Following the UK’s departure from the European Union (Brexit) on December 31, 2020, the UK Regulator is now exercising its freedom to move away from fundamental EU insurance prudential regulatory standards. These moves include liberalisation of the EU Solvency II regime to release hundreds of billions of pounds of regulatory capital from UK insurers’ balance sheets. In the UK, the reformed Solvency II regime has been coined ‘Solvency UK’.
The Government published its initial Solvency II consultation on 28 April 2022. The consultation closed on 21 July 2022 and the Response can be found at https://www.gov.uk/government/consultations/solvency-ii-review-consultation
The Prudential Regulation Authority (PRA) issued a press release on 29th June 2023 stating “The Prudential Regulation Authority (PRA) is consulting today on a major set of reforms to Solvency II with the aim of creating a new UK regulatory regime for insurance firms, known as Solvency UK, which is better adapted to the UK insurance market. The proposals include further streamlining of reporting requirements for all firms and substantially simplifying and improving the flexibility in the assessment of internal models. They will also foster new entrants into the UK insurance market by easing entry of new firms and simplifying the regulation of international insurers operating through branches.
Sam Woods, CEO of the PRA said: “These measures will reduce bureaucracy, facilitate competition, and support UK economic growth and competitiveness without lowering prudential standards or weakening policyholder protection.”
A link to the Consultation Paper can be found at https://edu.bankofengland.co.uk/prudential-regulation/publication/2023/june/review-of-solvency-ii-adapting-to-the-uk-insurance-market.
The PRA’s stated objectives are:
- Simplifications and process improvements to the calculation of the transitional measure on technical provisions (TMTP) to reduce costs and complexity for firms including the costs involved in retaining legacy Solvency I models, while ensuring firms plan effectively for the end of these transitional measures in 2032.
- A new, streamlined set of rules for internal models (IM) where these are used by insurers to calculate their capital requirements, designed to maintain robust standards while reducing the number of prescriptive requirements firms have to meet under the current framework. Instead, the focus will be on the application of supervisory judgement on a smaller number of more principles-based requirements.
- Greater flexibility for insurance groups in the calculation of group solvency requirements to provide more flexibility in the development of group IMs.
- The removal of certain requirements for branches of international insurers operating in the UK, to facilitate entry/expansion and competition and the international competitiveness of the UK insurance sector.
- The streamlining and removal of reporting requirements that the PRA considers are not needed for the UK insurance sector, to increase proportionality and reduce complexity.
- A new ‘mobilisation’ regime to facilitate entry and expansion for new insurers and to facilitate competition, and the international competitiveness and growth of the UK insurance sector.
- An increase to the size thresholds at which small insurers are required to enter the Solvency II regime, to increase proportionality for smaller or newer insurance firms.
Summary proposed amendments
Risk Margin: The risk margin is an additional reserve required to be maintained by an insurer above its best estimate of liabilities (BEL) and below its solvency capital requirement (SCR). The risk margin is currently calculated using a ‘cost-of-capital’ approach, which is set at 6% for both life and non-life firms.
Matching Adjustment (MA): The MA benefits insurers who hold long-term assets that match the cash flows of similarly long-term insurance liabilities, by allowing them to recognize upfront as capital part of as-yet-unearned future cashflows by means of illiquidity premium.
The PRA’s overall consultation plans for the Solvency II review
In addition to the 29th June CP, a second CP planned for September 2023, which will cover reform proposals for life insurers relating to investment flexibility and the matching adjustment (MA), including to eligibility rules, new attestation requirements and certain changes to its calculation, and reporting. The overall scope of reform areas covered by these two tranches is consistent with those areas originally covered by the Solvency II review in 2022, and outcomes as set out in the Government’s response to its Solvency II review consultation. Through these two consultations in 2023, and the PRA’s intention (subject to feedback) to publish final policy following this CP around the end of 2023, the PRA considers that firms will have a good sense of how the PRA expects the new regime to operate by that point, and so can begin to prepare for implementation and adapt their plans as they wish.
The insurance industry will welcome progress on the new Solvency UK regime with an ambitious timeline for implementing the reform in phases, starting with Risk Margin changes, by the end of 2023. Firms should read the proposals carefully and could now start the process of quantifying the impact of the reform on their solvency capital requirements, and the likely significant release of regulatory capital to enable investment and growth.