Many industry commentators see post-Brexit Solvency II reform as an ’opportunity’ for insurers and shareholders, but could it leave policyholders paying higher prices? Insurance Times investigates… 

UK regulators and the government came under fire in February 2022 for potentially exposing insurance policyholders to higher premiums following the latest updates to the proposed post-Brexit Solvency II reform, which aims to unlock capital to support the UK’s infrastructure.

One subscriber to this view is former FCA board member Mick McAteer, who is now a co-director at think tank the Financial Inclusion Centre (FIC), as reported by the Financial Times.

McAteer believes the Solvency II reform could weaken consumer protections and that regulators should debate the possible implications before finalising a deal. He thinks that although changes to Solvency II are attractive to insurers - because it could generate higher fees and provide a windfall to shareholders – this could be at the expense of policyholders.

Introduced in January 2016, Solvency II is a European Union (EU) legislative programme that sets out regulatory requirements for insurance firms around financial resources, governance and accountability and risk assessment. Striving to codify and harmonise EU insurance regulation, Solvency II primarily deals with the amount of capital that EU insurance companies must hold to reduce the risk of insolvency.

In February 2022, member of parliament and economic secretary to the Treasury, John Glen, proposed plans to overhaul Solvency II to capitalise on Brexit and make sure that national regulation was tailored to the UK.

This followed an announcement by prime minister Boris Johnson in January 2022, which revealed plans to fast-track a new Brexit Freedoms Bill, to end the special status of EU law in the UK.

Speaking at the ABI’s annual dinner on 21 February 2022, Glen said: “EU regulation doesn’t work for us anymore and the government is determined to fix that by tailoring the prudential regulation of insurers to our unique circumstances.”

The changes that Glen wishes to implement centre around three main components of Solvency II include:

  • The risk margin.
  • The matching adjustment.
  • The reporting and administrative burden of the regime.

Although Glen described the reform as a “genuine opportunity” to grow an innovative and vibrant insurance industry, some voices in the sector believe that reform ramifications might not be that simple.

Fit for purpose regulation

For the ABI’s head of prudential regulation, David Otudeko, reforming Solvency II is a “once in a lifetime opportunity to have a fit for purpose regulatory regime for the UK” that enables the insurance sector to contribute more investment back into national infrastructure.

Otudeko told Insurance Times: “Independent analysis indicates that with appropriate reforms, up to £95bn could be released for this purpose.

“Protection for policyholders should, of course, remain at the heart of everything we do, but the changes that are being discussed will still ensure the industry can withstand an extreme one-in-200-year shock.”

Gerry Goodwin, director of sales at data firm Dufrain, also views the Solvency II reform as an industry-wide investment opportunity.

“There is opportunity there – it’s just who is best set up to take advantage of it? In our experience, it’s the [firms] that have better control over their data – that’s the asset that all these companies have,” Goodwin said.

But Martin Mankabady, partner in the corporate insurance team at Eversheds Sutherland, said insurers with excess capital due to the Solvency II reform might return it to shareholders, use it to write more business, or simply spend it rather than looking at infrastructure investment.

“M&A activity in the insurance industry is already high. A whole market capital release is likely to drive activity levels even higher,” he warned.

Consumer Intelligence’s chief executive Ian Hughes is also cautious about reform results.

He said: ”If insurance providers were to face an event as significant as the global pandemic again, many could find themselves hamstrung without the necessary capital available to pay out claims, creating yet another scandal and leaving consumer trust obliterated.”

Matching adjustment

Despite market-wide appetite for the Solvency II reform, Otudeko noted that its matching adjustment (MA) provision ”has worked as intended” so far, meaning that ”any changes to it need to be fully justified and need to avoid introducing unintended consequences – such as bringing volatility on to insurers’ balance sheets, with associated risks to wider financial stability”.

The MA provision gives insurers relief for holding certain long-term assets that match the cash flows of a designated insurance portfolio.

However, Otudeko added that under the current rules for the MA framework, it is harder for firms to invest in renewable energy or the infrastructure that is needed to help the UK meet its target of being carbon neutral by 2050.

Henry Dean, senior associate for financial services at Eversheds Sutherland, warned: “Insurers will need to be careful that the restructuring of their investments doesn’t have a negative impact on the value of their portfolios and the market.”

Dean explained that if all insurance firms look to acquire long-term assets at the same time, there is a risk of price inflation for more desirable assets.

Equally, if insurers collectively exit the bond market in search of higher yields elsewhere, there is a risk of price inflation for less desirable assets too.

On the flip side, the formula that’s used to calculate Solvency II’s risk margin is “overly sensitive to interest rates and forces insurers to hold capital worth billions over and above the prudent amount needed to meet obligations to customers”, Otudeko said.

Preferred changes

The ABI believes that additional capital arising from the Solvency II reform should be used to support the UK government’s Levelling Up agenda, as well as the country’s drive to net zero.

Johnson’s Levelling Up campaign aims to reduce economic imbalances between areas and social groups in the UK.

Otudeko continued: “The ABI’s preferred changes to the regime will also be helpful to reduce the large volume of private reporting insurers are required to make to regulators which, as they stand, reflect the varying needs of all EU member states and have increased by up to eight times the amount that was required in the UK before the introduction of Solvency II.”

Impacting customer trust

Gerry Goodwin, director of sales at data firm Dufrain warned that significantly reducing reporting requirements could impact consumer trust.

customer service

The proposed changes which were developed by HM Treasury alongside the Prudential Regulation Authority (PRA) to Solvency II include:

  • More sensitive treatment of credit risk in the matching adjustment.
  • A significant increase in flexibility to allow insurers to invest in long-term assets, such as infrastructure.
  • A meaningful reduction in the current reporting and administrative burden on firms.

Goodwin said: ”At the highest level, being able to say ’this is the risk we have got across our portfolio and this is the capital we need to cover it’ is a really positive thing.

”One of the benefits that came out of Solvency II was more control over your business. The market has got used to that level of information – if you take it away, trust is impacted.”

Ian Hughes, chief executive of market research firm Consumer Intelligence, believes that Solvency II changes could work to improve customers’ trust in the insurance sector, however, because consumers generally want to buy from ethical companies that make long-term investments in the world.

Communicating this message to successfully boost customer trust and the industry’s reputation would ”come down to the strength of a brand’s marketing and storytelling capabilities,” he added.