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News on reforms in Solvency II risk margin for UK entities

The UK regulator – Prudential Regulatory Authority (PRA) – has concerns that the build-up of offshore reinsurance by undertakings can become a major issue when unconstrained. In fact, they believe the stock build-up of offshore reinsurance is an unintended consequence, and that it might become a significant prudential concern when not restrained. The regulator has questioned insurers about their use of the offshore reinsurance as a way of transferring risk.

PRA has requested for a significant level of information when forming reinsurance arrangements that insurers and pension providers are entering into. The UK regulator well understands the need for risk transfer and the fact that reinsurers have an appetite for the assumption of pension liabilities from insurers. However, clarity is still lacking on the significant immediate concerns about exactly how reinsurance is facilitated. Besides, it’s not clear whether Solvency II (the EU insurance regulation directive) is hurting policyholders by way of annuity prices.

Solvency II remains one of the most sophisticated regulations on insurance. It verifies that insurers have strong financial buffers so that they can meet claims from policyholders. It’s dependent on the principles of market consistency, the embedment of strong risk management, and the governances of insurance firms. In checking the stock build-up of offshore insurance, PRA will have to change the way risk margin is determined.

Most reinsurers and insurers headquartered in the EU, be it mutual or firms in run-off (if their premium income is more than €5 million annually) fall under the Solvency II regime. The Bank of England, through lobbying efforts from politicians and the industry, has put forward plans for reforming the directive. The reforms will ensure that it’s easy for such companies to invest in long-term infrastructure assets. Many firms have complained that PRA’s interpretation of the matching adjustments remains very restrictive, cancelling out most of the potential advantages of the reforms.

Though the UK regulator has been reviewing its supervisory approach for future risk mitigation and transfer mechanisms like calculating risk margins, there remains no lasting way to implement these changes. There isn’t enough certainty for firms due to the unpredictability in the future of UK’s relationship with the EU when it comes to financial services. However, PRA will continue evaluating its position, and will offer further updates once there is sufficient clarity around the situation as to what will happen to UK companies after Brexit.