The Treasury Committee has published its report on the Solvency II Directive—a harmonised EU-wide insurance regulatory scheme.
In response to the practical difficulties of the directive, the report recommends that the Prudential Regulation Authority (PRA) should have a pragmatic discussion with the insurance industry. This should focus on the scope for amendments and increased proportionality in the implementation of the directive.
As well as the PRA's primary objectives, it has a secondary objective, which is to facilitate effective competition. The Committee recommends that the Treasury should consider giving this objective equal primacy.
Nicky Morgan MP, Chair of the Treasury Committee, "The UK insurance industry managed investments of over £1.9 trillion in 2016 and paid nearly £12 billion in taxes to the Government. We should not ignore the consequences of Brexit on this important UK industry, nor the way that it is regulated irrespective of Brexit. The implementation of Solvency II in the UK has come at a considerable cost. Industry and the PRA do not appear to be aligned on some key issues, including the impact on consumers. They should agree what is best for UK industry and consumers as a matter of urgency. They should develop a roadmap that provides a prudent regulatory structure without stifling competition and innovation.Such a roadmap should both inform the Brexit negotiations and reflect the opportunities afforded post Brexit to develop the international competitiveness of the UK insurance industry."
The development and implementation of Solvency II has been a major event for firms and regulators across the European Union. During the last Parliament, the Treasury Committee received over 50 pieces of written evidence on EU insurance regulation, and held three oral evidence sessions, from a diverse range of stakeholders including insurance firms, financial regulators, consultants, trade bodies, expert associations, and individuals. This report draws on that evidence and concludes an inquiry for which much of the groundwork was done by the previous Treasury Committee.
With such a large piece of legislation, it should not be a surprise that there are a number of areas that need to be refined. Specific areas explored in this report include:
- Risk of procyclicality and market distortion;
- Potential impact on long term savings and investment, and the function of the Matching Adjustment;
- Calibration of the Risk Margin;
- Approval of Internal Models and subsequent model change;
- Volume and complexity of data required from firms;
- Usability of the Volatility Adjustment;
- Working of the Transitional Measure on Technical Provisions; and
- Rigidity of Solvency II’s approach to Contract Boundaries.
The evidence submitted highlighted problems both with the legislation as drafted and with the way it has been implemented in the UK by the Prudential Regulation Authority (PRA). While some differences of opinion are to be expected, the Committee is concerned at the extent of disagreement between the PRA and industry on matters that should be relatively factual–for example, around the availability of investment grade long-term assets. Such disagreements do not foster good policymaking.
The Committee understands that the PRA can act on its own initiative in a number of policy areas, whereas in others it currently has to act within the EU legal framework. However, the PRA and industry differ as to precisely where this line is drawn. The Committee strongly encourage the insurance industry and the PRA to come to an understanding on what aspects of Solvency II can be changed unilaterally while the UK remains an EU member state.
There will be some areas where it is clear that the PRA cannot act on its own initiative and where it may look to discuss changes as part of the ongoing review of Solvency II initiated by the European Insurance and Occupational Pensions Authority (EIOPA). Clearly it will be helpful and constructive if EU member states can agree changes together because, regardless of Brexit, there is a value to harmonisation of the industry’s regulation.
The overriding priority is to develop a system of regulation which is right for the UK insurance industry, and which meets all the current and future needs of consumers, providing a prudent regulatory structure without stifling competition and innovation. We would expect the UK regulators—with close input from the industry and HM Treasury—to work on this task. It will be desirable to keep in step with the EU and other international initiatives as far as this is possible.
The Committee notes the views of many of those who gave evidence that the PRA’s approach is overly focused on solvency—to the detriment of its secondary competition objective, and to the ability of the industry to meet the savings and protection needs of consumers. Many respondents had advocated a clear competition objective for the PRA—to act as a counter balance to the solvency objective. The Committee advocates a review of this alleged conflict by HM Treasury.
Given the complexity of the task and the importance of the industry, both domestically and internationally, the Committee would like to see the development of a clear agreed strategy designed to provide a roadmap for:
What changes to insurance regulation can be implemented by the UK authorities now, unilaterally, without the need for a change in the Solvency II Directive (to include consideration of what steps would be required to allow regulatory forbearance to limit systemic risks in the event of market turbulence);
- What steps the UK regulator would like to see taken to refine the Directive or its applicability to the UK post-Brexit, as a contribution to the Brexit negotiations;
- What action can be taken post-Brexit to foster innovation, competition and competitiveness for the benefit of UK consumers and the standing of the UK’s place in the international insurance industry; and
- How UK insurance regulation will harmonise with international capital standards and emerging accounting standards.
Huw Evans of the ABI, “This is an important report which urges sensible reform so that the UK’s insurance sector can operate effectively to serve customers, business and the wider economy. Our sector has a vital role in helping Britain thrive following Brexit while continuing to be a major employer, tax contributor and provider of security to millions of individuals and businesses. We can only do this if we have a well-balanced regulatory system with pragmatic implementation of the Solvency II regime. We welcome the Treasury Select Committee’s detailed focus on pragmatic improvements and will continue to work constructively with the PRA to implement change, which will need to go beyond proposals the regulator announced earlier, The committee is right to recognise the importance of successful Brexit negotiations for our world-leading insurance sector which serves millions of individual and business customers across the EU. It is vital politicians allow regulators to agree a process to handle pre-Brexit contracts and that the PRA is allowed to help EEA businesses operating in the UK have certainty on their regulatory status after March 2019. These are technical issues which have real-world consequences for millions of customers if they are not fixed.”
The Prudential Regulation Authority’s (PRA) has a proposal to make improvements to the Solvency II regime, less than two years after its implementation.
The PRA has begun by consulting on the Matching Adjustment (MA), which helps insurers invest in long-term assets as a natural match to their long-term liabilities.
The PRA has also committed to making further improvements to other areas including on internal model change, and on the burden of Solvency II reporting.