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Solvency II review should ‘hold the extra-hot sauce’: PRA’s Woods

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Brexit concept - UK and European flags waving in the wind
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Prudential Regulation Authority (PRA) CEO Sam Woods has sought to disabuse insurers of the notion that the UK’s Solvency II review will result in a significant lowering of capital requirements.

The UK life insurance market has since soon after the inception of the five-year-old risk management framework lobbied hard for change. Regulators have agreed that certain limited elements of Solvency II, including the risk margin capital buffer, are ripe for reform.

However, in a speech today at an Association of British Insurers (ABI) conference Woods cast doubt on recent claims about the capital-releasing possibilities of the Solvency II overhaul, including the ABI’s assertion that reforms to the risk margin could free up £35bn ($48.7bn).

He said such numbers “are a little speculative”. Woods said that if policymakers resisted the temptation to indulge in “too much extra-hot sauce” the Solvency II review could generate “really important gains for the UK without weakening safety or soundness or policyholder protection”.

A consultation on the reforms closed last month. Woods’ comments will allay fears of many in the P&C industry that an overly radical Solvency II overhaul - as desired by the life sector - would give the EU reason to withhold an equivalence designation from the UK (re)insurance sector. The EU is conducting its own separate review of the Solvency II framework.

Woods said today: “You will not be surprised to hear that I have some doubts about a reform package which materially decapitalises the insurance sector. While it’s natural for the private sector to focus on private interests, it’s part of our job to keep an eye on the potential public costs of significant insurance failures.”

Woods’ comments echo those of PRA director of insurance supervision Anna Sweeney, who said in February that she sees no “persuasive evidence” of badly pitched capital requirements.

Life insurers have argued strenuously that the existing regime is curbing investment in long-term infrastructure projects and green assets.

But Woods said: “I am wary of calls to encourage specific forms of investment with prudential regulatory incentives, which is usually polite code for lowering capital requirements.”

Woods also urged caution about sweeping changes to the matching adjustment – another bugbear of the life industry. The matching adjustment is designed to ensure long-term investors match assets closely to long-term liabilities.

He said he was open to “process improvements” that could lift obstacles to carrier investment in infrastructure, however.

Woods said that the PRA doesn’t intend “some radical departure from the current ways of setting capital requirements. But we are interested in having one or more independent checks that the combination of actual capital held by firms and the shape of their balance sheets and business models adds up to a sector that we can be confident is resilient to plausible shocks”.

In the speech Woods outlined the rationale of a government plan to give regulators greater power to shape rules – but make them more accountable to parliament.

He noted that it was the norm in all major jurisdictions apart from the EU and Switzerland for rules to be in regulators’ handbooks rather than laid down in law.

Woods also pushed back against the notion of the PRA gaining a statutory competitiveness objective, following calls from across the (re)insurance industry.

He said such an objective is not normal globally.

“I worry therefore that having such an objective might be seen by others as an intention to weaken regulation in the UK, and thus undercut our authority in international bodies.

“I also think it’s a bit of a red herring. A robust prudential regime focused on objectives of safety and soundness and policyholder protection is part of the national infrastructure that underpins the attractiveness of UK firms as counterparties.”

He added: “Loading something up with ever more objects is an excellent way to decorate your Christmas tree but it’s not the best way to create an effective regulator.”

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