Hustle from Brussels: the UK’s race to bid Solvency II adieu
Westminster is raring to revoke EU-based rules that have deterred insurers from investing in its flagship projects. Will deregulation put firms and their policy-holders at greater risk?
The UK insurance industry is poised for a shake-up that’s likely to release tens of billions in investment for government projects aimed at building greener infrastructure and advancing Boris Johnson’s “levelling up” policy.
Westminster wants to clear away numerous regulatory obstacles – a legacy of EU membership – that have hitherto dissuaded pension funds and insurers from channelling as much money into net-zero modernisation programmes as it would like. Its planned changes would allow more investment capital to shift from bonds to wind farms, for example. Critics of the current rules argue that they make it easier for insurers to invest in coal mining than in renewable energy.
Keen to demonstrate a benefit of Brexit, the government has called for an “investment big bang” and is targeting the insurance industry’s considerable coffers. Having discussed the matter for the past year, ministers are thought to be close to agreeing reforms with the sector’s regulators, with a focus on maintaining safeguards for insurers and policy-holders.
But this overhaul lags a similar initiative already afoot in Brussels to unlock €90bn (£76bn) in EU insurance assets. The European Commission has adopted a comprehensive review of its insurance rules, known as Solvency II, so that insurers in the bloc can scale up long-term investments in Europe’s recovery from the Covid crisis and the impacts of Russia’s war against Ukraine.
EU insurers will be incentivised to increase long-term capital investment to boost member states’ economies, but at the same time the industry will be better scrutinised, according to the commission.
Westminster is keen to push ahead with its plans, because the UK would be put at a competitive disadvantage if Brussels were to enact its proposed reforms first.
In February, the economic secretary to the Treasury, John Glen, revealed the government’s plan to shake off some of the shackles of Solvency II, which the UK had adopted when it was an EU member state. He outlined the proposed changes in a speech at the annual dinner of the Association of British Insurers (ABI).
Glen said that the overhaul would create a more bespoke and dynamic regime, unlocking billions for infrastructure investment. But he stressed that safeguarding the financial stability of insurers and protecting policy-holders would remain a top priority.
British insurers have been subject to Solvency II since it was introduced in 2016 to harmonise regulation across the EU. Glen pledged that this “EU-focused, rules-driven, inflexible and burdensome” body of regulation would be slimmed down and adjusted to better suit the nation’s public investment needs.
“EU regulation doesn’t work for us anymore. The government is determined to fix that by tailoring the prudential regulation of insurers to our unique circumstances,” he said. “We have a genuine opportunity to maintain and grow an innovative and vibrant insurance sector, while protecting policy-holders and making it easier for insurance firms to use long-term capital to unlock growth.”
The reform package has been developed by the Treasury alongside the Bank of England’s Prudential Regulation Authority (PRA), which has emphasised the need for maintaining effective measures to ensure that firms and their policy-holders aren’t exposed to any more risk as a result of the changes.
In December 2021, the Bank’s governor, Andrew Bailey, stressed that the PRA’s prime focus would be to safeguard their interests. Addressing the Institute and Faculty of Actuaries at the time, he added: “Reforming Solvency II is sensible, because the world moves on – and because it was never well suited to some aspects of the UK market.”
Planned reforms include a substantial reduction in the risk margin, including a cut of between 60% and 70% for long-term life insurers and the more sensitive treatment of credit risk in the so-called matching adjustment. The risk margin calculates the reserves that life insurance firms must hold and the matching adjustment protects against price volatility, incentivising investors to back secure long-term assets.
The risk margin and the matching adjustment are two key areas of scrutiny, according to Bailey.
“Public policy objectives like safety and soundness and policy-holder protection are the bedrock of prudential insurance regulation,” he said in his speech. “But let’s not assume that the answers to the question of how much of it we should have are obvious. That said, I cannot emphasise enough that we must come up with well-considered answers to the question of ‘how much protection?’ to allow prudential regulation to do its job effectively.”
As well as giving insurers more flexibility to invest in long-term assets, the reform package includes reductions in their administrative burden and reporting obligations.
Charlotte Clark, director of regulation at the ABI, believes that reforms to Solvency II are “vital to ensure that we have a post-Brexit regulatory regime that’s fit for purpose for the UK and not overly restrictive. It should enable more investment in green infrastructure and the levelling-up agenda. Analysis shows that £95bn could be freed up if sensible changes are made to the matching adjustment and the risk margin, while upholding high levels of protection for policy-holders.”
The government is due to publish a full consultation document in April. This should feature more detailed proposals with supporting analysis.
The Pension Insurance Corporation (PIC), which holds more than £47bn in investments, agrees that the Solvency II framework for insurance companies has hampered the UK’s investment in low-carbon projects so far.
In December 2021, the PIC published a research report entitled Investment Unleashed, which argued that flaws in the regulation had incentivised life insurance firms to invest primarily in large, well-funded companies. This had skewed investments towards mature technologies and sectors, rather than helping the government to achieve its goals in respect of building greener infrastructure and levelling up the economy.
“The government’s levelling-up and net-zero ambitions require significant investment if they are to be achieved. Quite simply, the government itself cannot provide this funding,” the report states.
The PIC’s chief executive, Tracy Blackwell, views the planned Solvency II reforms as a chance to rewrite the script. “We have a once-in-a-lifetime opportunity to channel new investment into communities across the UK, building high-quality homes, decarbonising our economy, creating jobs and levelling up,” she says.
Clark agrees, noting that the ABI has “long been calling for the meaningful reform of Solvency II. The changes being discussed will not diminish the high regulatory standards that are rightly placed on insurers and long-term savings providers. These will retain their ability to withstand a one-in-200-year shock.”
She continues: “Our sector recognises the crucial role it has to play in tackling climate change. Calling for regulatory reforms to enable more investment in renewable energy, as well as other infrastructure needed to aid the UK’s transition to net zero, is just one aspect of the many actions we are taking.”