Solvency II with crème anglaise: More sweat?

While the EU’s Solvency II (SII) review pursuits its course in the Union, the UK Treasury also pulled the starting gun for its own, and now separate, review. On 19 October 2020, HM Treasury published a call for evidence in its follow-up announcement from June. This call for evidence is the first stage in the British review of SII. HM Treasury explains that this call for evidence is a targeted review of the regulatory approach taken under key aspects of the UK’s SII regime. But a broader review will also take place. Separately, it continues, “the Government is conducting a long-term review – the Future Regulatory Framework (FRF) Review – to determine how the overall framework for financial services regulation will need to adapt to the UK’s position outside the EU. The FRF Review will examine the allocation of regulatory responsibilities between Parliament, HM Treasury and the financial services regulators.”

As for the SII review, the objectives of the British review are to ensure that SII “properly reflects the unique structural features of the UK insurance sector. By design, the current regime is tailored to the EU insurance sector as a whole but, in several important ways, the UK insurance sector is different.” The review will be guided by three objectives: (1) to ensure a vibrant and prosperous insurance sector, (2) to provide long-term capital to support growth, and (3) to uphold high standards of policyholder protection and promote the safety and soundness of firms.”

The HM Treasury review emphasises potential areas for reform of SII that could not only improve the efficiency and effectiveness of the application of the UK prudential regulatory regime, but also allow it to better recognise the unique features of the UK insurance sector. “As a result, households and businesses should benefit from a wider choice of competitively priced products and services and the Prudential Regulation Authority should have the tools that it needs to supervise the safety and soundness of the UK insurance sector.”

The deadline for responses is 19 January, 2021. In terms of the next steps, there may be need for further analysis by the PRA, including whether changes to the PRA’s rules should be considered. If so, and where appropriate, the PRA would consider that further, more technical, consultations would be appropriate. Other proposed changes may require legislation. The UK Government will set out how the reforms will be taken forward in its response to the call for evidence and will consult further if necessary. No further timeline is given.

There are 10 areas for review in the call for evidence. These are (1) the risk margin (no surprise), (2) the matching adjustment, (3) the calculation of the SCR (both the standard formula and the internal model calculation), (4) the calculation of the group SCR using multiple internal models, (5) the calculation of transitional measures on technical provisions, (6) (supervisory and public) reporting requirements, (7) branch capital requirements for foreign insurance firms, (8) the threshold for regulating non-directive firms, (9) the mobilisation of new insurance firms and (10) the risk free rate change from LIBOR – which will cease to be published end 2021 – to overnight indexed swap rate. The call for evidence closes its list of 28 questions on the above ten points with a last question asking for comments on other areas of SII which may be appropriate for inclusion in the review.

A few observations:

• The review is underpinned by three objectives, one of which is “to support insurance firms to provide long-term capital to underpin growth, including investment in infrastructure, venture capital and growth equity, and other long-term productive assets, as well as investment consistent with the Government’s climate change objectives.” The MA area makes the link to sustainable finance. And in the area ‘calculation of the SCR’ the call refers to the SCR as a logical place for insurance firms to allow for climate change-related risks. It adds that “the one-year time horizon on which the SCR is based may not be well suited for long-dated risks such as those arising from climate change, which may not become apparent for many years.” But it leaves it open to respondents to suggest further areas for improvement such as on certain asset risks (see in the intro the reference to the UK ‘s “patient capital’ gap);
• The fundamentals of SII are there to stay. What about the reference to the SCR which “may not be well suited for long-dated risks such as those arising from climate change”?
• With exception of the issue of the supervisory reporting requirements, nearly all areas for review relate to pillar 1: capital requirements;
• There is no governance-related area in the list, although the rationale to put the SCR calculation in the list seems to suggest that there should be more scope for supervisory judgement and link between Pillar 1 and 2;
• There is no reference to the data used for the standard formula risk module calibrations, some of which arguably do not fit the UK market;
• Given the EU’s broad indication that the SII regime should enshrine more proportionality, the area “mobilisation of new insurance firms” which HM Treasury put on the list should invite for further debate, also in the EU. Because new insurance firms that are expected to exceed the SII minimum size thresholds within five years and which subsequently are subject to the full application of SII from the point of authorisation, HM Treasury argues that such outcome may not be proportionate for ‘start-up’ insurance firms and may discourage new entrants in the sector. “There may be scope to improve the mobilisation of new insurance firms.”

The UK review promises an interesting discussion, and seems to focus on a few quick wins. But it is certainly one to watch especially in terms of competition (and possibly, but not necessary, equivalence).

For the UK SII review: Call for evidence, click here

Lieve Lowet