Beyond Brexit: How to make sure an evolving Solvency II works for your business
While the core of Solvency II looks set to remain in place following the UK’s exit from the EU, there’s scope for the Prudential Regulation Authority (PRA) to improve competitiveness by bringing capital requirements more into line with the distinctive nature of the UK market. However, there are also significant risks, including what happens to a matching adjustment that few Continental insurers use. How can your business manage the regulatory upsides and downsides?
Nearly three years into Solvency II, debates continue over whether the UK’s estimated £3 billion implementation cost was worthwhile.
With the risk-based Individual Capital Adequacy Standards (ICAS) already in place, the benefits for the UK in areas such as policyholder protection were always going to be second order compared to EU markets with less sophisticated prudential regimes. Moreover, the discrepancies between Standard Formula and Internal Model evaluation have called into question the promise of greater market-wide harmonisation and comparability.
Yet, many would point to an improved basis for capital allocation, asset-liability matching and wider strategic decision making emanating from more granular, transparent and rigorously calibrated modelling. The Directive has also provided the catalyst for better model understanding at senior level.
Refinements could heighten the benefits. For example, a simplified, streamlined and more agile process for sharing information with regulators and agreeing model changes could improve value for money and help clear away potential barriers to innovation. There could also be benefits from continued calibration review and adjustment. For example, does the longevity calibration remain relevant given the current slowdown in increased life expectancy?
Scope for UK-specific Solvency II
From a regulatory perspective, leaving the EU offers further opportunities for refinement. The terms of Solvency II were inevitably a compromise between numerous member states with very different markets, product designs and associated risks, especially in relation to long-term life and pensions policies. Once the dust settles on Brexit, the PRA could adjust aspects of the regulation to align them with UK circumstances and help make UK insurers more competitive. This includes a review and possible redesign of the risk margin. The PRA acknowledges that the risk margin is “too high at current low levels of interest rates”, though it is reluctant to make any changes before there is greater certainty over the UK’s future relationship with the EU. Other areas of focus could include the use of simplifications and streamlined requirements for Pillar 3 reporting.
Risk of a capital spike
Yet, there are also risks. One of the most prominent Solvency II compromises was the creation of the matching adjustment (MA), which is vital in easing the market-sensitive volatility and resulting capital demands on annuity business.
As the matching adjustment has been designed primarily for the UK, there are questions over how much incentive there will be for the European Insurance and Occupational Pensions Authority (EIOPA) to keep the MA up-to-date or even up-and-running at all. It’s therefore important to build potential scenarios for the future of the MA and the resulting impact on capital demands into forward-looking assessments. It’s also important to engage with both the PRA and EIOPA over the issue and lobby for the continued maintenance and retention of these provisions.
Moreover, Solvency II has yet to reach an entirely steady state. Challenges ahead include even tighter reporting timelines. With IFRS 17 also coming into view, the reporting demands are set to provide further impetus for investment in technology and closer collaboration between finance and actuarial teams.
In conclusion, there are opportunities to make Solvency II more relevant and workable. Yet, key aspects remain fluid and therefore active assessment, management and lobbying are vital.
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