UK launches post-Brexit shake-up of insurance rules

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Rishi Sunak, UK chancellor, has launched a consultation on radically changing the rules governing insurance companies, with the aim of allowing them to invest tens of billions of pounds more in infrastructure — including green energy.

The government argues that reform of the EU’s Solvency II rules — and their replacement with a British regulatory regime — could unleash what prime minister Boris Johnson has called an “investment big bang”.

The Treasury’s consultation on changes to the Solvency II regime, announced on Thursday, has been eagerly awaited by industry as the first big break between UK and EU financial rules since Brexit.

Solvency II, a 1,000-page piece of EU legislation, has long been seen as too burdensome by UK insurance companies. But the prospect of watering down the regime has prompted warnings that it could create risks for insurance policyholders.

The first big proposed adjustment would mean easing solvency requirements by reducing the so-called risk margin, an extra capital buffer that companies must hold, by 60-70 per cent for life insurers.

The second would be to reform what is known as the “matching adjustment” — which allows insurers to reduce their long-term liabilities if they invest in certain “matching” assets — to allow long-term projects, such as offshore wind, to be included in these portfolios.

The third reform is intended to cut reporting and other administrative burdens on companies, including doubling the thresholds at which insurers are included within the solvency regime.

The combination of the reforms would allow life insurers, who particularly benefit from the changes, to redeploy as much as 15 per cent of the overall capital they currently set aside, the government said. That would equate to about £18bn based on data from the end of 2020.

John Glen, City minister, said the reforms could unlock tens of billions of pounds for long-term investments. “I am confident that these reforms will help maintain and grow the insurance sector whilst ensuring both a very high standard of policyholder protection and the safety and soundness of UK insurers,” he said.

Shares in life insurers Legal & General and Aviva rose 1.7 per cent and 0.9 per cent, respectively, by late afternoon trading, against a 0.8 per cent rise in the blue-chip FTSE 100 index.

The Prudential Regulation Authority, which issued its own documents on Thursday outlining its position, said that while the reforms “would involve an increase in the risk of insurer failure compared to the current position”, the capital requirements could be eased without threatening the robustness of insurers’ balance sheets.

The PRA said a combination of reforms that included other changes to the matching adjustment to better reflect credit risks would ensure that the overall package was “within the PRA’s risk appetite and should continue to advance its statutory objectives”.

The Association of British Insurers, a trade body, said it would consider the proposals in more detail “to ensure what is being proposed meets the common objectives” of the sector and the government.

Its director of regulation, Charlotte Clark, said that “only meaningful reform can enable our industry to provide much needed investment in green infrastructure, particularly at a time when energy security is increasingly vital”.

“Insurers will want to study the details of the proposals carefully,” said consultancy KPMG’s insurance director Matthew Francis, highlighting how changes to the calculation of the matching adjustment “partially offset” gains from the reduced risk margin.

The PRA said that the freed-up capital under the suggested package of changes, if not returned to shareholders, could enable insurers to do between £45bn and £90bn worth of new business.

Consumer campaigners have previously raised concerns about the Solvency II changes. In February, Mick McAteer, a former UK regulator who is now co-director of the Financial Inclusion Centre think-tank, warned that the reform could weaken consumer protections while providing a windfall for shareholders.

In September, Brussels unveiled its own proposals for changing Solvency II, which it said would deliver a short-term capital boost of up to €90bn for European insurers. This triggered concerns in Whitehall that the EU was moving faster than the UK.

FTSE 100 life insurer Phoenix Group said in December that with the right regulatory and policy changes, it could invest up to £40bn to £50bn in illiquid and sustainable assets.