UK launches post-Brexit shake-up of insurance rules

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 Boris Johnson has called an “investment big bang”.

The Treasury’s plans to change the Solvency II regime have been eagerly awaited by the industry as the first big break between UK and EU financial rules since Brexit.

The consultation on the new regime, announced before markets opened on Thursday morning, aims to make it easier for insurers to invest in long-term illiquid assets, such as offshore wind projects.

Solvency II, a 1,000-page piece of EU legislation, has long been seen as too burdensome by UK insurance companies. An industry report claimed that they would have an extra £ 95bn to invest if the rules were relaxed.

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. That would allow those companies to redeploy as much as 15 per cent of the overall capital they currently set aside, the government said, without giving details.

The second would be to reform what is known as the “matching adjustment”, which influences where insurers invest, to allow more money to be deployed to long-term projects, such as offshore wind.

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.

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.

“The publication of the government’s consultation document should be well-received,” said Jefferies analysts. Shares in life insurers Legal & General and Aviva rose 1.8 per cent and 1.7 per cent, respectively, by mid-morning trading, against a 1 per cent rise in the blue-chip FTSE 100 index.

The Prudential Regulation Authority 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 “while continuing to ensure the UK regime provides an appropriate level of safety and soundness” .

The PRA said a combination of reforms that included other changes to the matching adjustment – which reduces insurers’ long-term liabilities – 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 ”.

But consumer campaigners have warned that reforms to Solvency II could be detrimental to policyholders. In February, Mick McAteer, a former UK regulator who is now co-director of the Financial Inclusion Center 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 and allow them to invest more in long-term investments.

This triggered concerns in Whitehall that the EU was moving faster than the UK. The Association of British Insurers, a trade body, warned last year of a risk that the reforms could prove a “Brexit penalty” rather than a “Brexit dividend” if they came up short.

Life insurers, which are expected to benefit most from changes to the rules, have promised to invest billions more in long-term UK assets if reforms are implemented.

In December, FTSE 100 life insurer Phoenix Group urged ministers to relax solvency rules to help it release up to £ 50bn in investments to revive the economy, boost infrastructure and meet climate change pledges.

Phoenix, which has £ 300bn of assets under management and 13mn customers, said that with the right regulatory and policy changes, it could invest up to £ 40bn to £ 50bn in illiquid and sustainable assets to accelerate the government’s “leveling-up” plans for revitalizing poorer regions and its efforts to decarbonize the economy.

Life insurers use liability matching to make sure they don’t run out of money to pay pensioners. But under the EU’s Solvency II rules, they are penalized for using certain illiquid assets in matching adjustment portfolios because they are considered too risky.

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