As part of the UK Government’s review of Solvency II, a ‘Call for Evidence’ was published in October 2020. The Call for Evidence closed in February 2021. The insurance industry has been waiting for the results of the feedback to the Call for Evidence which was finally published on 1 July 2021.
The Call for Evidence asked for views and evidence from respondents on ten areas of the regime for review which were: the risk margin, the matching adjustment, the calculation of the Solvency Capital Requirement, the calculation of the consolidated group Solvency Capital Requirement using multiple internal models, the calculation of the Transitional Measure on Technical Provisions (TMTP), reporting requirements, branch capital requirements for foreign insurance firms, thresholds for regulation by the Prudential Regulation Authority (PRA) under Solvency II, mobilisation of new insurance firms (i.e. barriers for new market entrants) and risk-free rates: transition from LIBOR.
Respondents were strongly supportive of the Solvency II regime, commenting that the regime had overall improved risk management and reporting in the insurance sector. There was evidence from the industry that the current regime, however, was overly rigid and could be made more proportionate. There is a desire on the part of the Government for the UK insurance industry to provide more long-term capital to the economy, including investments that align with the UK Government’s objectives for climate change.
Summary of the responses and Government comments:
- There was consensus that the risk margin is currently too high and too volatile. There are unforeseen consequences in a low interest rate environment. The Government therefore thinks that there is a strong case for reform of the risk margin.
- The eligibility of different asset classes with different characteristics for the matching adjustment will be a key determinant for insurance firms’ provision of capital into the UK economy. The Government believes that the application process for the matching adjustment needs to be proportionate to benefits and risks, allowing firms to invest quickly in assets that are eligible. Reforms to the matching adjustment need to be informed by the credit and other long-term risks that firms are exposed to. Many firms expressed support in principle for a matching adjustment, particularly in enabling firms to write annuities to reflect only the market risks they are exposed to.
- The Government agrees with responses proposing reforms to the framework for the calculation of the Solvency Capital Requirement. Any changes must ensure that the framework does not place a disproportionate burden on firms.
- A majority of firms supported the removal of branch capital requirements for foreign firms and proposed the recognition of home state supervision.
- The reporting framework should be streamlined to avoid it being too onerous and should avoid duplication between different reports.
- Clarity is needed to support the transition from LIBOR to Overnight Indexed Swap rates. A number of firms responded to say that they wanted clarity on the transition as soon as possible.
The responses to the Call for Evidence will determine the areas for reform. The Government has asked the PRA to model different options to reform. To support the development of these options the PRA will launch a quantitative impact study (QIS) in the summer. A comprehensive package of reforms will be published for consultation in early 2022.
The changes to Solvency II must be aligned with wider changes being considered to the UK financial services framework after Brexit.