The UK has announced changes to its Solvency II regime that will help insurers free up capital but raise concerns over policyholder protection.\r\n\r\nAnnouncing the changes as part of his much-anticipated Autumn Statement, Chancellor of the Exchequer Jeremy Hunt said the reforms will distance the UK\u2019s capital adequacy regime from the EU\u2019s Solvency II. Although Solvency II is under review at EU level, with similar changes put forward in draft proposals.\r\n\r\nHunt predicted that changes in the UK will \u201cunlock tens of billions of pounds of investment for our growth-enhancing industries\u201d.\r\n\r\nIn particular, the new UK regime will reduce the risk margin by 65% for life insurers and 30% for non-life insurers. The risk margin ensures insurers hold sufficient assets to transfer their liabilities to another insurer. Its reduction tackles concerns that the risk margin inherited from the EU\u2019s Solvency II regime was too large and sensitive to interest rates.\r\n\r\nThe UK will also increase the range of asset and liability eligibility criteria for the matching adjustment under Solvency II, which will allow insurers to invest in a broader range of assets.\r\n\r\nAnd in response to concerns raised by insurers that reform of the fundamental spread would increase regulatory capital requirements, the UK government has confirmed that its design and calibration will remain unchanged. The fundamental spread is the expected cost of default and downgrade of assets that back annuities.\r\n\r\nOther changes designed to cut red tape and reporting requirements include the removal of branch capital requirements for foreign firms and a doubling of the premium and reserve threshold for companies before Solvency II applies.\r\n\r\nThe UK\u2019s consultation on Solvency II reforms, which began in April 2022, is reported to have caused a tussle between HM Treasury and the Bank of England\u2019s Prudential Regulation Authority (PRA), which is responsible for policyholder protection. The UK government reminded the PRA that under its proposed Financial Services and Markets Bill, which will repeal retained EU laws, both the PRA and the Financial Conduct Authority will also have competitiveness and growth objectives.\r\n\r\nThe government made clear the split between the lawmakers and regulators in its response to the Solvency II consultation. \u201cThe most challenging element of the debate has been about the matching adjustment, including both its eligibility requirements and the fundamental spread component,\u201d the Treasury said. \u201cThere has been no consensus on the best approach on reform of the fundamental spread,\u201d it added. But the UK government ultimately rejected the case for reform, including proposals from the PRA.\r\n\r\n\u201cAlthough the government has decided not to take forward the PRA\u2019s proposals for reform of the fundamental spread, the government recognises the importance of policyholder protection. With this in mind, the government recognises that the rules set out in legislation must work in close combination with supervisory tools held by the regulator,\u201d it said.\r\n\r\nIt assured the PRA that the regulator will have powers to hold insurers to account and maintain policyholder protection. It announced several new measures to help deliver this. These include regular stress tests for insurers to measure their resilience to PRA scenarios. There is also a new requirement for insurers to nominate a senior manager to attest that the level of fundamental spread on their firm\u2019s assets is sufficient and reflects all retained risks.\r\n\r\n\u201cThe government also supports the PRA in expecting that at all times insurers will apply high standards of risk management and will cooperate fully with the PRA in the use of these supervisory tools,\u201d it said.\r\n\r\nThe government has asked the PRA to \u201ckeep use of the matching adjustment under close scrutiny\u201d, while review of the calibration of the fundamental spread will take place in five years.\r\n\r\nEarlier in the Solvency II consultation process, insurers made clear\u00a0that the draft proposals could in fact increase capital requirements and fail to realise the objective of freeing up more capital for investment.\r\n\r\nBut welcoming the confirmed changes, Association of British Insurers (ABI) director general Hannah Gurga said the reforms are \u201cmeaningful\u201d and could potentially release at least \u00a3100bn in the next ten years for investment in social infrastructure and green energy. Gurga added that the new regime will \u201cencourage a thriving and competitive industry\u201d.\r\n\r\nBarry O\u2019Dwyer, ABI president, argued that the changes to the Solvency II regime will maintain the highest standards of policyholder protection.\r\n\r\nAmanda Blanc, chief executive of Aviva, said: \u201cThis is a very welcome boost for UK investment. We estimate reforms to Solvency II will allow Aviva to invest at least \u00a325bn over the next ten years across the UK, including in critical areas such as social housing, schools, hospitals and green energy projects.\u201d\r\n\r\nTrevor Jones, head of insurance at KPMG UK, said insurers could unlock up to \u00a335bn of surplus capital from changes to the risk margin. \u201cThe government\u2019s reforms on Solvency II are a strong step in the right direction for the insurance sector. The changes strike a sensible balance to enable additional investment and improve internal competitiveness, while ensuring the regulator has sufficient powers to scrutinise decision-making and the protection of policyholders,\u201d he said.\r\n\r\nMoody\u2019s analyst Will Keen-Tomlinson said the UK\u2019s changes to the Solvency II regime will be \u201cmoderately positive\u201d for insurers\u2019 earnings but could lead to lower levels of capitalisation.\r\n\r\n\u201cThe existing calibration of the fundamental spread together with the reduction in the risk margin will trigger a modest release of capital, which insurers can return to shareholders or use to take additional risks,\u201d he said.