The United Kingdom’s HM Treasury has announced that it plans to review Solvency II rules for insurers and reinsurers ahead of the Brexit transition end on 31 December 2020.
The government said that the review would ensure that Solvency II is “properly tailored” to take account of the structural features of the UK re/insurance sector.
It will consider areas that have been the subject of long-standing discussion, such as risk margin, the matching adjustment, the operation of internal models and reporting requirements.
Analysts at Morgan Stanley noted that the risk margin could be the most impactful area of change, as the current design is felt to be inadequate by both the industry and the PRA.
“The principal flaw with the risk margin is the combination of a fixed cost of capital (6%) and a swaps based discount rate – which has the impact of inflating the risk margin when yields are low,” they explained.
Prudential Regulation Authority (PRA) CEO Saw Woods has similarly said in the past that “the current design of the risk margin is too sensitive to the level of interest rates, and it is therefore too high at current low levels of interest rates.”
However, given the current practice of annuity writers heavily reinsuring longevity risk on new business in order to mitigate the risk margin, Morgan Stanley believes a substantial design change is likely to be necessary in order to have a material impact on the industry.
Since the implementation of Solvency II, the majority of new business has seen longevity risk reinsured offshore, and it is possible that a new regime could aim to reduce this.
The European Commission is conducting its own review of Solvency II, which is delayed to the end of December 2020 due to the COVID-19 pandemic, but will likely cover much of the same ground.