The shape of the government’s package of reform to the UK version of Solvency II is becoming clearer, with the Economic Secretary to the Treasury, John Glen MP, describing key aspects of its proposals at a recent dinner of the Association of British Insurers. 

Solvency II – the prudential framework that governs UK-regulated insurers – was originally an EU regime, but it was carried across into UK law broadly unchanged following the UK’s exit from the EU. The intention was that the government would subsequently review Solvency II, with a key goal of ensuring that it is optimised for the UK market. 

While HM Treasury’s October 2020 Call for Evidence and July 2021 response document provided some insight into the government’s thinking on Solvency II reform, John Glen’s speech to the ABI last month seems to herald a new phase in the review process. Not only does the speech itself contain a fair amount of information on the government’s proposals (“quite a lot to digest,” Glen quipped, “particularly over dinner”), it also delivers the news that the government will launch a full consultation document next month, with a PRA technical consultation to follow later in the year.

The speech underscores the government’s commitment to reducing the size of the risk margin (a prudential resource which insurers must hold on their balance sheets in addition to the assets backing their ‘best estimate’ insurance liabilities and their regulatory capital requirements). Although he does not describe the mechanics, Glen comments that this would result in a cut of around 60 to 70% in the size of the risk margin for long-term life insurers – the first indication of quantum that the government has given on this topic. He also says that the government’s proposals on the risk margin will reduce pro-cyclicality and cut incentives to reinsure longevity risk offshore. 

Another key area for reform is the matching adjustment (which is notably utilised by annuity providers and provides some capital relief where there is sufficient matching between asset and liability cash-flows). Here, the government will look to widen eligibility requirements for assets and liabilities in matching adjustment portfolios and revisit how credit risk is treated in the MA calculation. 

The overall impact of the package on the sector’s regulatory capital position is not yet clear. It is possible that a reduction of capital requirements in some areas (e.g. the risk margin) will to some extent be balanced out by an increase in others (e.g., potentially, the MA calculation) and, of course, a great deal will hang off the business models and balance sheets of individual insurers. However, Glen does indicate that he expects there to be a capital release of “as much as 10% or even 15% of the capital currently held by life insurers”. This, he says, would allow them to “put tens of billions of pounds into long-term productive assets”, chiming with another key objective of the review – to support insurers to invest in long-term assets such as infrastructure. 

The release of significant amounts of regulatory capital by the sector would, of course, be a matter of interest to policyholders, including pension scheme trustees, who will want to remain assured of the safety and soundness of the institutions with which they deal. On that point, Glen emphasises that the government is confident that its reforms will safeguard policyholder protection, the overall level of which will remain “very strong”. With its focus on promoting the safety and soundness of firms and ensuring policyholder protection, the PRA’s views on the appropriateness of any capital release are also likely to be influential. 

While John Glen’s speech has started to sharpen the picture, many of the details still need to be filled out. It is likely to become clearer still when the government launches its consultation in the next few weeks.