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A glimpse of the planned Solvency II reforms – What could it all mean?

  • United Kingdom
  • Financial services and markets regulation
  • Insurance and reinsurance
  • Financial services


The recent speech by Economic Secretary to Treasury John Glen MP to the Association of British Insurers gives insurers a glimpse of HM Treasury’s Solvency II reforms.  The UK (re)insurance industry has cause to be optimistic, although, as with all things, the devil will be in the detail.  

The four key reforms are:

  • a substantial reduction in the risk margin – of around 60% - 70% - for life insurers
  • a revised method of calculation of the matching adjustment “to better reflect its sensitivity to credit risk”
  • increased flexibility to permit investment in long-term illiquid assets including UK infrastructure
  • reform of legacy EU regulation to reduce the reporting and administrative burden on the industry

Mr Glen said that the proposed changes could free up as much as 15% of life insurers’ capital, which could release as much as £95bn for investment.  These are not trivial sums, however, some in the insurance industry are more cautious, as proposed changes to the matching adjustment may require part of that released capital to be set aside.

The UK (re)insurance industry has called for reforms of this nature since Solvency II was introduced, particularly the proposed changes to the risk margin and matching adjustment.  The direction of the government reforms will be welcomed by most, if not all, (re)insurers.

More money, more problems?

UK (re)insurers will need to decide what to do with the capital released by the changes to Solvency II.

Martin Mankabady, Partner in our Corporate Insurance team comments:

Insurers who find themselves with more capital at their disposal as a result of the Solvency II reforms might return it to shareholders, use it to write more business or spend it.  M&A activity in the insurance industry is already high.  A whole-market capital release is likely to drive activity levels even higher.

Short term effects of long term asset reforms

The combination of newly released capital and the proposed expansion of the scope of eligible long term assets in which insurers can invest could lead to asset price inflation as insurers compete to acquire suitable assets.

Henry Dean, Senior Associate in our Financial Services team comments:

Insurers will need to be careful that restructuring of their investments doesn’t have a negative impact on the value of their portfolios and the market.  If everyone is looking to acquire long term assets at the same time, there is a risk of price inflation for more desirable assets.  Equally, if insurers collectively exit the bond market in search of higher yields elsewhere, there is a risk of price inflation for those less desirable assets.

The first steps to divergence

In his speech, Mr Glen says the EU Solvency II regime “never worked well for us [the UK]” and casts the reforms as a move away from “an EU-focused, rules-driven, inflexible and burdensome body of regulation”.  The reforms effect regulatory divergence from the EU’s Solvency II regime.

Currently the EU has suspended its consideration of whether UK financial services regulations are equivalent to EU rules and will not recommence consideration until a UK-EU memorandum of understanding on financial services is in place.  We do not expect a UK-EU MoU to be agreed anytime soon and the matter has become embroiled with UK-EU disputes over fishing and the Northern Ireland Protocol.

When and if the EU does come to consider whether UK insurance regulation is equivalent, however, these reforms will be part of its considerations.  While the EU has absolute discretion as to whether to grant equivalence, the decision will be made after a technical assessment of UK regulation.

Adriana Cotter, Insurance Partner comments:

“As and when the EU comes to consider equivalence, the UK government's decision to diverge from legacy EU Solvency II rules will provide the EU with technical grounds on which to decline to find equivalence should it wish to do so.

“For insurance groups operating in both the UK and Europe, there is also the potential for some added operational complexities, as companies within a group are subject to increasingly different solvency regimes – although this is a problem with which insurers with a US or Bermudian presence will already be used to managing.”

Next Steps

The speech is only an introduction to the reforms.  There will be a general consultation in April, to be followed by a more detailed PRA technical consultation later this year.

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