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Solvency UK is born

By Anthony Plotnek and Ed Hawkins | September 25, 2023

In this Solvency UK article series, we consider the latest updates on the UK Solvency II reforms and explore the potential implications for the insurance industry
Insurance Consulting and Technology

Part 4 - CP12/23 Countdown: Reflections ahead of the consultation closure and gearing up for September

By Ed Hawkins

The CP12/23 consultation period ends on 1 September, and focus is beginning to shift towards the upcoming September consultation. With this in mind, we have been reflecting on CP12/23.

Initial sentiment on CP12/23 and other ongoing regulatory developments was provided by 21 UK life insurers in July by way of a short survey in advance of our WTW breakfast roundtable. The roundtable itself was attended by 40 participants representing 26 UK life insurers and subsequent discussions with industry participants have highlighted further views on the consultation and other aspects.

Since our roundtable, we have also been considering what the much awaited September consultation may bring. Some are anticipating a potentially contentious consultation which is likely to contain some hotly debated proposals as well as some surprises.

This article provides some of our high-level reflections on CP12/23, as well as some thoughts on the upcoming September consultation. While CP12/23 generally appears to have landed well with firms, there was a lot of detail to work through and a number of aspects that will likely require further detail and clarification. Attention will soon turn to the September Prudential Regulation Authority (PRA) consultation with key topics including matching adjustment attestation, notching and investment flexibility.

Reflections ahead of the consultation closure

The length of CP12/23 certainly came as a surprise to many in the insurance industry. The main consultation document ran to 182 pages and was then followed by 30 appendices, spanning 390 pages of further detail. This first consultation of 2023 was generally expected to be more straightforward covering topics requiring less debate, with the September consultation covering aspects which may be more divisive.

Nearly 600 pages of detail was a lot for firms to work through with certain details in appendices creating some uncertainty on the intended nature of implementation for these proposals. Firms are now expressing concerns about the potential volume of information to be included in the upcoming September consultation, with some already looking to line up resource to support the review of the September consultation when it lands.

Will the PRA’s September consultation manage to top the 1,225 pages of Tolstoy’s War and Peace? Or will it be more concise, given it is likely to focus on a small number of key topics?

Smoother sailing compared to previous consultations

The overall sentiment from the 21 life insurers that took part in our mini survey on CP12/23 was much more positive than previous consultations and discussion papers on the reforms, with firms generally suggesting that the consultation was in line with their expectations.

While internal model (IM) firms are slightly less satisfied than standard formula firms, which is perhaps unsurprising given a number of the proposals focus solely on IMs, the PRA’s consultation generally appears to have landed well.

In particular, where firms do have feedback on proposals, they have indicated an intention to provide views on how the proposals could be amended, rather than simply disagreeing with them, to help Solvency UK deliver on its stated objectives.

Transitional Measures on Technical Provisions – from raised eyebrows to embracing simplicity

Immediately following the release of the consultation, a number of firms suggested to us that they would want to pursue the legacy approach to the calculation of the transitional measures on technical provisions (TMTP), rather than adopt the proposed simplified method. Firms’ rationales included: operational burden, lack of sensitivity of the simplified method, and materiality of the impact between the two approaches.

However, once firms had assessed the impact of the simplified method versus the legacy approach and further understood the PRA’s high bar of expectations and requirements to use the legacy approach, only two firms in our mini-survey sample still suggested they would want to pursue using the legacy approach.

There still remain some points of detail relating to the TMTP simplification proposals that will need to be ironed out including inconsistency of timing between proposed TMTP and risk margin changes. The risk margin changes are expected to come into force at YE23 whereas the Financial Resource Requirements (FRR) test, which is used in the current TMTP calculation approach, would continue to apply until YE24. It is likely that a number of firms will suggest in their consultation responses that the timing of the FRR test should be accelerated in order to align with the proposed risk margin implementation date.

Swimming in a sea of acronyms but left in a fog of uncertainty

CP12/23 introduced a number of new acronyms and concepts relating to IMs such as Residual Model Limitation Capital Add-Ons (RML CAOs) and Model Limitation Adjustments (MLAs). RML CAOs have been introduced as a mechanism to speed up the time taken to obtain regulatory permission to use an IM, with firms suggesting that this appears a useful mechanism in principle.

However, from our various discussions with the industry, it is not immediately obvious that there will be many existing standard formula firms looking to develop an IM as a result of the proposals. In addition, firms do not feel there is sufficient clarity as to how the introduction of RML CAOs apply where existing IM approvals are already in place. For firms with existing partial or full IM approvals, it is less clear if or how this proposal will serve to speed up the model change process.

Given the PRA’s expectations and standards will remain largely unchanged under the new regulatory regime, it is not obvious that the proposals will result in any material change from the existing process. Further detail on how the PRA plans to implement concepts such as RML CAOs and MLAs, and how processes such as major model changes will be affected, would be beneficial to help firms better assess any potential impacts.

Reporting changes – a few flies in the ointment

Reporting changes being proposed in CP12/23 have generally been welcomed by firms, with the removal of the Regular Supervisory Report being viewed on the key list of benefits.

However, there have been some concerns from firms about proposals to change existing templates due to the operational burden this would create. Smaller-sized insurers have also suggested that the impact of the combined reporting proposals on them is likely to be fairly immaterial.

Further to this, some firms have suggested that they plan to maintain some of the proposed removed requirements, such as the Profit and Loss Attribution (or variants of this), as they are already well embedded into existing processes and provide useful management information.

Internal Model attestations and CAO disclosures – a few bumps in the road

Proposals that would require the Chief Risk Officer (CRO) to attest to the appropriateness of the IM have generally been viewed as reasonable, with many firms commenting that this broadly aligns to the existing ongoing validation requirement.

However, the key change for firms is likely to be the precise meaning and requirements of an attestation. Firms may need to undertake some additional work to ensure that the format and content of the attestation aligns to the expectations of the CRO (and regulator) such that the CRO is comfortable to provide sign-off.

The PRA is also proposing that CAOs will be disclosed, and while it is important to encourage transparency where appropriate, there are some concerns that initial disclosures may lead to some market volatility if a firm is perceived to have problems within their IM. Further to this, firms may feel pressure from investors and analysts to individually disclose details of CAOs which may not align to the PRA’s intended principle of CAOs.

Untangling the web of rule changes

There are a number of appendices to the consultation which provide mappings of proposals against existing tests and standards, regulatory requirements or laws, to help understand linkages that already exist. However, a summary of changes would be helpful to provide further clarity.

Given the volume of changes that are being proposed to the rulebook and the interconnectedness of various changes, firms have suggested that they would want to see a full rulebook refresh in one place. This will enable an assessment of whether all the changes work when the different pieces have been put together, as well as whether there are any obvious gaps compared to the existing rules, to be conducted.

Gearing up for September

The consultation shrouded in a mist of uncertainty

There has been much discussion and speculation over the summer months about the content and form of the PRA’s September consultation.

The various Subject Expert Groups (SEGs) between the PRA and industry discussed the key topics which are likely to feature in the September consultation, but firms who participated in one or multiple SEGs do not have much of a sense of the extent to which the discussions at the SEGs will have helped the PRA to shape its proposals. For example, based on discussions at the SEG focussed on the notching of the Matching Adjustment (MA), a simple approach based on interpolation was generally favoured, however there is a possibility that the proposed approach in the consultation may differ from this.

Proposals relating to investment flexibility and the definition of “highly predictable” cash flows, which are linked to HM Treasury’s economic growth and investment objective, have the most potential to lead to disappointment.

We anticipate that many firms may feel that the proposals that end up being consulted upon do not go far enough to enable any material change in investment approach compared to the existing regime. In particular, the investment flexibility SEG suggested that any proposed framework should contain sufficient flexibility for inclusion of new asset classes in the future without the need for case-by-case applications for approval. While this is sensible from operational and management perspectives, it is very difficult in practice to find and agree a robust regulatory framework to allow such a degree of flexibility whilst ensuring a level of consistency between firms.

In many areas there were also a wide range of views on the best way forward between firms with numerous potentially conflicting proposals discussed in the SEG sessions.

Matching Adjustment attestation – opening a can of worms

The proposals on the MA attestations are likely to be the most hotly discussed and debated aspect of the September consultation, given this is being newly introduced as part of Solvency UK. There is a split of opinion on the attestation, with some firms sceptically suggesting that the MA attestation is being introduced as a mechanism for Fundamental Spread (FS) add-ons to be applied, while others more optimistically consider that it could help strengthen their defence of the level of MA being achieved.

Regardless of which side of the fence they fall on, all firms are expecting the MA attestation to be a material undertaking and that the PRA is likely to require significant additional granularity on the MA and FS compared to previous MA-related information requests. There is also some ambiguity surrounding what firms will be required to attest on – will it be the MA, FS, Liquidity Premium or something else? If the attestation is on the liquidity premium, a clear definition of what is meant by liquidity premium would be helpful to ensure consistency in attestations.

While the PRA’s expectations for the MA attestation will be covered in the September consultation, we have been developing views on the analysis and format required for an MA attestation to help firms accelerate the process.

Internal Model treatment – the elephant in the room

The majority of discussion on key issues at the SEGs focussed on base balance sheet treatment, but participants in the SEGs did flag that there would likely be knock-on impacts on the IM treatment.

However, it is not clear whether the upcoming September consultation will include any proposals surrounding the regulator’s expectations of allowing for any developments under stress to update Supervisory Statement SS8/18 – this was similarly the case following the introduction of the Effective Value Test (EVT) for equity release where the regulatory expectations for the EVT in stress (and the requirement to consider this) developed in the years following the EVT being consulted upon and implemented for the base balance sheet.

The two key aspects likely to need consideration in stress are notching and the removal of the BBB cliff.

For notching, an interpolation approach is likely to be favoured in base due to an absence of data, so it is difficult to see how firms could be expected to allow for notching under a 1-in-200 stress other than through a similar interpolation approach if deemed required. However, to do so would still require a notched view of ratings in the IM (potentially in all modelled simulations over a multiple year time period) which would be spurious and overly complicated in an already complicated area of model calibration for credit risk.

The removal of the BBB cliff in base may not naturally lead to the PRA being comfortable with its removal in stress (in models where it is applied) given the potential implications for the level of investment in sub-investment grade assets. We understand that the PRA has been asking firms whether they view the removal of the BBB cliff in their IMs would constitute a major change and it is possible expectations on this may be clarified within the consultation. Ultimately, the overall level of credit capital that firms are expected to hold by the regulator is unlikely to materially reduce as a consequence of the reform changes. Any reduction in one area may result in increased scrutiny of the overall modelling approach with an expectation the reduction will be offset by an additional capital allowance elsewhere in the calibration.

If you would like to discuss CP12/23 or the upcoming September consultation further, please do not hesitate to contact us on the details provided below.

Part 3 - Overview and highlights from PRA CP12/23 - Review of Solvency II: Adapting to the UK insurance market

By Ed Hawkins

The PRA has now published its first consultation paper (CP12/23 – Review of Solvency II: Adapting to the UK insurance market) on the Solvency II reforms following the publication of the draft statutory instrument by HM Treasury.

From the length of CP12/23, it is clear that a lot of work has been going on at the PRA over the last few months (combined with views from industry via the Subject Expert Groups) to develop proposals and there are a lot of specific details to explore and understand.

Below is an overview of what is covered in the consultation as well as some of the headlines from each area of the consultation.

As is often the case and given the length of the CP, there’s certainly more work to be done to explore the proposals further and the potential impact of the proposals are likely to vary from firm to firm.

Overview of CP12/23

  • CP12/23 sets out the PRA’s proposals to deliver reforms where the UK government has chosen not to legislate directly with a focus on measures to simply Solvency II, improve flexibility and encourage entry into UK insurance market.
  • The PRA is of the view that the proposals result in a meaningful reduction in administration and reporting requirements (and therefore costs) while maintaining prudential standards.
  • This is the first consultation of 2023 with a further consultation planned for September 2023 which will cover proposals relating to investment flexibility and matching adjustment (including eligibility rules, attestation requirements as well as calculation and reporting).
  • The PRA are aiming to publish final policy towards the end of 2023 to allow firms to begin preparing for implementation.
  • There will also be a further consultation in 2024 to transfer the remaining Solvency II requirements into the PRA rulebook – however no substantive changes are expected by the PRA.
  • The CP has limited discussion on the risk margin given this is being captured via government legislation.
  • There is a 2 month consultation period for CP12/23 (deadline of Friday 1 September 2023) with the exception of the section of the consultation covering ‘Administrative amendments to PRA rules’ which will have a 1 month consultation period (deadline of Monday 31 July 2023).
  • The CP can be broken down into 5 key themes:
    1. Simplification (covering Transitional Measures on Technical Provisions (TMTP) simplification and reduced reporting requirements)
    2. Improved flexibility (covering flexibility in the calculation of Group SCR, streamlined Internal Model (IM) rules and threshold increases)
    3. Encouraging entry (covering third country branches and a mobilisation regime)
    4. Capital add-ons (covering the existing framework but with some amendments!)
    5. Administrative changes (covering aspects such as currency redenomination and administrative amendments to PRA rules)

TMTP simplification

  • The proposals introduce a new simplified default method (referred to as the TMTP method) which combines Solvency II figures with point-in-time scaling factors to remove reliance on Solvency 1 calculations.
  • Firms will be allowed to use their existing TMTP calculation approach but subject to approvals and conditions.
  • The proposals will remove the existing Financial Resource Requirement (FRR) test while also introducing a consistent approach to amortise TMTP.
  • The PRA would no longer need to approve recalculations and the Chief Actuary would take on responsibility for the TMTP, removing the existing audit committee sign-off.

Streamlined IM rules

  • The PRA would grant “permission” to use an IM rather than “approve” an IM – a change in the legal mechanism but not a substantive change.
  • Existing IM Tests and Standards have either been transferred and restated in the PRA rulebook, moved to expectations in a Supervisory Statement, not transferred, will be assessed through the PRA’s Business as Usual supervision or replaced by a new requirement.
  • The PRA are proposing to replace the existing Solvency II Profit & Loss attribution with a SCR Analysis of Change (AoC) as the PRA considers that it is a more efficient tool for understanding movements in the SCR.
  • Permission to use an IM that has some Residual Model Limitations (RML) could be granted if safeguards are in place (either an RML Capital Add-on or qualitative safeguards).
  • The PRA propose to formalise an Internal Model Ongoing Review framework covering PRA-driven thematic reviews, an analysis of change exercise, an assessment of ongoing IM compliance (including an annual IM attestation by the Chief Risk Officer) and monitoring of safeguards.

Capital add-ons (CAO)

  • The proposals introduce the concept of a Residual Model Limitations Capital Add-On (or RML CAO!) to remove the existing binary nature of IM permissions while potentially enabling the PRA to grant model permission more quickly.
  • The statement of policy for capital add-ons will broadly be based on the existing CAO requirements within retained EU law. An alternative approach for calculating a CAO for an internal model significant risk profile deviation is set out.
  • The PRA are proposing to review CAOs on a “regular basis” with timing dependent on case-specific circumstances.
  • The PRA plans to release a regular aggregate report summarising the use of CAOs at an industry level to promote consistency and transparency.

Flexibility in calculation of Group SCR

  • The PRA is proposing to introduce the ability to temporarily allow a group to add together the results of two or more different SCR calculation approaches.
  • The proposals also allow an overseas sub-group SCR to be included in the group SCR under method 2.

Removal of branch capital requirements and risk margin

  • The CP removes rules that require third-country branch undertakings to calculate branch capital requirements and removes the SCR localisation requirement.
  • It also removes the requirement to establish a branch risk margin for purposes of ongoing branch supervision.

Reduced reporting requirements

  • The PRA sets out that the reporting proposals result in an overall reduction of reporting for all Solvency II firm while aligning to proposals elsewhere in the CP and HM Treasury review of Solvency II.
  • It is proposed to remove the requirement to produce Regulatory Supervisory Report (RSR) given the design and triennial frequency makes comparable analysis of content challenging.
  • There are a number of deletions and amendments to reporting requirements but some new templates have been introduced to fill gaps (e.g. through removal of RSR). However the PRA has assessed that overall there will be a net reduction in templates.

Mobilisation regime

  • The PRA is proposing to introduce a mobilisation regime for new insurers – an optional, time-limited stage at the point of authorisation.
  • There would be restrictions on the nature, scale and complexity of business that firms can write during mobilisation, but firms would be subject to a lower MCR floor of £1m.

Threshold increase

  • The PRA is proposing to increase to Solvency II thresholds and is undertaking redenomination into GBP from EUR (£15m Gross Written Premium, £50m technical provisions).

Currency redenomination

  • The proposals redenominate the rules in GBP from EUR using the average daily GBP/EUR spot exchange rate covering the 12 month period prior to 31 December 2020 (£1 = €1.13).

Administrative amendments to PRA rules

  • Minor amendments are required to PRA rules to ensure consistency with the onshored Solvency II Commission Delegated Regulation.

Please reach out to us on the details provided below if you would like to discuss implications of the consultation further.

Part 2 - Love it or hate it: Solvency II reform

By Anthony Plotnek and Ed Hawkins

There is now a final package of reforms. However as is often the case, the devil and the outcome of discussions between industry and the regulator will help shape the future direction.

In Sam Woods speech in February at the ABI Annual Dinner,[1] he likened the trickier Solvency UK changes to the sticky and salty “love it or hate it” paste, Marmite. Certainly, the terms “overwhelming” and “controversial” could apply to both the condiment and the reform process! Love it or hate it, there is now a final package of reforms. However, there remains much detail still to be worked out and there is a large role for industry to play.

In this second article in our Solvency UK series, following our Solvency UK is Born article, we explore the areas of change that will require further thought and attention over the coming months. We will cover the “stickiest” topics, such as asset eligibility, senior manager attestations and reporting. We will also take another look at the impacts of changes to the Matching Adjustment (MA) – introducing rating notches and removing the BBB cliff edge – and the Risk Margin (RM). We will also discuss key points arising from the industry-regulator subject expert groups (SEGs).

In the second half of 2023, we expect further detail to emerge on these key areas and we also expect progress to be made in the legislative process to bring Solvency UK into effect. The Financial Services and Markets Bill continues its (rather slow) passage through Parliament and, following Royal Assent, will grant powers to introduce the Statutory Instrument to reform Solvency II.

Meanwhile, the PRA has indicated that it will consult in June and September, with the latter consultation benefiting from engagement between industry and the PRA. To this end, three industry-regulator SEGs have been meeting covering attestation, MA investment flexibility and Fundamental Spread (FS) ratings notching[2]. While summaries of these SEG meetings have been published on the PRA’s website, it is difficult to get a real sense of the direction of travel on each of these areas.

Further SEGs are taking place, as highlighted by Charlotte Gerken’s ‘Moderation in all things’ speech[3], to think through stress testing and disclosures. While the PRA has indicated that these SEGs may help reduce the risk of surprises in the upcoming consultations, there is still room to manoeuvre between the consultation and finalised regulations.

What is meant by highly predictable?

For many, widening the eligibility criteria for the MA to cover a wider range of asset types is where the reforms could offer the most material benefits. The Government believes that extending the MA eligibility criteria to assets with highly predictable cashflows could encourage investment in long-term, productive assets.

However, there are concerns that this aspect of the reform package will not deliver material benefits. Such fears relate to constraints on the concentrations firms may be permitted to hold (HM Treasury has stated that the vast majority of assets in MA portfolios are still expected to have fixed cashflows) and the potential for increases being applied to the FS for such assets (as permitted under one of the new “additional measures” being granted to the PRA).

Moreover, for assets being mooted as becoming newly eligible, there already exist precedents for these featuring in MA portfolios. One key area of discussion within the SEG focussing on MA investment flexibility has been future proofing any MA eligibility framework to reduce the risk of running into issues for future asset classes not yet known about. While this is a clearly a desirable feature, implementation of such a framework may prove difficult given the unknown nature of future asset classes.

This leads into the biggest question hanging over this aspect of the reforms: just what is meant by “highly predictable”? A 2021 actuarial working party paper concluded that a more pragmatic interpretation of cash flow “fixity” is required to address the challenges of investing in emerging technologies, green / clean energy investments and long-term real assets under the current MA rules.[4] The working party paper takes a closer look at asset construction phases, prepayment clauses and rental income as existing inhibitors for assets that would otherwise be prime candidates for inclusion in MA portfolios.

While both the SEG and working party paper consider a variety of options to relax the current “fixed cashflow” MA requirement, it’s unclear the extent to which these changes will lead to any significant change in the assets held in MA portfolios. Therefore, there may be limited additional investment in long-term, productive assets as a result of these changes beyond the levels insurers have already been investing in over recent years.

Getting ready for senior manager attestations

Another of the new supervisory tools to be granted to the PRA will require nominated senior managers with responsibilities under the Senior Managers Regime to attest formally to the PRA whether or not the level of the FS on their firm’s assets is sufficient to reflect all retained risks, and that the resulting MA reflects only liquidity premium, on the basis of a rigorous assessment of the characteristics and valuations of assets held in their MA portfolios, including the results of stress testing exercises.

We would expect the level of attestation required for tradable bond assets in firms’ MA portfolios to be more limited given that the prescribed FS was calibrated by EIOPA for such bonds which aligns to the three-tiered approach being discussed as part of the SEG. The regulator’s focus is evidently unsurprisingly on the non-traded, illiquid assets in the portfolio which are subject to internal valuations and credit ratings. Firms should expect scrutiny on how they treat these assets and may need to prepare for the prospect of FS add-ons to apply to assets in periods where there might be increased uncertainty.

Additional supervisory tools will allow insurers to apply a higher FS if the analysis to support the attestation indicates that the standard allowance is insufficient. The extent of additional regulatory and external audit challenge (beyond what is already applied in the existing regime) is yet to be seen but, regardless, firms and nominated senior managers will need to be ready to stand behind their assessments.

The consensus amongst members of the attestation SEG suggested that the attestation requirement should sit with the Chief Financial function given its ownership of the balance sheet while potentially requiring input from these functions and others within the business. Disclosures could be used to provide a view on how the MA has been determined with underlying stress tests being published for only the largest annuity providers in the market. However there remains an open question around the level of granularity of attestation, whether this should be done at group, entity or portfolio level, which may become clearer through the upcoming consultations. 

Any form of attestation will still add to the workload of already stretched teams. There may be scope to outsource some or all of the work involved to alleviate the burden (granted that this may depend on the specific details of attestation and on any changes to the Senior Managers Regime).

The review of the Senior Managers & Certification Regime[5] may lead to other changes to the regulatory responsibilities of senior leadership. Given how embedded the SMCR has become in other regulatory initiatives such as the Consumer Duty, the extension to Solvency UK is part of a wider trend.

Reporting: the “must have” and the “nice to have”

Now into Phase 2 of consultations, the review of Solvency UK’s reporting requirements is relevant to all insurers and has the potential to deliver the most value to the smallest firms. Big ticket items such as the Solvency and Financial Condition Report (SFCR) and the Regular Supervisory Report (RSR) have been left out of scope for the time being – a disappointment to those who feel these reports are failing to deliver insightful information on the business.

We support the proposal to include a reporting template for Excess Capital Generation, which is something WTW called for as long ago as 2017.[6] Solvency II external reporting focuses on the solvency of the balance sheet at the calculation date; however, additional metrics, including sensitivities and analysing the sources of surpluses or deficits arising in the reporting period, are critical to understanding the business model and risks faced by the firm. Currently, these are published by firms on a voluntary basis with no prescription or common approach and would benefit from a degree of standardisation.

More generally, it appears that the more ambitious hopes to alleviate the reporting burden will not be fulfilled. There will be reporting template deletions, consolidations and changes to the thresholds and frequencies of some reporting aspects, but the review has lacked a much-needed analysis of what reporting is “nice to have” and what is “must have”.

Furthermore, the PRA’s new SEG on disclosures suggests that there will be more requirements to come, particularly around the new stress test requirements specified for the MA. Conversely, new requirements for the PRA to report on MA application timelines and approval rates will be a welcome development for firms planning moves into more sophisticated and higher yielding assets.

Fundamental Spreads (not the breakfast condiment variety)

The decision to leave the MA approach relatively unchanged has been hailed as a positive outcome for the industry. The parts of the FS calculation that will change are the credit rating buckets (which will move to using “notched” allowances for retained credit risk) and removal of the BBB cliff edge (MA benefit for sub-investment grade debt will not be limited to that achieved on a BBB-rating).

The notching SEG has identified two key methods for notching. One is a data-driven approach where the resulting notched FS are derived purely from data while the other involves some form of interpolation between ratings leveraging the existing FS tables. There are pros and cons to both approaches and so the chosen approach will need to balance key features such as simplicity and transparency, consistency, availability of data, financial intuitiveness and the impact on the SCR calculation.

Our understanding is that the industry is in broad agreement of not wanting to overcomplicate notching and therefore is likely to favour an interpolation method. However the SEG has recognised that there are limitations with a more simplistic interpolation method such as the extent to which the existing FS is disturbed.

Our analysis of the impact of moving to notched ratings based on a simple linear interpolation indicates that firms might expect a 4 to 8 basis point increase to the FS for a MA portfolio at year-end 2020 with a c. 40% allocation to BBB rated assets.[7] The primary driver of the increase is the re-allocation of BBB assets to BBB- since spread differences between ratings become much higher as one goes down the credit quality curve. Firms could see further increases in portfolio FS if there is an expectation of the regulator that internally rated assets should move to lower credit rating notches.

Removing the BBB cliff edge should eliminate the strong aversion to lower-rated assets; however, firms will likely want to maintain investment-grade assets in their portfolios to comply with their risk management policies. While the BBB cliff edge is being removed in the Solvency II base balance sheet matching adjustment calculation, there is ongoing discussion around how the BBB cliff edge is reflected under stress with the industry and the regulator being somewhat divided on this topic and the extent to which it may lead to any impact on the levels of capital held.

Risk Margin: a done deal?

Reform of the RM was supported by the industry and the regulator, with the only real challenge being how it would be done. Now that the modified cost of capital method has been singled out as the preferred approach and HM Treasury has stated that long-term life insurers will see the RM reduce by 65% under recent economic conditions, it looks like the work here is almost finished.

More cautious stakeholders have enquired as to the meaning of “recent economic conditions”. By our calculations, the RM for a typical in-payment annuity fell by 53% between December 2020 and December 2022. Much of this reduction has largely already materialised recently, as interest rates rose substantially in the second half of 2022 and again in recent weeks, leading some to speculate that the wording allows an interpretation that part of the 65% targeted reduction has already been achieved.

Momentum however seems to be clearly behind the interpretation that the reforms alone will deliver a 65% reduction in RM. Based upon our own analysis, applying a further 65% reduction to current RM levels would lead to around a 85% overall reduction compared to year-end 2020.

The latest draft of the Statutory Instrument (SI) sets out the proposed changes to the risk margin calculation which will be a modified cost of capital approach. The cost of capital parameter is 4% with a risk tapering factor (lambda) of 90% for life insurers subject to a floor of 25%. As these parameters for the risk margin sit in the SI, any future changes to these parameters will likely involve an onerous process, suggesting that the risk margin approach will remain relatively stable.

Of course, the PRA advocated for a reduction in the RM only if there were a material strengthening of the FS. In a 22 February 2023 letter, Andrew Bailey set out the Bank’s estimation that the proposed reform of the RM will raise the annual risk of an insurance company failure from 0.5% to 0.6%.[8] How will the PRA feel about and deal with this perceived dilution of the industry’s “1-in-200” tolerance for failure?

The end is in sight

The UK’s Solvency II reform programme has run a long (and at times winding) course. We now have Solvency UK and potentially a new abbreviation to get used to – time will tell whether it becomes an initialism or an (unfortunate) acronym.

While the start date for Solvency UK is still unclear, there is a target implementation of the risk margin changes later in 2023 to coincide with the biennial recalculation of Transitional Measure on Technical Provisions (TMTP) on 31 December 2023.

We can take heart that the end is in sight, but there is still a way to go and detail to be worked out. Understanding the detail is important, as we hope this article has illustrated.

If you would like to discuss the implications of the reforms with one of our team, please don’t hesitate to contact us on the details provided below.

Part 1 - Solvency UK is born

By Anthony Plotnek

While questions remain, firms should be acting now to understand the impacts, influence the future direction of technical consultation, and identify opportunities

On 17 November 2022 “Solvency UK” was born as Chancellor of the Exchequer, Jeremy Hunt, gave his Autumn Statement alongside the release of the highly awaited response to the Solvency II reform consultation.

The revised Solvency UK package signals a significant departure from that consulted upon and the direction set by the Prudential Regulation Authority (PRA) in its discussion paper, DP2/22. Some aspects of the reforms are undoubtedly positive for insurers, especially when considering what was being consulted upon. However, if measuring Solvency UK against the existing Solvency II, how significant are the changes that are now coming – have the Government objectives for the reforms been met?

WTW held a second Solvency II Reforms Breakfast Roundtable on 29 November, following the success of our 10 May event which followed the publication of the HMT consultation in April. We were joined by 38 roundtable participants representing 24 insurance client companies. In this first of a series of blogs we will summarise what we believe we can now expect from Solvency UK reflecting on some of the discussion at our roundtable.

Solvency UK versus existing Solvency II – what’s changing?

The PRA has been arguing for changes to the Matching Adjustment (MA) calculation approach to give a higher allowance for retained credit risk through the Fundamental Spread (FS), and for it to have a more direct link to current spreads. Instead, the consultation response confirms that the existing calculation approach will be maintained with only a modest variation[9].

Alongside this, the long-anticipated changes to the Risk Margin (RM) will also be adopted with an intention to reduce the RM by an average of 65% for long-term life insurers; a benefit the PRA had previously argued as possible only if there was a significant increase in the FS. Similarly, additional flexibility is being granted to allow a greater range of assets and liabilities to be considered eligible for MA portfolios.

As Anthony Plotnek, Director in our Insurance Investment team, comments; “It is both unusual and pleasing to see such a significant reversal of the changes that were consulted upon, with the industry lobbying messages seemingly striking a chord with Government. Whilst the reforms announcement is generally viewed as a positive step forward, shifting the balance of the key areas of debate on MA and RM in favour of the insurance industry, some industry participants are more cautious about celebrating prematurely.”

Whilst the reforms announcement is generally viewed as a positive step forward, some industry participants are more cautious about celebrating prematurely.”

Anthony Plotnek | Director, Insurance Consulting and Technology

The consultation response introduces additional regulatory powers that could have a sting in the tail for firms that have (or are considering in future) MA approvals. There remain many questions to be answered on how these new powers will be shaped and how aggressively they might be applied by the PRA. Furthermore, the “Edinburgh Reforms”, announced by Government on 9 December 2022, may give rise to further changes that would amplify uncertainty where crossover exists, for example the proposed review of the Senior Managers Regime and the new FS attestation requirement for Senior Managers (one such additional regulatory power in the Solvency II reforms).

The PRA may also be given the key to unlocking the benefits of the RM reduction and additional flexibility for the MA, through deciding upon the calibration of the modified cost of capital approach for RM and the specific criteria for additional flexibility for MA assets (offset by any potential strengthening of FS through the notching approach and/or the mechanism of the additional measures). Until this detail is known, it is not possible to make credible estimates of the overall financial impact that the reforms will have.

Clarity is also still being sought on areas such as simplifying Transitional Measures on Technical Provisions (TMTP) – where the PRA has proposed a ‘straw person’ standardised approach to industry – and streamlining regulatory approval processes, with the hope that changes to these will reduce the burden on insurers.

Solvency II reporting requirements

A Phase 2 consultation on reporting requirements is underway. Several changes are proposed, including a new reporting template on excess capital generation and separating out life outwards reinsurance from non-life, but any proposals for the Solvency and Financial Condition Report (SFCR) and Regular Supervisory Report (RSR) are deferred to a later date. While the PRA has indicated that it expects industry to have overall cost savings from the changes, the net impact is uncertain and will vary from firm to firm.

The removal of UK branch capital requirements for foreign insurers (and increase in thresholds for Solvency UK) will also come as a material positive for example for those firms who have until recently been considering challenging branch internal model applications.

What is the expected timeline for reform?

Consultation on specific technical aspects of the reform measures (led by the PRA) is expected to run over 2023, despite an original expectation that this would be carried out before the end of this year.

It is possible that consultation to technical changes may be consulted on simultaneously with the existing consultation on reporting requirements that closes on 8 May. With this in mind, it is unlikely that any changes to the regime will be adopted ahead of year-end 2024, the due date for reporting changes as specified in consultation paper CP14/22.

More information required

There are a number of priority areas where more direction is needed in order to make an informative assessment of the potential outcomes from the reforms. These are:

  1. Whether to interpret the targeted 65% reduction in RM as deriving solely from modifying the cost of capital calculation approach, or whether reductions in RM due to recent rises in interest rates will be deemed to contribute to meeting this target when setting the revised parametrisation of the RM. We have found industry to be split in this regard over what to expect.
  2. What to expect from the PRA on the additional measures, including the frequency and nature of stress tests and who from the firm is expected to provide the attestation. Might the Index Spread Model originally proposed be used in the PRA’s Quantitative Indicators (QI) with the potential for consideration in portfolio or asset level FS add-ons i.e., application through the backdoor?.
  3. Further details on the definition of “highly predictable” when considering asset eligibility for inclusion in MA portfolios. Could this eliminate the need to structure certain assets if they would qualify for treatment under this category but potentially subject to add-ons to the FS. Additionally, will there be any limits on the proportion of highly predictable (rather than fixed) cashflows allowable within MA portfolios?
  4. Direction on how Transitional Measures on Technical Provisions (TMTP) will be reformed to reduce the burden of calculation, potentially building from the straw person proposed by the PRA in its 6 October 2022 roundtable, although we note that firms may find that the importance of TMTP diminishes as the RM reduces further.
  5. When we can expect the reforms to come into effect. We expect the legislative process to be the deciding factor here and note that reporting reforms are due to come in at the end of 2024 which could serve as a target for the wider reforms.

In many aspects the key messages seem much more positive than last year’s proposals. Some key questions remain but nonetheless firms should be acting now to understand the impacts and identify opportunities. For the industry as a whole, input into the ongoing and upcoming PRA consultations will be critical for shaping the final outcome.

What should firms be doing now?

Firms with MA portfolios should be:

  • Estimating potential financial and operational impacts of using notched ratings in the FS. We have tools to estimate the impact of these under a range of assumptions around the implementation and asset portfolio composition.
  • Considering the net benefits of admitting a wider range of assets into the MA portfolio (those which have “highly predictable” cashflows or which are sub-investment grade). Balancing the cost of the PRA’s additional measures for these assets will be essential to this analysis.
  • Reviewing stress testing capabilities for the MA portfolio. While the nature of the testing is still to be defined, the testing and underlying analysis of the FS and liquidity premium will be a key input into the new attestation requirement.

All firms should be, where relevant:

  • Evaluating how the calculations for the RM will be updated to use the modified cost of capital. Again, here we have tools to estimate the impact of these under different calibration assumptions.
  • Assessing what changes may be necessary under the review of reporting requirements which is due to come into effect by 31 December 2024. Reporting processes will need to adapt accordingly and additional requirements will mean firms will need to prepare new information for disclosure.
  • Prepare for the excess capital generation template and form views about what content would work well for the firm and for industry.
  • Reconsidering strategic ambitions and business plans.
  • Considering applying for MA (or extending an existing MA) treatment on liabilities that are expected to become eligible, i.e. morbidity claims. Preparing for an MA on these liabilities may involve forward planning, team training and drafting of the application itself.
  • Evaluating the impacts of the proposed TMTP methodology, if relevant. This may be approached from the perspective of financial implications as well as the effect it would have on existing processes.

If you would like to discuss the implications of the reforms with one of our team, please don’t hesitate to contact us on the details provided below.


  1. Sam Woods speech Fundamental Spreads given at the ABI Annual Dinner on 20 February 2023. Return to article
  2. Solvency UK: PRA/ABI Insurer Engagement page. Return to article
  3. Charlotte Gerken speech Moderation in all things given at the 20th Annual Conference on Bulk Annuities on 27 April 2023. Return to article
  4. Institute and Faculty of Actuaries Matching Adjustment Working Party paper Fixity of Cash Flows published in December 2021. Return to article
  5. DP23/3: Review of the Senior Managers and Certification Regime (SM&CR). Return to article
  6. Joint report from WTW and Autonomous Research, Solvency II One Year On, published in April 2017. Return to article
  7. WTW report Solvency II Review: Analysis of Proposed Solvency II Reforms published on 21 July 2022. Return to article
  8. Letter from Andrew Bailey to Harriett Baldwin MP on 22 February 2023. Return to article
  9. The FS calculation will move to using “notched” allowances for retained credit risk within major credit ratings (for example, different allowances for assets rated AA+ or AA- compared with AA) and the severe treatment of sub-investment grade MA assets will be removed. Additionally, the MA eligibility criteria is to be broadened to include assets with ‘highly predictable’ cashflows (subject to increased FS) and liabilities that are subject to morbidity risk. Return to article

Director and Head of WTW PACM proposition, Insurance Consulting and Technology

Anthony leads WTW’s Private Assets and Capital Management (‘PACM’) proposition and oversees WTW’s activity on the topic of Solvency UK reforms. He is a member of the Equity Release Council Funding Forum, a member of the IFoA Solvency UK Matching Adjustment Attestation Forum and co-author of WTW’s independent ABI commissioned report on SII reforms.

Associate Director, Insurance Consulting and Technology
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