to encourage a vibrant, innovative, and internationally competitive insurance sector
to protect policyholders and ensure the safety and soundness of firms
to support firms in providing long-term capital to foster growth, including investment in infrastructure, venture capital and growth equity, and other long-term productive assets, as well as investment consistent with the Government’s climate change objectives.
Following HMT’s consultation paper on Solvency II reform in the UK, two key consultation papers have been released by the PRA thus far in 2023.
Review of Solvency II: Adapting to the UK insurance market (CP12/23)
On 29 June, the Government published the first of its two consultation papers, CP 12/23. The Prudential Regulation Authority (PRA)’s proposals and the key benefits covered by this consultation are:
Simplifications and process improvements to the transitional measure on technical provisions (TMTP) calculation so as to reduce costs and complexity for firms. Also to make sure firms plan effectively for the end of these transitional measures in 2032.
Who benefits? The 24 life insurance firms that currently have TMTP approval and any firm that is granted TMTP permission in the future after accepting business that already benefits from TMTP.
A new, streamlined set of rules for internal models (IM) where these are used by insurers to calculate their capital requirements.
Who benefits? All insurers that already have IM approval from the PRA, and those that may consider applying for permission in future.
Greater flexibility for insurance groups in calculating group solvency requirements. This in turn would provide more flexibility in the development of group IMs and allow a better reflection of underlying risks.
Who benefits? Any UK insurer for which the PRA is group supervisor.
The removal of certain requirements for branches of international insurers operating in the UK, to facilitate entry or expansion and the international competitiveness of the UK insurance sector.
Who benefits? The 130+ branches of international insurers that currently operate in the UK across a range of business models. This includes general insurance firms that operate in the wholesale London insurance market and reinsurance firms.
The streamlining and removal of reporting requirements that the PRA considers unnecessary for the UK insurance sector, to increase proportionality and reduce complexity.
Who benefits? All insurers, to varying extents.
A new ‘mobilisation’ regime, to facilitate entry and expansion for new insurers and encourage the international competitiveness and growth of the UK insurance sector.
Who benefits? Firms that are thinking of applying for authorisation as an insurer in the UK, now or in the future.
Solvency II reporting thresholds
The final benefit, and perhaps of most interest to those at the lower end of the UK insurance market, relates to thresholds for Solvency II reporting. The Government has recently withdrawn several proposed audit and corporate governance reforms. CP 12/23 also raises the size thresholds at which small insurers – including many mutuals – are required to enter the Solvency II regime. So it’s welcome news that the PRA still seems committed to the principle that smaller insurers are not burdened with onerous and disproportionate compliance costs.
Solvency II thresholds would be permanently switched from euros to pounds sterling. Those relating to gross written premiums would increase from €5m to £15m, whilst thresholds relating to an insurer’s gross technical provisions would increase from €25m to £50m.
These changes would likely affect nine firms currently within the Solvency II reporting regime, whilst also giving smaller insurers room to grow without fear of being caught by the rules. These nine firms would, in the future, have the option to operate under the non-directive firm (NDF) sector rules.
Interestingly, if the GWP or technical provisions thresholds were increased further to £20m and £75m respectively, eight more firms would likely have the option to operate under NDF rules. The PRA is keen to emphasise its aim for balance and proportionality throughout. This is why the new £15m and £50m thresholds were chosen.
Whilst all insurance firms will always have the option to report under Solvency II rules, the PRA considers that the proposals would mean a more proportionate approach to the regulation of small firms, supporting their ability to grow and compete in UK insurance markets.
Matching adjustment proposals
The PRA launched the second consultation paper in September, CP 19/23, which specifically covers reforms to the matching adjustment (MA).
These proposals have three broad objectives: to improve business flexibility; to be more responsive to the level of risk; and to increase firms’ responsibility for risk management.
Improving business flexibility
This aims to give firms more latitude for their investment portfolios. One example is widening the range of investments which qualify for MA (which might include assets with ‘highly predictable’ cash flows, rather than just fixed cash flows). Another is expanding the types of insurance business which may claim MA, and allowing more MA to be claimed from sub-investment grade (SIG) assets.
Being more responsive to the level of risk
The PRA aims to establish a streamlined MA application process for a range of suitable assets. This would vary according to risk, and would make the regulatory treatment of breaches of MA conditions more proportionate, so providing for more flexible and appropriate consequences. This reform aims to remove the ‘cliff-edge’ effect of losing the MA completely. Finally, the granularity of the fundamental spread would be increased, improving its risk sensitivity when used to calculate technical provisions.
Enhancing firms’ responsibility for risk management
Firms would be allowed more flexibility in various measures, while the PRA would be more responsive to the level of risk. That means more onus on firms to stay on top of risk management. This would take the form of an MA benefit attestation process, clarifying risk expectations for management of SIG assets, formalising data submissions on MA assets and liabilities, formalising requirements for internal credit assessments, and ensuring MA eligible firms demonstrate compliance with the Prudent Person Principle.
Legislative changes already passed
By way of an early Christmas present, HMT has recently passed legislation bringing in to law some of the key changes proposed in HMT’s initial consultation. Most notably, the proposed reforms to the risk margin calculation have been passed, as has removal of the requirement to produce the Regular Supervisory Report (‘RSR’). Both of these are effective for the 31 December 2023 year end.
The consultation comment periods are now closed. So the proposals contained in CP 12/23 and CP 19/23 are likely to be implemented for 31 December 2024 year ends. Although affected firms may incur some initial costs, the PRA expects the long-term reduction in compliance costs to substantially outweigh these.
If you would like advice on any of the issues raised in this article, please contact James Randall.