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The UK’s financial services regulatory body, the Prudential Regulation Authority (PRA), last week authored a new update on the continuing reform process of Solvency II, which could affect how UK insurers invest their portfolios in the future.
Last week, the PRA published CP19/23 – Review of Solvency II: Reform of the Matching Adjustment, seeking consultation from the industry.
“This [Consultation Paper] (CP) is the second PRA consultation needed to implement the conclusions of the Solvency II Review. It sets out the PRA’s proposed reforms that will enable broader and quicker investment by insurers in their Matching Adjustments (MA) portfolios,” the body said.
Matching Adjustment is a mechanism that allows insurance companies to identify upfront a proportion of their potential investment return as a capital resource they are confident they will earn on the assets held against their long-term insurance liabilities.
"We propose to adjust regulations to reflect the decisions made by the Government about the level of financial resilience that should be required of insurance companies."
The proposals on MA will be part of the new UK prudential regime for insurers, which the PRA said would eventually be known as ‘Solvency UK’.
The PRA added that it considers “that by adapting the MA rules for the features of insurance business in the UK and the financing demands of the wider economy, the proposals will allow the life insurance sector to play a bigger role in productive investment in the UK economy while continuing to offer their policyholders the level of security determined by legislation.”
"We propose to adjust regulations to reflect the decisions made by the Government about the level of financial resilience that should be required of insurance companies,” said Sam Woods, Deputy Governor for Prudential Regulation. “These proposals aim to promote policyholder protection while enabling the annuity sector to meet its commitments to the Government to increase investment in the UK economy.”
Changing Solvency II rules have been a large part of the UK government’s overall post-Brexit financial services strategy.
Late last year, these proposed changes by the UK to the Solvency II framework, which were announced by the Bank of England (BoE) in November 2022, prompted many UK-domiciled insurers to rethink their investment strategies.
The purpose of the Solvency II reform is to free up capital so insurers can do more – particularly investing in both internal and external policies.
Both the wider insurance market and the government have expressed a desire for this capital to be used as part of the UK’s regional infrastructure investment projects, known as ‘Levelling Up’. The aim of this strategy is to provide a more equitable financial spread around the UK, instead of just in London and South East England.
“Although investment flexibility is being expanded, the risk management
enhancements that go with it are going to affect all firms.”
Given the potential of large amounts of newly freed capital being released – the industry could invest over £100 billion in the next ten years – one of the main questions is which projects should take precedence for investors.
Reaction from the industry was mostly positive, with industry body the Association of British Insurers (ABI) saying these plans would enable further development.
“Solvency UK will enable our sector to play an even bigger role as an institutional investor,” said Charlotte Clark, Director of Regulation at the ABI. “We’re committed to using the reforms to drive £100 billion into green and good projects, whilst ensuring policyholder protection remain in place. This consultation brings us another step forward to achieving that.”
Deloitte also published a glowing response saying the consultation was another part of a puzzle to be completed. “Overall, this set of proposals provide a detailed view of what the future of investment and risk management in MA portfolios will look like under Solvency UK,” said the firm in a response from Director Kareline Daguer and Senior Manager Claire McColl.
“Although investment flexibility is being expanded, the risk management enhancements that go with it are going to affect all firms, even those not interested in using the greater flexibility that these proposals provide,” they added.
The consultation period will close on Friday, 5 January 2024.
