UK government sets out final reform plan for Solvency II

UK chancellor of the exchequer Jeremy Hunt last week (17 November 2022) set out his plans for the economy in his Autumn Statement, via a speech to Parliament.

Contained within the statement was backing for the Treasury’s Review of Solvency II consultation response, which was also published on 17 November.

In its consultation response, the government said it hoped the final package of Solvency II reform measures would “spur a vibrant, innovative and internationally competitive insurance sector” and “support insurance firms to provide long-term capital to support growth”.

Announcing his plans to Parliament, Hunt said: “We are publishing our decision on Solvency II, which will unlock tens of billions of pounds of investment for our growth enhancing industries”.

The consultation response confirmed that the government would legislate to reduce the risk margin for general insurance businesses by 30%, as well as introduce a modified cost of capital approach for this calculation.

Current Solvency II regulation requires insurers to hold a solvency capital ratio (SCR) of at least 100%, meaning they must hold eligible assets in reserve to the value of 100% of what they could be liable to lose over the next year.

The government’s plan to lower this threshold by 30% would mean that insurers would only be required to hold a SCR of 70%.

The consultation response added that the government would maintain the existing methodology and calibration of the fundamental spread - which forms part of the calculation determining how much assets are worth or rated - and broaden the matching adjustment eligibility criteria to include assets with highly predictable cash flows.

Currently, the matching adjustment provision gives insurers relief for holding certain long-term assets that match the cash flows of a designated portfolio.

The government also outlined additional powers it would provide to the Prudential Regulation Authority to regulate insurers.

These include providing the regulator with the ability to seek assurance on firms’ internal ratings and require changes and adjustments where appropriate.

Additionally, the government said it would introduce a new mobilisation regime for insurers and “at least double” the premium and reserve thresholds before Solvency II applies.

The consultation response explained: “By choosing to retain some aspects of the package within legislation, the government is providing insurers with the required regulatory certainty to make long-term productive investments.

“The government is confident that this package and implementation plan delivers on its objectives, setting the UK up for success with a tailored and stable regulatory regime.”

A precise timetable for the planned changes has yet to be confirmed, however. The consultation response simply stated: ”The government will legislate as necessary to implement this new regime.”

Solvency II explained

Solvency II is a European Union (EU) directive retained in UK law that regulates the insurance industry and requires firms within the sector to hold a certain amount of capital to reduce the risk of their financial collapse.

The UK government took aim at the retained EU regulations with its Financial Services and Markets Bill, published in June this year. The bill allowed the UK government to repeal EU laws in a move that it believed would increase the competitiveness of the UK financial sector.

By amending Solvency II requirements, the UK government aims to unlock millions of pounds for investment – ministers hope that by relaxing the amount of capital required to be held in reserve, UK insurance companies will be able to use the freed capital to make investments in the UK’s growth.

Industry reaction

Commenting on the news that reform to the Solvency II regime had been confirmed, Hugh Savill, senior advisor at risk and regulation consultancy Sicsic Advisory, said: “The Treasury’s announcement about the Solvency II review will unlock billions of pounds of much needed investment by insurers in infrastructure projects and adaption to climate change.

“It is big progress in terms of what the insurance industry has been hoping and making the case for.”

Savill added that while the decision to leave the fundamental spread unchanged was “highly technical”, it was also “hugely significant”.

He recommended: “Insurers should ensure that they have the governance and skill set to take advantage of the new flexibilities.”

Aviva’s group chief executive, Amanda Blanc, added: “This a very welcome boost for UK investment.

“We estimate [that reform] to Solvency II will allow Aviva to invest at least £25bn over the next 10 years across the UK, including in critical areas such as social housing, schools, hospitals and green energy projects.”

Necessary plans?

Despite the government steaming ahead with plans to amend the Solvency II regime, research from GlobalData published in November 2022 showed that five of the UK’s top 10 general insurers – Aviva, Axa, Allianz, AIG and Admiral – all operated with SCRs of at least 145.7% in 2021.

Only two of the 139 insurers analysed in GlobalData’s database had SCRs between the current 100% requirement and 110% last year, with the rest holding higher amounts of capital in reserve.

This data shows that insurers are not generally crying out for lower capital requirements, as the majority of them exceed minimum capital requirements by some stretch.

Ben Carey-Evans, senior insurance analyst at GlobalData, said: “Rules that allow [insurers] to invest even more of their capital are not an urgent requirement, as insurers could invest considerably more than they are at present if they wanted to.”