The UK government and the Bank of England are reforming insurers’ capital rules, seen as a post-Brexit test of the UK’s willingness to “unleash” the City of London after leaving the European Union.
Reforms could potentially free up billions of pounds to invest in infrastructure to boost growth and help Britain meet net zero climate targets.
Treasury Secretary Jeremy Hunt could unveil changes on Thursday as part of his fiscal statement. But Hunt could be constrained by the collapse in UK government bond markets in September following his predecessor’s mini budget, which hit pension funds hard. This could curb Hunt’s appetite for radical change.
WHAT RULES ARE WE TALKING ABOUT?
The EU’s Solvency II rules were introduced for insurers in 2016, after years of debate, when Britain was still a member of the EU.
They are designed to ensure that insurers hold enough capital to remain stable and able to make payouts on policies.
Insurance companies and UK lawmakers see the rule reform as a major “Brexit dividend” now that the UK is free to write its own rules.
Insurers have already complained that EU rules are too restrictive, prompting them to move business abroad and tying up billions of pounds of capital that they don’t need.
“Today we would have to hold less regulatory capital to invest in a coal mine than we would in a wind farm, which we don’t think is right,” said Mike Eakins, chief investment officer of life insurance company Phoenix. PHNX.Lreferring to the Solvency II regime of the EU.
WHAT HAS BEEN DONE SO FAR?
A draft Financial Services and Markets Bill is awaiting Parliament’s approval, which will, among other things, give the Bank of England the power to amend Solvency II.
The bank has already discussed potential changes that it says would free up £45-90 billion ($53.65-$107.30 billion) of investment capital. Insurers say this doesn’t go far enough, but the BoE has said the reform should not become a “free lunch” that puts pensioners’ and policyholders’ money at risk.
The Treasury Department is trying to broker a deal, but it is unclear whether it will override the BoE. Following the UK government bond turmoil in September, the government is trying to reassure markets that the UK financial system is stable and that regulators are independent.
WHAT WILL THE REFORMS CHANGE?
There are three main elements.
The first is the risk margin, which acts as a capital buffer when an insurer takes over policies from another insurer that has run into trouble. It was costly when interest rates – and investment returns – were at historic lows, as it meant insurers had to hold more capital to pay for future policies. That burden has fallen with higher rates.
Consensus is emerging on this plan, but it will have less impact due to the rise in interest rates since the reforms were proposed.
The second element involves easing reporting requirements, broadening the range of assets insurers can invest in and adjusting the way insurers’ internal capital models are approved. There is general agreement on this.
The third and final element is reforming something called the matching adjustment (MA), where agreement has proven difficult.
WHAT IS THE MATCHING ADJUSTMENT?
The MA helps ensure that insurers’ assets generate enough cash in the coming years to cover payouts on policies and pensions.
By investing in assets that generate cash at the right time, an insurer can recognize some of that return upfront and reduce capital requirements.
But there is a “haircut” or discount – known under the rules as a “fundamental spread” – that limits how much capital can be knocked off.
The BoE favors a bigger haircut. It also wants the MA to regularly reflect changes in market prices for the asset.
Insurers want a much quicker response from regulators when seeking approval of whether an investment should benefit from capital reduction.
HOW DOES LDI FIT INTO IT?
Funds that offer commitment-based investments (LDI) are also used by retirement funds to help match assets with payouts. The funds threatened to collapse in September when they could not get collateral fast enough to cope with the collapse of UK government bonds.
Regulators argue that the painful lessons from the LDI turmoil are having an impact on MA, meaning caution should be key to any reforms.
“The recent LDI crisis has undoubtedly taken certain politicians and regulators in parts of the market by surprise,” said Eakins.
He said it shouldn’t affect the Solvency II reform, but others might disagree.
“It shouldn’t have any impact as LDI is completely separate from matching-correction. I think the reality is people might say, ‘shouldn’t we be looking at financial services regulation more broadly?'”
WHAT ABOUT THE EU?
The EU is also updating its Solvency II rules, but is ahead of Britain. The European Parliament and the member states approve the latest changes. The BoE has said its own package would free up more capital than the proposed changes to the bloc.
($1 = 0.8388 pounds)
(Reporting by Huw Jones; Editing by Jane Merriman)
Carriers Europe Uk
Interested in Brexit?
Receive automatic notifications for this topic.