Solvency II Call for Evidence Response

How Solvency II can be Improved for Smaller General Insurers

HM Treasury’s recent call for evidence as to how the UK can use its Brexit freedoms to improve Solvency II for UK insurers, policyholders and society closed a few weeks ago. City Actuaries shares some thoughts on the Call and some of the specific items addressed.


The Call for Evidence is internally inconsistent. The introduction sets out objectives that are a mix of the obvious – policyholder protection and a thriving insurance sector – with the political: long-term investment in venture capital, growth equity, infrastructure and consistency with Government’s climate change objective.


Having set this scene, the questions then dive into the arcane technical world of risk margin, matching adjustment and the transitional measure for technical provisions, amongst other things.


There is a section on the calculation of the solvency capital requirement, which is probably the area in the numbers that has the greatest impact on the incentives and disincentives of investing in different assets and asset classes. But apart from an open question on what might be changed, there is no hint to indicate what the government might be thinking. Which leads me to wonder if it is thinking about anything other than having a world-leading solvency regime (yes, “world-leading” did feature twice in the HMT document).


Having said in the introduction that Government supports the underlying principles of a market-consistent and risk-based solvency regime, it isn’t clear how these principles can be squared with the desire to encourage insurers to invest in illiquid, long-term, high-risk assets without compromising policyholder security and/or the price of insurance.


There are areas where we believe Solvency II can be improved, especially for small general insurers.


The place to start would be with the thresholds for inclusion in the Solvency II regime. It seems to us that a premium income threshold of £25m, or assets of £100m, might be more appropriate for all of the provisions to apply.


In terms of the technical aspects of SII, we believe the current risk margin is too large for many insurers. In the annuity market, we understand that the current levels are not consistent with market prices for reinsurance, and a lower cost-of-capital could easily be justified.


For the solvency capital requirement we think there is scope to allow for more flexibility in the use of undertaking specific parameters when using the standard formula to calculate capital requirements. The current EIOPA method is overly prescriptive and a wider range of methods should be made acceptable (as seemed to be envisaged in the original design phase of Solvency II). These can be used to more accurately calculate the risk capital required.


Students of Solvency II will know that there are three pillars to the regime:

  • Financial requirements,
  • Governance requirements, and
  • Reporting requirements.


However, the Solvency II reporting requirements are significantly more onerous than the previous Solvency I regime, and it isn’t very clear how much of the collected data is used by the regulators. Certainly the timing of some queries we have seen from regulators suggests that they take a long time to make their way onto a supervisor’s desk.


The standout area of redundant reporting is the look-through of collective funds. The look-through makes sense in trying to quantify and manage concentration risk. And, we suspect, it is actually more useful to smaller insurers than it is to larger ones. But, in our view, it does not need to form part of reporting. Attestation by a senior manager should be sufficient.


Which leads us on to governance. In the development of Solvency II, research into past failures of insurance companies identified flawed or weak governance as the most frequent principal reason for failure, although it may have manifested itself as insufficient reserving or poor pricing. So, the strength of boards and effectiveness of risk management frameworks are key to having a thriving insurance industry that looks after the interests of its customers. I would take that further and try to place the ORSA (Own Risk and Solvency Assessment) at the heart of supervision.


Solvency regimes have always deemed that being solvent at a date that is now in the past is (almost) sufficient to continue in business. In fairness, regulators do now use the ORSA to give them a much more holistic picture of insurers (especially smaller ones), but our suggestion would be to formally make the ORSA the primary regulatory tool and perhaps require boards to attest to the ORSA as a true and fair reflection of their expectations for the business over a specified horizon; we would suggest that two years is sufficient as a starting point. This wouldn’t be very different in principle from the going concern test that boards are required to carry out each year before signing their financial statements.


It will be interesting to see where this review leads and whether it brings meaningful change to the management of UK insurers and their role in society.


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