UK post-Brexit reform of Solvency II will limit not free up capital, argues ABI

The Association of British Insurers (ABI) believes the UK government’s plan to reform Solvency II, reduce capital requirements and therefore free up investment in key areas such as infrastructure and the transition to net zero will not work as it stands. The ABI issued its strong statement after Nadhim Zahawi, Chancellor of the Exchequer, tabled the Financial Services and Markets Bill on Wednesday, which is intended to boost the post-Brexit competitiveness of the nation’s financial services industry, while still maintaining internationally respected standards. Some experts have labelled the UK government’s planned reform of Solvency II “reckless” and fear that a focus on promoting London to attract and retain more capital and compete with EU finance centres such as Paris and Frankfurt could ultimately lead to a financial meltdown similar to the credit crisis of 2007-2008. But the ABI focused on the details of the reform proposals and actually believes the plans would require life insurers to hold even more capital to cover potential liabilities, thus reducing investment and having the opposite effect of what is intended. “Progress is being made but more work is needed to realise the benefit of the reform,” stated the insurer association. “The insurance and long-term savings industry has today submitted its response to the government’s consultation on Solvency II, the insurance and long-term savings industry’s prudential regulatory regime, setting out how the current reform proposals would not realise the opportunity to release more capital for investment,” stated the ABI. “A key government objective in reforming Solvency II includes the ambition to support insurance firms to ‘provide long-term capital to support growth, including investment in infrastructure’. Reform of Solvency II is a significant opportunity to tailor regulation to the specific needs of the UK. If we get reform right, it will benefit customers – upholding the highest levels of global standards to protect them – supporting the levelling up of our economy and boosting the transition to a greener UK,” continued the association. The ABI stated that its own analysis, and that of independent technical experts, suggests that the current proposals would not achieve the suggested release of 10%-15% of capital for reinvestment. It said life insurance firms would actually have to hold more capital than currently required, preventing them from being able to provide the funds that are needed for investment across the UK. “Increases in capital are also not costless. Rather they are paid for by customers through lower returns and by society through less investment in productive assets,” argued the ABI. The association said it welcomes many of the changes already proposed. Risk-margin reform and broadening the eligibility of liabilities and assets to benefit from the ‘matching adjustment’ (a provision that allows insurance firms to adjust the relevant risk-free interest rate term structure for the calculation of a best estimate of a portfolio of eligible insurance obligations) will widen the portfolio of projects that insurers can invest in. This should increase UK investment in much-needed areas, while also allowing more diverse investment portfolios that ultimately improve policyholder protection, said the ABI. But it also pointed out that any positive benefits will be “more than offset” by the adverse consequences of the proposed reforms to the ‘fundamental spread’ – the expected cost of default and downgrade of assets that back providers' annuity business and that firms are therefore exposed to. “We have listened carefully to the Prudential Regulation Authority (PRA) on the crucial issue of the calculation of the matching adjustment. However, the burden of proof for reform, which could increase regulatory capital requirements and operational complexity but reduce capital resources, would need to be extremely strong, and we have seen no evidence that would justify taking such measures,” stated the ABI. The reform process has only just formally begun and is yet to be debated by MPs in parliament, so the ABI hopes there is still time to correct the proposals. It said it remains committed to working with HM Treasury and the PRA to develop a final set of proposals that “meet all of our objectives and enable the UK to seize this unique opportunity for the benefit of the UK economy, the environment and customers”. Hannah Gurga, ABI director general, concluded: “We all want to see reform of the Solvency II regime that works best for the needs of the UK and enables investment at a crucial time. The insurance and long-term savings industry could invest more capital to help level up the UK, boost the economy and support the transition to net zero. The current proposals do not realise that opportunity and would risk penalising pension customers as a result of the increased costs associated with the proposed reforms. We are committed to working with the government and the PRA to find a solution that meets all of our objectives.” The ABI is not the only insurance market representative body that will have its say in the development of these critical reform proposals. The London & International Insurance Brokers Association (LIIBA) said it would like to see a sharper focus on enhancing the competitiveness of the UK insurance market post-Brexit. LIIIBA CEO Christopher Croft said: “The London market is the leading global centre for commercial risk and reinsurance, but other international centres are snapping at our heels and doing business in the UK is increasingly seen as having a greater burden of regulatory costs. Government legislation for a regulators' competitiveness objective is welcome but will only work if matched by a strong culture, capacity and capability in the regulator. We would like to see the legislation include a requirement for metrics to be set and reported on by the regulators, to incentivise and track concrete action on competitiveness.” UK risk and insurance management association Airmic has not formally commented on the reform proposals but has argued for some time that it could offer an opportunity to create a new and less onerous captive regime in the UK. Back in February, Airmic issued a statement in response to the initial reform proposals debated by the House of Lords, which argued that the creation of a separate regulatory regime for captives outside a revised Solvency II could allow the UK to develop as a captive domicile. Airmic expressed its support for a new regulatory regime for captives in the UK but argued that “such an environment would only be appealing if it exists outside of Solvency II”. It cited the example of the successful bifurcated regulatory regime in Bermuda, the largest captive domicile in the world. Bermuda’s commercial insurance regulation has Solvency II equivalence, while its captive classes of insurer (Class 1, 2 and 3) remain governed by a separate risk-based framework, pointed out the association. Airmic added that its members currently make good use of captives in established jurisdictions around the world that tailor their solvency regimes and regulations to the unique profile of captives. Under Solvency II, this is currently very hard to do in the UK as proportionality is rarely and inconsistently applied, as it is across Europe. Airmic said in its submission: “A risk-based solvency regime would recognise that a captive insurer that writes only the first-party exposures of its parent is not a risk to the wider financial system or consumers.” The London Market Group (LMG), the body that represents the London insurance market, also told the House of Lords committee that UK insurance regulation that is “appropriate to the solvency risks of the insurer” would benefit the competitiveness of the London market and the creation of captive insurers. The UK implementation of Solvency II, which many argue was “goldplated”, has meant a disproportionate regulatory and compliance burden that raises costs and makes the UK less competitive, the LMG argued.

UK post-Brexit reform of Solvency II will limit not free up capital, argues ABI

Airmic likely to push for UK captive regime

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