Government reforms to Solvency II could potentially increase the price of bulk purchase annuities (BPAs) depending on the final changes implemented, the industry says.
HM Treasury published its consultation on Solvency II reform on 28 April this year. At the same time, the Prudential Regulation Authority (PRA) published a statement on the reform alongside a discussion paper on potential reforms to risk margin and matching adjustment within Solvency II.
Both the Treasury's consultation and the feedback period on the PRA's discussion paper close today.
The Treasury said its proposed reforms to Solvency II could reduce risk margins for insurers as well as allow them to invest in a broader range of assets. In addition, it said it was also considering reform to the so-called "fundamental spread" - the deduction to investment return assumption that insurers use to calculate the matching adjustment in their portfolios.
Consultants said the changes being considered will impact insurer pricing for bulk annuities - but added that the nature of the impact was dependent on the final changes agreed.
Mercer partner Andrew Ward welcomed the consultation on Solvency II reform as "once in a generation opportunity" to ensure the insurance regime is fit for purpose and strikes the right balance between protecting policyholders and supporting investment in productive assets - but noted the government had to get this right.
He said reform should have an eye on the wider impact on defined benefit (DB) schemes - noting that BPA pricing could either increase or reduce depending on the precise changes to the risk margin and fundamental spread agreed, adding the impact could also differ between insurers.
He said: "Broadly speaking, the consultation suggests a reduction in the risk margin, which should improve pricing although this impact may be less significant than the increase in fundamental spread, particularly for insurers that reinsure longevity risk.
"Therefore, the net impact on pricing may be that buyout becomes less affordable despite what some press commentary has suggested."
Ward said the changes could either discourage or encourage new entrants into the buy-out market, depending on where the consultation lands.
He added: "Despite most of the focus of Solvency II reform being on the insurance industry, given the potential change to buyout affordability it may have significant knock-on impacts for DB pension schemes' funding and investment strategies."
Ward said it was also important that the Treasury considers ensuring that the form and type of illiquid, private market assets which pension schemes might ideally like to hold in the run up to buyout are considered as potential eligible assets for insurers.
In a note to clients in June, Hymans Robertson partner Michael Abramson also noted the reforms may not be positive for bulk annuity pricing as some in the industry first thought.
He said: "We should raise the possibility that, overall, the reforms actually increase the level of capital required for some insurers, which would increase both pricing and member security.
"This will vary from insurer to insurer, noting that for new business, insurers may be able to amend their investment strategies in order to avoid any increase in pricing."
No revolution needed
In its response to HMT's proposals on Solvency II reform, the Institute and Faculty of Actuaries (IFoA) said it believed the PRA had "justifiable concerns" over aspects of the current fundamental spread methodology but added it did not believe the "revolution in approach" proposed in the consultation was appropriate.
The IFoA said its response had considered how adjustments could be made to the existing fundamental spread methodology, in an "evolution" of the current regime - addressing some of the PRA's concerns around risk sensitivity and better reflecting the characteristics of different asset classes.
IFoA president Matt Saker added: "It is really important to find an appropriate fundamental spread methodology if the new Solvency regime is to meet the government's ambitions to increase the insurance industry's investment flexibility.
"We believe our response and our research address the Treasury's wider objectives to provide a prudent regulatory regime, foster innovation and competitiveness, provide policyholder protection and release long-term infrastructure and green investment."