We find ourselves in the middle of an intense period of activity, as we progress through the final days of Solvency II in the lead up to the full implementation of Solvency UK at the end of 2024. The ABI is committed to the realisation of a prudential regime that fulfils the Government's three key objectives around competitiveness, policyholder protection, and investment in long-term productive finance. Below we spotlight four areas where there has been a particular focus this autumn.
Risk Margin
HM Treasury has confirmed in draft legislation that reforms to the Risk Margin will be implemented for year-end 2023. As set out in HM Treasury’s November 2022 response on its Solvency II review, life insurance business will see a reduction of c65% in the Risk Margin; non-life business will see a reduction of c30%.
On October 17, the ABI hosted a Risk Margin roundtable with the PRA. The main area of discussion was the treatment of Periodical Payment Order (PPO) business. The PRA confirmed that PPOs will be included within the definition of ‘long-term insurance and reinsurance obligations’ within PRA Rules, and will thus be eligible for the lambda = 0.9 ‘taper’. It is considering whether this treatment will apply to potential PPOs as well as settled PPOs, and will “revert in due course”. The ABI will alert members when the PRA reaches a decision.
FRR test
In consultation paper CP12/23, the PRA proposed the deletion of the Financial Resources Requirement (FRR) test used in the calculation of the Transitional Measure on Technical Provisions (TMTP) at year-end 2024. ABI feedback on this consultation urged the PRA to delete this requirement at the end of 2023, at the same time as the reforms to the Risk Margin are implemented.
Draft HM Treasury legislation includes text that would remove the requirement for the PRA to revoke TMTP approvals if the FRR is not met; however, it does not delete the test in its entirety. We have emphasised to HM Treasury that the continued existence of the FRR cap could result in a material temporary reduction to the capital release as a direct result of the Risk Margin change, contrary to the Government’s objectives for these reforms.
The PRA is considering feedback received on CP12/23; the ABI will alert members if there are any developments regarding timelines for deletion of the FRR test.
Matching Adjustment
On 28 September, the PRA published consultation paper CP19/23 Review of Solvency II: Reform of the Matching Adjustment, and an accompanying news release. The ABI’s Prudential Regulation Team provided a detailed summary of the contents of this consultation in our September Newsletter.
The ABI is drafting a comprehensive response to this consultation. There are some positive proposals, including confirmation that:
- Assets whose cash flows depend only on an inflation index, and those where they may be changed only when the investor receives sufficient compensation, should continue to be deemed as ‘fixed’.
- A more proportionate approach to MA portfolio compliance breaches will be introduced.
- There will be no reference to a ‘liquidity premium’ in the PRA’s proposed standard attestation wording.
However, there are also some emerging areas of concern, including:
- The criteria for the inclusion of assets with highly predictable cash flows – certain assets currently regarded as ‘fixed’ (such as those with investor friendly clauses) may in future fall into the ‘highly predictable’ bucket. It is not clear whether this is intentional, or just poor drafting. Additionally, the definition of ‘highly predictable’ used by the PRA appears to be very restrictive and will limit insurers’ appetite to invest in such assets. There is a question as to whether a definition of ‘highly predictable’ is needed, given the safeguards that the PRA is proposing around the quality of matching.
- Controls on the quality of matching – the PRA has introduced a range of safeguards (additional matching tests, a de minimis Fundamental Spread uplift of 10 bps, etc.). Not all these additions may be necessary, and there may be an impact on insurers’ appetite for assets with ‘highly predictable’ cash flows.
- The quantum of the proposed Fundamental Spread addition for non-fixity risks – the PRA proposes that for assets with economic (pure) variability, such as callable bonds, under a standard approach firms could project cash flows on a ‘yield to worst’ basis, together with the 10 bps de minimis addition. For assets with non-economic (event) variability, most commonly seen where the borrower has options contingent on particular specified events, for the standard approach, the PRA proposes that firms provision a proportion (at least 25%) of the difference in MA benefit arising from the worst case and the best estimate cash flow projection. It is not clear whether this latter proposal is viable, or what impact these calibrations will have on insurers’ appetite for assets with ‘highly predictable’ cash flows.
- The attestation – the PRA considers the proposed attestation requirement for the ‘MA to be earned with a high degree of confidence’ is an appropriate standard to provide a safeguard to the amount of MA being claimed. This would require the MA in base to be materially more certain than a 50th percentile or best estimate basis. Under stress, the PRA appears to be saying that it expects the Matching Adjustment to decrease significantly – however, industry was not expecting a significant impact on overall capital levels from these proposals. There is a concern that this may be introducing a more onerous Fundamental Spread calibration via the back door.
Regulatory reporting
In our feedback to CP12/23, the ABI urged the PRA to bring forward the deletion of regulatory reports and templates it has stated it no longer needs from year-end 2024 to year-end 2023 – in particular, the Regular Supervisory Report (RSR). The latest HM Treasury draft legislation removes the requirement for firms to submit an annual list of ‘material changes’ that have occurred since submission of the previous ‘full’ RSR; however, it does not delete the RSR in its entirety.
The PRA has informed us that a number of the responses it received to CP12/23 called for the early deletion of the RSR. It cannot comment on year-end 2023 requirements ahead of the publication of the final legislation; however, it “intends for PRA’s rules and expectations to be aligned with the legislation once it comes into effect”. The PRA will issue a public statement to clarify the impact of the legislation once it is finalised.
Next steps
There are many milestones on the road to Solvency UK implementation; some of the more important are as follows:
- The ABI will circulate a first draft response to Matching Adjustment consultation CP19/23 by 3 November. We intend to submit a finalised response to the PRA no later than 21 December 2023.
- Solvency II legislation will be introduced in the form of Statutory Instruments (SIs), which will be laid before Parliament. There will be at least two SIs; a temporary one bringing in the Risk Margin reforms at the end of 2023, and permanent legislation laying the groundwork for full Solvency UK implementation at the end of 2024. HM Treasury cannot confirm when these SIs will be laid; it has said that this is not in its gift, and will happen “when Parliamentary time allows”.
- A further major Solvency UK PRA consultation will be published early in 2024; the primary purpose of this will be to transfer the remaining retained EU Solvency II legislation into the PRA Rulebook.
- We expect to see final policy from the Matching Adjustment consultation CP19/23 early in 2024; the PRA intends to implement these reforms for half-year 2024.
- At the end of 2024, remaining retained EU Solvency II legislation will be repealed, and Solvency UK will be implemented in full.