Solvency II Review: Analysis of Proposed Solvency II Reforms

On 28 April 2022, HM Treasury released its consultation on the Solvency II reforms package outlining proposals for the Risk Margin (RM) and Matching Adjustment (MA), among others. This was accompanied by DP2/22, in which the PRA assessed a package of around 60% reduction in RM for life insurers and a new approach to determining the Fundamental Spread (FS) that is more penal than the current approach. WTW has prepared a report that investigates key aspects of the current and proposed regimes, and has assessed the proposed approach against the original HM Treasury objectives of the reform programme.

In our view, the proposed reform package:

• has the potential to create clear winners and losers
• would introduce unnecessary prudence in the MA to the detriment of best delivering on HM Treasury’s competition and sustainable growth objectives
• has a negative net balance sheet impact on annuity firms

The WTW report leverages analysis from WTW’s representative MA portfolio and UK life insurer data submitted in the QIS, representing approximately three-quarters of the life insurance industry by technical provisions. It has been prepared by the UK insurance practice of WTW for the Association of British Insurers (ABI).

The findings¹ from the WTW analysis are:

• We see that the PRA’s 10-15% estimate of the release of current capital held does not apply in practice for many insurers. We estimate almost no change – in fact, a marginal decrease in 'own funds' (OF) – based on our QIS data set after allowing for the reduction in transitional arrangements and assuming that the RM and MA changes take effect at the same time.
• For specialist annuity writers, rather than facilitate a 10-15% capital release to spur growth in the sector, we estimate that the reforms package offered would lead to specialist annuity firms requiring a capital injection to restore existing levels of solvency coverage unless there was an offsetting reduction in SCR which PRA indicates in DP2/22 it does not envisage. We estimate a 5.9% decrease in OF for annuity specialists.
• Our historical analysis shows significant margin between the current FS allowance within the existing regime and the actual default loss experienced. The current FS allows for a multiple of 3 times historic losses and the proposals would allow for 5 times.
• Significant change in the relative attractiveness of different asset classes due to the proposals would have material consequences on firms’ investment approaches and allocations.

WTW believes that it is detrimental to the UK economy and future policyholders to have overly prudent protection for existing policyholders as this will drive up future prices, likely increase the use of overseas reinsurance and reduce the capital for UK Government climate change and productive finance objectives.

A more balanced package of reforms is required which avoids significant change to the level and volatility of MA and results in a less polarised outcome for different types of insurers.

¹ The results are aggregate figures based on a sample of participants in the 2021 Quantitative Impact Study (QIS) and do not represent the effect on individual firms or the UK insurance market in total.

Disclaimer

The analysis contained in WTW’s report is based on year-end 2020 QIS data that WTW has not independently audited or verified. This data will not reflect the material changes on insurers’ balance sheets that will have resulted from the significant rises in risk-free rates (c. 200bps) since that date. Our analysis should be considered in its entirety as individual sections are not intended to be considered in isolation.

Authors

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Kenneth McIvor

Director, Insurance Consulting and Technology

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Anthony Plotnek

Director, Private Asset and Capital Management Lead, Insurance Consulting and Technology

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Gareth Sutcliffe

Head of Insurance Investment Team

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