is either too low or too high: I discussed the health of returns on equity briefly earlier; nor do I see evidence of current capital requirements meaning that demand for insurance goes unmet.”
Woods added that, while whole balance sheet modelling is fundamental to understanding the risk profile of large insurers, amidst all the detail and complexity of Solvency II internal models risk being precisely wrong.
“We need more explicit sanity checks and a conversation about resilience to big, plausible risks – the kind of conversation that should be a cornerstone of the relationship between the PRA and regulated firms at board level,” he added.
“And we need ways to ensure that we recognise that while some areas are relatively easily modelled, others are not. I suspect that these basic, common sense points have got somewhat lost in the wake of the detailed, bottom-up model development and approval processes prescribed by Solvency II.”