As part of its review into Solvency II, the UK Government is planning to reform risk margin rules once the transition period with the EU has ended.
Back in June, the government said it would review Solvency II ahead of the December 31st transition deadline to make sure all rules were “properly tailored” to the UK re/insurance sector.
Now, it has confirmed that it intends to work with the PRA to “reform the risk margin” after Brexit, which it believes “can be improved to better meet its objectives, without reducing policyholder protection.”
The risk margin is an extra layer of capital that re/insurers must hold against some kinds of long-term business, such as annuities.
Its purpose is to ensure that an insurer has sufficient resources to either raise capital to restore its solvency position, or to transfer liabilities to a viable third party, even when under stress.
However, the UK Government acknowledged that the rule has been contentious within the UK industry, with some analysts raising concerns about the size and volatility of the risk margin as it is currently designed.
For instance, the PRA has previously noted that the risk margin has been larger than anticipated for life insurance firms.
“Reform could reduce the volatility and pro-cyclicality of insurance firms’ balance sheets and enable them to increase the choice and affordability of products available to businesses and households,” the government’s review stated.
“It could also release additional resource over the medium-term which insurance firms could use to provide long-term capital to support growth, including investment in infrastructure, venture capital and growth equity, and other long-term productive assets.”
UK re/insurers currently remain tied to all of the EU’s rules as they are set out under Solvency II, but after December 31st the government will be free to amend the rules as it sees fit.
The move to reform risk margins will likely be welcomed by UK life re/insurers, who have had to deal with most of the complications that have accompanied these rules.
But for other re/insurance sectors with a more international customer base, the departure from EU guidelines could be a concern.
Commercial insurers in particular may be nervous about what this move away from regulatory equivalence could mean for their cross-border business.
The London Market Group (LMG) has previously been very vocal in urging the government to seek regulatory equivalence with the EU after Brexit, and says there is “little appetite” amongst its members for regulatory upheaval.
That said, analysts at Peel Hunt noted that any changes to the Solvency II model will not have an immediate impact.
“UK Life insurers already enjoy significant capital relief in the form of, for example, transitional measures (TMTP), which allows a phased increase in life reserves between 2016 and 2032, and helps the UK Life industry adapt to SII,” Peel Hunt observed.
“This does, however, mean that Life new business has a high capital strain and as the back book unwinds and is replaced by new business, capital requirements will gradually increase. ”
The PRA has also emphasised that it still broadly backs the Solvency model and said that not all investment assets would qualify for re-investment, indicating there will be a review of investment assets to ensure an adequate reallocation of capital into those areas that protect policyholders.