Solvency UK is born: Treasury announces divergence from Solvency II rules
Insurance Insurance market insight Solvency II
On 22 June 2023 HM Treasury published draft regulations (here and here) outlining proposed changes to the calculation of the risk margin, matching adjustment and fundamental spread for UK insurers.
The announcement also contained clues about the future shape of the “Solvency UK” regulatory regime.
These changes, once implemented, will represent the first material deviations between the UK and EU on insurance regulation since Solvency II was introduced in 2016.
The key points are:
- Risk margin: Cost of capital rate reduces from 6% to 4%, cutting risk margins across the industry by approximately 30%. In addition, life business benefits from a risk taper that reduces the risk margin further for long-term liabilities. These changes are due to be introduced by December 2023, so insurers will be able to take advantage of them in their year-end 2023 returns.
- Matching adjustment / fundamental spread: This is less relevant to general insurers and the regulations do not appear to go as far as the November 2022 consultation. The main change is a slight easing of requirements for assets to have fixed cashflows, provided that assets with uncertain cashflows are a limited proportion of the total matching adjustment portfolio and do not compromise the quality of matching. The introduction date is expected to be (no later than) June 2024.
- Signaling of future changes: The accompanying press release from HM Treasury indicates that the Government intends to remove the vast majority of the Solvency II regulations from the statute book, and replace them with (initially very similar) prescriptions in the PRA rule book. This will make regulatory change simpler in the future, potentially allowing the PRA to be more responsive to requests from the market.
What do the changes mean for insurers?
Key actions for insurers
The key change for general insurers is the risk margin cost of capital rate reduction from 6% to 4%, expected to take effect from December 2023. We recommend that insurers consider:
- Updating SCR and TP calculations to reflect new parameters and assessing the impact of change on TPs and SCR coverage.
- Making plans for how to deploy additional surplus capital.
- Assessing any changes to pricing and reinsurance strategies.
Changes to the matching adjustment and fundamental spread are less likely to be directly relevant to general insurers. However, we recommend that those with life-like liabilities (eg PPOs and income protection) continue to monitor for further developments, as future legislative changes may bring these into scope.
Overall, we are pleased to see the Treasury acting on feedback from the industry, but had hoped to see these reforms go further.
What was missing from the announcement?
The draft legislation published by HM Treasury is narrow in scope and omits the following areas that were discussed in previous consultations:
- Plans to reduce the regulatory reporting burden, for example by simplifying or scrapping some of the QRTs.
- A simplified internal model approval framework to give smaller insurers more control over their capital.
- Further detail regarding the matching adjustment and fundamental spread.
When might we expect more changes?
The press release accompanying the draft legislation suggests that the Treasury plans to remove the statutory basis of the Solvency II regime and migrate the rules to the PRA rule book, by December 2024. This would:
- Make the approach to Solvency UK consistent with the way other rules (such as the Senior Managers’ Regime) are implemented.
- Give the PRA significantly more scope to amend regulations which are ineffective or causing market distortions. The PRA may be more inclined to do so in the future, given that the Financial Markets and Services bill will soon give it a secondary objective of ensuring the competitiveness of the UK financial services sector.
Our view is that regulatory changes omitted from these draft regulations have not been forgotten and may well be implemented by the PRA once Solvency II has been migrated into the PRA rule book in 2024.
Wasn’t the EU making SII changes of its own?
Yes – in 2022 the EU separately advanced similar (but different) plans to reform the risk margin, matching adjustment and fundamental spread. These changes would not have automatically affected the UK post-Brexit.
The legislation that would implement these changes has stalled because of a lack of consensus amongst members of the European Parliament’s Committee on Economic and Monetary Affairs. There is no clear timescale for implementation at this stage and a risk of significant delay beyond the next European Parliamentary elections.
As a consequence, firms with both UK and EU operations may see significant divergence in the risk margins (and matching adjustments) between these entities in the coming years.
