In a speech at the ABI, Sam Woods, Executive Director of insurance supervision at the PRA took the opportunity to ‘bust two myths’ about the approach to capital under Solvency II that the Bank of England will take. First, the idea that the Bank is planning to use Solvency II to increase required capital across the sector and, second, that the regulator intends to recreate the current ICAS regime under the guise of Solvency II.
Woods dismisses market concerns that the PRA will use Solvency II to increase levels of capitalisation or ‘load the sector’ with more capital in preparation for the new regime stating clearly that ‘there is no such plan’. The PRA believes that the current regime secures an appropriate level of capitalisation and means the insurance sector is in a good position to shift to Solvency II.
Addressing the second myth, Woods explains that Solvency II will be the foundation of the PRA’s approach and the regulator will fulling embrace the change that accompanies the new regime. The EU is moving towards a harmonised, risk-based, transparent and ‘going concern’ regime, which means some significant changes to the shape of the balance sheet and the PRA’s assessment of financial resources. Woods notes that the risk margin in particular is a fundamentally new component of the UK regulatory framework and the source of some tension. Regardless of the debate around the risk margin and its calculation, it is part of the Solvency II legislative framework and, therefore, the PRA must implement it accordingly.
Having dealt with the myths, Woods goes on the assure firms that they will be given plenty of time to adjust to the new regime and that those firms who wish to make use of transitional measure will be given the freedom to do so. The PRA advocates an ‘orderly transition’ which will promote financial stability and support the regulator’s objectives of safety and soundness and policyholder protection.
According to the PRA, the Solvency II Directive sensibly includes transitional measures which allow firms significant breathing space as they adapt to the new regime. Woods explains that the Bank will allow full use of transitional measures by those firms that qualify to use them and that, consistent with the approach being taken across Europe, the transitional asset created by the transitional deduction from technical provisions (TDTP) will qualify as Tier 1 capital. Woods argues that there needs to be a shared understanding of the practical details about how transitional measures will operate in order for them to achieve their purpose. The PRA will be working with firms to ensure transparency in the way in which transitionals apply including how measures might apply to books of business that are subject to a Part VII transfer, and the frequency with which some measures need to be re-calculated.
On the process of internal model approvals, it is the PRA’s intention that, following a thorough and consistent review of firms’ applications, final decisions on all models will be made and communicated to firms in early December.
View PRA speech: Adapting to Solvency II, 9 July 2015