Solvency II reform: UK gov expands on ‘ambitious and innovative’ reform agenda

Economic Secretary to the Treasury, John Glen MP, has expanded on the government’s plans to reform Solvency II, unveiling “ambitious and innovative” plans in a speech at the Association of British Insurers Annual Dinner.

Solvency II has long been the backbone of the insurance industry, underpinning the regulatory framework for insurers since 2016. However, since the UK’s withdrawal from the European Union, the UK government has been keen to overhaul the framework to better suit UK markets. As Glen pointed out, Solvency II was “developed to reconcile insurance markets for 28 different countries in the European Union” – he added that “this never worked well for us”. Looking ahead, following Brexit, the government is looking to make a change.

What are the Solvency II reforms?

In his speech, Glen sets out an overarching goal for to government’s reforms to Solvency II. That goal is:

“To replace what is an EU-focused, rules-driven, inflexible and burdensome body of regulation… with one that is UK-focused, agile and easily adaptable. A body of regulation which facilitates, not hinders, market developments… which encourages the emergence of new types of assets… which supports the entry of new and innovative firms… and which, importantly, allows the release of meaningful amounts of capital for productive investment.”

When broken down, these reforms, which aim to make the UK insurance sector “even more dynamic, prosperous and internationally competitive” comprise 4 different elements:

1. A substantial reduction in the risk margin

Long-term life insurers would see the risk margin cut by around 60-70% under Solvency II reforms.

2. Reassessment of the fundamental spread used to calculate the matching adjustment

The government would look at alternative methodologies to improve the treatment of credit risk while avoiding the introduction of material volatility to balance sheets.

3. Introducing greater flexibility to facilitate an increase in investments in long-term assets

Solvency II reforms would look to broaden the range of eligible assets for the matching adjustment portfolio, expanding it to include assets” with the option to change the redemption date. This would include removing the “disproportionately severe” treatments of assets with ratings below BBB, though firms would still be expected to meet the Prudent Person Principle. The reforms would also look to provide flexibility around how assets that lack historical data are treated.

4. Reducing reporting and administrative burdens by reducing EU-derived regulatory obligations

The government will look to reform reporting requirements and introduce a mobilisation regiment for new insurers. In particular, reporting requirements would see exemptions given to new insurers, reduce the frequency of reporting and remove others entirely.

What will happen next for Solvency II?

In his speech, John Glen MP announced that the government will endeavour to publish a s full consultation document on fundamental spread reforms by April 2022, which will put forward detailed proposals underpinned by supporting analysis.  

CUBE comment

Over the last few years, the insurance sector has felt the sting of increased regulatory obligations and regulator scrutiny in turn. For many, Solvency II and the associated strict regulatory framework for insurance was a much-needed development. With it, it brought enhanced consumer protections, a more tapered approach to risk, as well as a modernised approach to insurance, bringing it into line with the developing wants and needs of society. For others, increased regulations have been a painful task in administration, reformed practices, and risk analysis.

It’s clear from Glen’s speech that the government is keen to relax Solvency II to free up investments, allowing – it hopes – billions of pounds to be pumped back into society – perhaps into renewable energy or social housing. On the face of it, this is a cause for good however, this relaxation of the rules could also mean a relaxation of consumer protections.

As it stands, the reforms will likely be an attractive proposal for those in the insurance sector, especially those with a UK customer base. There is the concern, however, that reforms designed to compliment UK markets may prove onerous for insurers and reinsurers with a more global reach. Whether these reforms will also be at the detriment of policyholders and consumers is another question.

It is interesting to hear the government talk of regulatory reform with little or no collaboration with the regulators themselves, an element that has not gone unnoticed by some. Indeed, many in the industry are calling for greater public and regulatory scrutiny of Solvency II reforms before anything is given the go-ahead. Hopefully the government is not putting political priorities ahead of what is genuinely best for insurance firms and their consumers. We await the results of the government consultation with bated breath.