Insurance Regulatory update - Prudential regulation

Capital regulation and product market outcomes
On 5 March, the Bank of England published a working paper which examines the impact of the introduction of a risk-based capital regulation regime in 2002 on product market outcomes for the insurance industry in the United Kingdom. Under the new regime, capital requirements became a function of risk exposures measured by stress-testing insurance balance sheets, in contrast to the old regime that was largely risk insensitive. The new regime led to a significant increase in capital requirements for traditional insurance products, products that typically provide policyholders with life cover or guaranteed savings. Capital requirements, however, remained low for linked products.

Using proprietary data on stress-test submissions from the Bank of England, the authors find that constrained firms reduced underwriting relative to unconstrained firms, particularly for traditional insurance products which became more capital intensive in the new regulatory regime. The paper shows that regulatory frictions affected the equilibrium product mix of the insurance sector and led to significant balance sheet restructuring and  firm reorganizations.

Financial Policy Committee statement - outlook for UK financial stability
On 16 March, the Financial Policy Committee (FPC) issued a statement following its 12 March meeting where it reviewed the outlook for UK financial stability, risks to UK financial stability from Brexit, and risks from crypto-assets.

The FPC continues to judge that, apart from those related to Brexit, domestic risks remain standard overall, and that risks from global vulnerabilities remain material. The FPC continues to identify and monitor UK financial stability risks associated with Brexit so that preparations can be made and actions taken to mitigate them. The FPC notes that since November, progress has been made towards mitigating risks of disruption to the availability of financial services. Nonetheless, material risks remain, particularly in areas where actions would be needed by both the UK and EU authorities.

The Statement’s Annex sets out the FPC’s Brexit checklist covering the following areas:

  • ensuring the UK legal and regulatory framework is in place;
  • timely agreement on an implementation period to allow firms to maximise their own preparations;
  • actions to ensure the continuity of existing cross-border contracts;
  • actions to avoid disruption to new services in the presence of barriers to cross border financial service provision and data sharing.
The FPC is tracking progress against the checklist and the Committee intends to update and publish this quarterly going forward.

Looking out for the policyholder — speech by Sam Woods
On 27 February, speaking at the annual conference of the Association of British Insurers (ABI), Sam Woods, Deputy Governor for Prudential Regulation and CEO of the PRA, said that to get insurance regulation right we should be considering two questions:
  • With the experience of operating Solvency II since it came into effect in 2016, can we make our implementation of the Directive work better? In his opinion, "despite some inevitable differences of view, there is a strong degree of agreement between the PRA, the Treasury Select Committee and the industry about the answer to that question" and consultation is now underway on an extensive package of reforms;
  • In the blizzard of insurance and regulatory jargon, however, he believes something has been missing from the discussion: "Where is the policyholder?" He notes that we have seen the significant human cost that can be associated with insurance failures, such as Equitable Life, and Parliament has given the PRA a particular duty to represent the interests of the policyholder. Delivering the PRA's responsibility means maintaining high standards of safety and soundness for UK insurers.
PRA response to the Treasury Committee’s inquiry into Solvency II
On 3 January 2018, Sam Woods, Deputy Governor for Prudential Regulation, set out in a letter his initial thoughts on the Treasury Committee’s report on ‘The Solvency II Directive and its Impact on the UK Insurance Industry’ and its recommendations. On 27 February the PRA published a formal response, as requested by the Treasury Committee, providing further detail on the areas discussed in the letter.

The response notes there are a number of differences between Solvency II and ICAS, and as the PRA’s experience of operating under the Solvency II Directive increases they are committed to making improvements where the regime is not working as intended, including in the areas highlighted by the Committee, while delivering the PRA’s statutory objectives and remaining within the constraints of the law.

The PRA has limited scope to change Solvency II due to its detailed, rules-based nature. But they are committed to making improvements to the PRA’s implementation of it, where appropriate, and where they have discretion to do so, and reflecting the common ground between the Committee, the industry and the PRA about aspects of Solvency II which do not work well.

The PRA's response covers four parts:
  1. an overview of the UK insurance industry and sets out the rationale for the prudential regulation of insurers;
  2. how Solvency II differs from ICAS and the impact Solvency II has had on insurers since it came into force on 1 January 2016;
  3. the Treasury Committee's recommendation in respect of the Secondary Competition Objective, and the points raised by the Committee about the PRA’s engagement with industry and its skills and experience in insurance;
  4. the PRA's response to specific policy recommendations made in the Committee's report and provide an update on further developments on other policy issues raised by the Association of British Insurers during the Committee's inquiry. 
Financial Services Compensation Scheme - Management Expenses Levy Limit 2018/19 – PS5/18
On 29 March, the PRA issued a Policy Statement (PS5/8) which follows its Consultation Paper (CP) 3/18 ‘Financial Services Compensation Scheme – Management Expenses Levy Limit 2018/19’.

The PS sets out the final rules for the Financial Services Compensation Scheme (FSCS) Management Expenses Levy Limit (MELL) for 2018/19. The PRA received no responses to the CP in which the PRA and FCA consulted on a proposed MELL of £77.7 million for 2018/19.

Responses to CP18/17 Occasional Consultation Paper – PS6/18
On 29 March, the PRA issued a Policy Statement (PS6/18) providing feedback to responses to Chapters 2 to 6, 9 and 10 of its Consultation Paper (CP) 18/17 ‘Occasional Consultation Paper’ (the CP). The PS also includes the final rules and updated Supervisory Statement (SS) 13/13 ‘Market risk’, and SS36/15 ‘Solvency II: life insurance product reporting codes’ as set out in the appendices.

The changes to the rules and SS’s, which for insurers are minor wording changes, will take effect from Friday 30 March 2018.