A new report commissioned by the ABI, and produced by KPMG, has been published today in response to the Government’s consultation on Solvency II. The analysis sets out how changes to the Matching Adjustment and the Risk Margin mechanisms could free up £95bn for re-investment, as well as providing broader benefits for the economy, HM Treasury and customers. These changes to the Solvency II regime would still ensure the industry holds enough capital to withstand a 1-in-200-year shock and meet its obligations whilst managing its assets responsibly and safely.
The changes proposed by the ABI would mean:
- £60bn of the c.£300bn funds held in Matching Adjustment portfolios could be re-invested if rules allow pension funds that insurers manage to invest in a broader and greener range of assets. It is currently much easier to invest in a highly-rated mining company than it is to invest for 30 years in a wind farm. The Matching Adjustment exists to ensure that long-term investments designed to pay long-term liabilities such as annuities are not valued on a short-term basis. The current framework, designed in the aftermath of the financial crisis, forces insurers and long-term savings providers to invest heavily in highly-rated corporate debt and in sovereign bonds. This skews investment towards non-green investments and makes it harder to invest in renewable energy, infrastructure and companies that will be vital to a successful transition to net zero. Amending the Matching Adjustment rules will ensure it reflects the types of investment that are safer and more productive in a world that will be changing rapidly to meet the challenges of climate change.
- £35bn of capital currently backing the Risk Margin, solvency capital requirement (SCR) and firms’ capital buffers could be redeployed either to increase investment in the sector, support the annuity market, or be returned to shareholders for investment elsewhere in the economy. The Risk Margin is an additional layer of capital, introduced by the EU, that insurers are required to hold over and above what they need to meet their obligations to customers and their capital requirement buffer. It is calculated by a formula that is overly-sensitive to very low interest rates, forcing insurers to hold billions of excess capital for no purpose and contributing to low levels of supply and competition in the annuity market.
- £16.6bn would be generated in additional annual GDP in the UK by 2051 at no cost to the Government. Every £1 productivity enhancement in 2021 will lead to a nearly £4 improvement in GDP in 2051. This is equivalent to a net present value economic benefit of c.£190bn in additional GDP over the next 30 years.
- An extra £1.4bn by 2030 could be received by the Exchequer in tax as a result of the economic growth.
- World-leading standards of policyholder protection would continue. The UK regulatory framework would remain one of the most sophisticated in the world, offering a high level of protection for policyholders. Insurers would continue to be required to hold capital to withstand a 1-in-200-year shock, take a sophisticated approach to risk management, and be subject to close and continuous supervision by the Prudential Regulation Authority
Huw Evans, ABI Director General, says:
“The insurance and long-term savings industry can do so much more to help our economy and society but only if Solvency II is made fit for purpose for the UK. Our sector can invest an amount equivalent to the budgets of eleven UK government departments in renewable energy, economic recovery and infrastructure investment if these reforms are made – with policyholders still having one of the best protected systems in the world. The independent analysis by KPMG experts sets out the £95billion of opportunities available and we must use our freedom from EU rule-making to seize them.
“Even with these changes, the UK market will still be one of the most highly regulated sectors in the world. This remains important to our future as an international financial centre and global capital of insurance. Nothing in the sensible changes we have proposed to an overly-prescriptive Solvency II regime will impair our ability to promote and lead high international regulatory standards. Indeed the EU is consulting on reforming Solvency II itself.”
The Government is also undertaking a consultation on the Financial Services Future Regulatory Framework (FRF) review, launched in parallel to the Solvency II review. The ABI also sees this as is an important review to ensure we have a UK regulatory system that is designed for the UK market. Legislating for and implementing changes to the whole financial services regulatory system is naturally a longer-term commitment so it is essential that these targeted Solvency II reforms are delivered first as we look ahead to the post-Covid economic recovery, and to the role the UK has to play in tackling climate change in the run up to COP26.