As trailed by John Glen MP, Economic Secretary to HM Treasury, in his speech earlier this year (see UK Solvency II reform – the picture sharpens), the Treasury has now launched an eagerly-anticipated consultation containing its proposals for reform of the UK’s version of Solvency II. The consultation provides further clarity over the government’s thinking on Solvency II reform. 

The package being proposed by HM Treasury could reduce some insurers’ regulatory capital requirements. It includes the following key elements:

• a cut of around 60-70% in the risk margin for long-term life insurers; 
• a change to the methodology used to calculate the matching adjustment to ensure that insurers fully cover the credit risk on the assets they hold in their matching adjustment portfolios;
• a broadening of the criteria for assets which insurers can include in their matching adjustment portfolios. This would allow for the inclusion of assets with prepayment risk (e.g. callable bonds and commercial real estate lending, to name but two) and assets with construction phases; and
• an extension to the range of liabilities eligible for matching adjustment portfolios to include products that insure against morbidity risk, such as income protection products. 

Although much will depend on the business models and balance sheets of individual insurers, the Treasury has suggested that its proposals could result in a material release of as much as 10% or even 15% of the capital currently held by life insurers. While this would provide some flexibility to insurers, any significant release of regulatory capital is likely to raise questions about whether policyholders, including pension scheme trustees, would continue to be protected and the safety and soundness of firms assured. 

Pension scheme trustees will no doubt be interested in the possible impact on pricing for bulk annuity and longevity transactions. All things being equal (and we do live in very unpredictable times), including a competitive market for this business, we would expect pricing to improve, although whether this will be by a material amount is currently unclear. Another possible impact is that UK insurers decide to retain longevity risk and maybe even write pure longevity business (so far the preserve of reinsurers) themselves, the latter given both the reduction in risk margin and the cashless nature of longevity.

Responses to both the Treasury’s consultation and the PRA’s related discussion paper are requested by 21 July 2022. A detailed technical consultation is expected to be published by the PRA later in the year, presumably once it knows which aspects are destined for its rules.

On the basis of this consultation taking place at the end of 2022 and running for three months, we would not expect implementation before Q3 2023 (and maybe well after).

Trustees who are currently considering de-risking transactions will clearly want to consider the impact of the proposed changes on their selected insurer and take advice from their covenant advisers. However, subject to that, the existence of the consultation should not prevent trustees from continuing to take steps to de-risk their schemes and better protect members’ benefits.

For further details around the key changes proposed by HM Treasury, please see our Summer edition of Investor Agenda, which covers this development in depth.