The Treasury Committee has chosen the new European Union supervisory framework for insurance, Solvency II, as the subject for its latest inquiry to "supplement its work on the relationships that the UK might now seek with the EU [following June's EU Referendum result]." The Committee suggests options around retention of the Directive and the implementation of subsequent amendments and seeks background information.
The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration and policy of HM Treasury, HM Revenue & Customs, and associated public bodies, including the Bank of England and the Financial Conduct Authority.
The objectives of the inquiry into Solvency II relate to options for the UK insurance industry on leaving the EU, competitiveness of the industry, meeting the needs of UK customers and the business economy and lessons to be learned.
Questions to the insurance industry and interested parties
The terms of reference include specific questions under the following 7 topics:
- Competitive implications of Solvency II
- Development of Solvency II
- Implementation of Solvency II
- Safety and soundness
- Financial reporting
- Wider implications of Solvency II
Answers to these questions are intended to inform decisions on the various options.
Regulatory support for the regime
Publicly, the UK's prudential regulator has previously expressed support for the new regime.
In the foreword to PS2/15, Mark Carney wrote that "risk-based capital requirements and transparent valuation practices are an important element of maintaining the resilience of insurers. This is what Solvency II introduces."
In a speech earlier this year, Andrew Bulley, then the PRA's Director of Life Insurance said that "the founding aims and principles of the new Solvency II regime, in particular the emphasis on proportionately and policyholder protection, underpinned by the Directive’s enshrining of the prudent person principle in assessing risk strategies, complements, indeed enhances, the PRA’s supervisory approach very well."
However, the regulator has also recognised that the regime is not flawless.
Andrew Bailey, the then PRA Deputy Governor, also wrote in the foreword to PS2/15 that "Solvency II must be applied proportionately, with the emphasis on substance over form, if we are to maintain our focus as a forward-looking and judgement-based regulator" and ended with "The new regime will not be perfect, but it is a welcome step in the right direction."
In particular, in a speech given by Sam Woods at the end of 2015, in his role as the BoE's Executive Director of Insurance Supervision, reference was made to the sub-optimal calculation of the risk margin and the "modest" differences in implementation across Europe.
The scope of the inquiry states, "There were fears that the much delayed EU directive would impose substantial costs on the insurance industry." The industry did indeed incur significant costs implementing the new regime. This expense has been met and firms are keen to manage the costs going forward.
The PRA is responsible for the prudential regulation and supervision of insurers. There will be very little appetite to abandon a regime that broadly meets the UK regulator's approach to insurance supervision.
The Prudential Regulation Authority’s approach to insurance supervision states "For UK branches of EEA insurers and those providing cross-border services into the United Kingdom, the PRA’s powers and responsibilities are limited under Solvency II." A move away from Solvency II might suggest a stronger stance.
Firms must comply with the regulator and there are consultation opportunities to influence that approach. Firms are unlikely to welcome any further costs transitioning from a regime that has required significant investment.
Past criticism for the PRA has been in respect of "gold-plating" requirements so a reduction in costs through reduced legislative demands may not seem very likely. For example, there has been some concern about fees for credit ratings and, in Supervisory Statement SS40/15, the PRA opted not to exempt UK firms from reporting external credit ratings. Reductions to Pillar III requirements would be welcomed by many in the industry and arguably effected without weakening supervision.
The scope also states "the Committee has already heard evidence suggesting that Brexit provides the opportunity to leave the Solvency II arrangement and that doing so would help insurance companies." However, industry commentators have noted the possible need to comply with Solvency II in order for the UK to gain equivalence. This is likely to be more relevant to larger firms and the PRA weights its supervision to insurers that, in its judgement, pose the greatest risk to its objectives. Might abandoning the Directive mean a more proportionate approach and lesser regulatory burden for smaller firms, resulting in lower costs?
Having said all that, the PRA is a subsidiary of the Bank of England and is a UK public regulatory body whose powers are set by statute. Perhaps this inquiry does represent a genuine opportunity to influence the regulatory framework from the very top?
Overall, in our opinion, it would seem unlikely that the core elements of the regulatory framework will change especially since a number of parties will wish the UK to be on a par with Europe. There are some aspects of the regulation where we would welcome a change, for example, the risk margin calculation. This inquiry may represent a good opportunity to suggest improvements and for this to be communicated to the PRA.
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