Government sets out Solvency II reform package

Reforms cut risk margin and overhaul eligibility rules for matching adjustments

Jonathan Stapleton
clock • 5 min read
The government noted the most challenging element of the debate had been about the matching adjustment
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The government noted the most challenging element of the debate had been about the matching adjustment

The government has set out its final reform package for the regulation of insurance companies in the UK following its consultation on the review of Solvency II.

In its consultation response, published by HM Treasury today (17 November), the government said it would introduce a "simpler, clearer, and much more tailored regime".

In particular, it said it would cut the required risk margin significantly, with a 65% cut for long-term life insurance business.

It said it would also increase investment flexibility by overhauling eligibility rules for the matching adjustments.

And the government pledged to "slash red tape lingering from the EU", which it said imposes "unnecessary burdens on firms, restricting innovation in our vibrant market".

The government said it had decided not to take forward the Prudential Regulation Authority‘s proposals for reform of the so-called "fundamental spread" and would maintain the existing methodology and calibration, while allowing for the use of notched ratings, for example, different allowances for assets rated AA+ or AA- compared with AA.

The government's response said: "[This package of measures] will enable insurers to invest tens of billions of pounds in long-term productive assets and will help to spur an internationally competitive insurance sector, while retaining high standards of policyholder protection."

The government noted the most challenging element of the debate had been about the matching adjustment - including both its eligibility requirements and the fundamental spread component.

It said that having considered a wide variety of different views, it has concluded that the eligibility requirements for the matching adjustment should be broadened to allow the inclusion of assets with highly predictable cashflows, subject to a number of safeguards which the PRA will implement.

Reaction

The insurance and long-term savings industry welcomed the Solvency II reform.

ABI director general Hannah Gurga said: "We strongly welcome these changes to the Solvency II regime which will allow the UK insurance and long-term savings sector to play an even greater role in supporting the levelling up agenda and the transition to Net Zero.

"Meaningful reform of the rules creates the potential for the industry to invest over £100bn in the next ten years in productive finance, such as UK social infrastructure and green energy supply, whilst ensuring very high levels of protection for policyholders remain in place.

"More broadly, it will encourage a thriving and competitive industry which will ultimately benefit the UK economy, the environment and customers. This meets the objectives that HM Treasury set out to achieve and which the industry has supported throughout."

ABI president and Royal London Group chief executive Barry O'Dwyer added: "We all want to see an insurance sector that maintains the highest standards of policyholder protection and also contributes significant investment into UK assets and infrastructure that will benefit our customers, the environment and wider society.

"This has always been our goal and with these proposed reforms, we can achieve that ambition. The industry will continue to work closely with the government, the PRA and other stakeholders as we move towards implementing the changes."

In particular, the ABI said it welcomed the proposed reduction to the risk margin by 65% for life insurers and 30% for non-life insurers - saying it agreed with the PRA's view that the risk margin was too large and sensitive to interest rates and considered the changes proposed address both these issues.

 The ABI said it was also pleased to see proposals to broaden the asset and liability eligibility criteria for the matching adjustment - noting this would allow industry to invest in a wider array of assets and also enable relevant insurers to include morbidity liabilities in matching adjustment portfolios.

And it said it supported the government's announcement that the design and calibration of the fundamental spread will remain as it is today. It said this will lead to less volatile annuity prices and ultimately provide a more stable income for UK pensioners.

Aviva group chief executive Amanda Blanc agreed the reforms were "a very welcome boost for UK investment".

She said: "We estimate reforms to Solvency 2 will allow Aviva to invest at least £25bn over the next ten years across the UK, including in critical areas such as social housing, schools, hospitals and green energy projects."

Phoenix Group chief executive Andy Briggs added: "The proposed reforms to Solvency II announced today present a very significant opportunity to ensure more private sector capital can be directed by insurers into the real economy and ensure we better mobilise the UK's £3.4trn of pension wealth.

"These regulations are an important component of the changes needed to the wider UK investment landscape which will enable Phoenix to meet its ambition to invest more in the future. Phoenix plans to invest £40-50bn in illiquid assets and sustainable investments over the next five years to support house building, green energy, and local communities across the country without compromising policyholder protection in any way."

The consultation

The government originally published its Solvency II consultation on 28 April 2022, a consultation which closed on 21 July 2022.

It sought views on the following proposals:

  • releasing capital by changing the calculation of the risk margin and cutting the risk margin substantially, including by 60-70% for long-term life insurers in recent economic conditions;
  • reforming the fundamental spread of the matching adjustment
  • unblocking long-term productive investment by making it easier to include a wider range of assets in matching adjustment portfolios
  • reforming reporting and administrative requirements to reduce EU-derived burdens.

In total, the consultation received 67 responses. These included responses from life insurers, general insurers, and composite insurers, as well as consultancies, industry groups, and members of the public.

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