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“Government proposals to reduce how much capital life insurers must hold to protect themselves against bankruptcy increase the annual chance of a firm collapsing by around 20 per cent, from 0.5 to 0.6 per cent, the Bank of England reveals in correspondence to the Treasury Committee,” said a release from the UK Parliament last week.
In a letter released in February, penned by Andrew Bailey, Governor of the Bank of England, a claim was made that the Government’s plans to overhaul Solvency II rules, which govern the ‘buffer’ of assets an insurer must keep on its balance sheet, would likely increase the probability of a failure in the life insurance sector.
“The annual risk of a failure will rise from 0.5 to 0.6 per cent if the changes are implemented, a relative increase in the probability of failure of around 20 per cent,” it added. “The Governor claims the Government’s plans increase the risk by twice compared to the Bank’s preferred reforms.”
“Less capital would be released were long term interest rates to be higher,
and conversely more capital would be released if they were lower."
In the letter, Bailey specified that, “the impact on the life insurance sector that is most readily quantifiable comes from the risk margin reduction, which will release capital for the life insurance sector. “
The memo goes on to say that the size of the reduction depends on prevailing economic conditions and also depends on the date chosen for the comparison, because there are existing transitional measures which smooth the impact of Solvency II on firms until 2032.
“Our estimate on capital release is based on insurers’ balance sheets and interest rates as at end-June 2022. Less capital would be released were long term interest rates to be higher, and conversely more capital would be released if they were lower,” it said.
Using firms’ reported figures at end-June 2022 as a basis, the risk margin for the life insurance sector was £22bn, the letter said. “Post reform, we expect this to shrink to c.£8bn, i.e., a release of c.£14bn, once transitional measures on technical provisions have run off (by 2032).”
Bailey’s note added that “had the PRA’s reforms of the financial services been taken forward, we expect that there would still have been a net capital reduction from the combination of these reforms, but that less than half of this capital would have been released in aggregate.”
Many in the financial services were wary on the mooted rise in bankruptcies.
“The UK life sector will continue to maintain strong capitalisation despite the government’s proposals to loosen Solvency II rules to release capital for insurers to invest more in long-term assets,” said a comment piece from Fitch Ratings.
"Moreover, while we expect insurers to deploy some of the capital freed up
by the Solvency II reforms into long-term investment."
Fitch Ratings said that, despite Bailey’s assertions, most insurers maintain Solvency II ratios well above the minimum requirements, which implies a much lower probability of failure than 0.5%.
“Moreover, while we expect insurers to deploy some of the capital freed up by the Solvency II reforms into long-term investments, attracted by the prospect of higher returns, we believe they would stay within their existing risk appetites and avoid depleting their capital enough to jeopardise ratings,” the statement said. “With solvency ratios at record highs, most insurers have strong capital headroom in their ratings.”
The UK government’s plans to loosen capital on hand requirements for insurers has been one if its flagship policies for the financial services post-Brexit shakeup and was popular with UK insurers.
“Meaningful reform of the rules creates the potential for the industry to invest over £100 billion in the next ten years in productive finance,” said Hannah Gurga, Association of British Insurers (ABI) Director General in November of last year when the full details of the proposed changes were announced.
Gurga said that this included areas such as UK social infrastructure and green energy supply, whilst ensuring high levels of protection for policyholders remained in place.
The ABI added that it welcomed the proposed reduction to the Risk Margin by 65% for life insurers and 30% for non-life insurers. “We agreed with the Prudential Regulation Authority’s (PRA) view that the Risk Margin was too large and sensitive to interest rates and consider that the changes proposed address both these issues,” it said in a statement.
“Solvency II changes will be a rethink of how government and institutional
investors can work together on big projects."
The social infrastructure and green energy projects that had been mentioned were hoped to fund a part of the government’s policy of Levelling Up and the Just Transition.
Insurers were positive toward the changes. At Insurance Investor’s conference in January, representatives both the life and pensions and P&C sides of the industry said they were cautiously optimistic about any proposed Solvency II regime.
“Solvency II changes will be a rethink of how government and institutional investors can work together on big projects, especially for green and ESG projects,” said Aileen Mathieson, Group Chief Investment Officer, Aspen, noting areas where this could be beneficial, such as post-pandemic recovery plans in local communities and the UK government’s ambitious – and controversial – Levelling Up project.
Tom Sumpster, Head of Private Markets at Phoenix Group, said his company welcomed the potential Solvency II changes at the event too. “It gives us predictable cash flows rather than certain cash flows and more ability to go into markets. The devil is in the detail, but we hope it’ll allow us to diversify.”
Whether or not the government achieve their goals, it is now likely that the changes – and the industry - will undergo more scrutiny.
