Treasury committee inquiry into Solvency II: the case for change - “at a glance”

The House of Commons Treasury Committee ("TC") is looking at the case for changing, or even replacing, Solvency II in a post-Brexit world. Its inquiry provides firms and industry bodies with perhaps their best opportunity to influence the future content of UK insurance regulation. The possible endorsement by the TC of views expressed by industry is likely to be particularly persuasive in future deliberations by the PRA. This guide looks at demands for reform put by industry to the TC and at the PRA’s response to some of the questions being asked of it. Comments attributed to Sam Woods, Deputy Governor for Prudential Regulation and CEO, PRA were made in oral evidence given to the TC on 22 February 2017. TERMS OF REFERENCE FOR TC INQUIRY The objectives of the inquiry are to: • Consider the options for the UK insurance industry that are created by the decision to leave the EU • Assess any impact of Solvency II on the competitiveness of the UK insurance industry • Examine the impact of Solvency II on the role of insurance in meeting the needs of UK customers and the wider UK business economy • Assess any lessons for both regulators and industry from the introduction of this major piece of insurance harmonising legislation. July 2016 EU Commission launches review of Solvency II SOLVENCY II REVIEW MILESTONES 13 Sept 2016 TC launches Solvency II inquiry Early 2017 TC hears oral evidence End of 2017 Deadline for EIOPA advice on Solvency II review End of 2018 First review of Solvency II due to be complete TC INQUIRY - KEY THEMES RAISED IN ORAL AND WRITTEN EVIDENCE THE PRA’S VIEW “The PRA’s implementation of Solvency II has been robust but proportionate, in line with our statutory objectives.” “We are not enforcing a higher standard than required by Solvency II.” David Rule, Executive Directive of Insurance Supervision, PRA “Basically, Solvency II is a sensible regime and is a good regime.” “But there are some bugs that need to be ironed out.” Sam Woods “Brexit provides an opportunity for the UK to assume greater control of insurance regulation.” Andrew Tyrie MP, TC Chairman “Solvency II was meant to create a pan-European harmonisation of regulation; it absolutely has not.” "We have produced a system that has way too much capital for all sorts of reasons." Nigel Wilson, CEO, Legal & General THE ABI’S VIEW Evidence provided to the TC during the course of its inquiry highlights the following : • Competing priorities within the industry lead to different levels of enthusiasm for Solvency II reform • Over-implementation by the PRA has put UK firms at a competitive disadvantage; design flaws in the Solvency II regime are only a part of the story • An overly complex and detailed regime makes it difficult to apply Solvency II requirements in a proportionate manner • There needs to be some formalisation of the role of the PRA in promoting UK competitiveness • Post-Brexit, the UK should avoid becoming a “rule-taker” instead of a “rule-maker” as a consequence, perhaps, of seeking to replace passporting rights with equivalence status • Overall, principles of Solvency II are sound; the regime is broadly fit for purpose for the UK market • After 10 years and over £3bn, the fundamental replacement of Solvency II is not merited • Brexit does, however, create the opportunity to refine the current regime so that it is appropriate for the UK market • “Gold-plating” of Solvency II requirements by the PRA goes beyond what is necessary for financial stability • Some changes are within the PRA’s remit today; others come down to poor design and need to be addressed (for now at least) at EU level “It is early days for Solvency II … but we have not seen at Lloyd’s new entrants being put off by the fact that they are entering a Solvency II regulatory regime.” John Parry, Head of Finance, Lloyd’s of London “The marginal benefit that we get from Solvency II is not worth £3 billion.” Julian Adams, Group Regulatory Director, Prudential THE CASE FOR CHANGE – “AT A GLANCE” CONTACTS DESIGN VS IMPLEMENTATION Industry argues that the PRA’s over-implementation of Solvency II has resulted in distorted market behaviour e.g. by driving longevity risk outside the UK market and consumer detriment e.g. by reducing product choice. Life companies point, in particular, to the inflexible approach taken by the PRA to applying criteria for use of the matching adjustment e.g. in relation to equity release mortgages. Other areas for concern include the PRA’s treatment of sovereign risk, application of the dynamic volatility adjustment, recalculation of transitionals and inflexibility of processes e.g. for major internal model change; group supervision approvals. Whilst the PRA accepts that some changes are in its gift, it argues that others are not. Overall, it takes the view that its approach to implementation of Solvency II has been proportionate and flexible, but recognises that aspects of the regime don’t work properly and need to be fixed. Where fault lies in each case can raise difficult questions of law: • A purposive approach to interpreting Solvency II legislation can lead to greater divergence in views than a more literal approach to interpretation; • Even allowing for a purposive approach to interpretation, EU legislation is often drafted in loose language that permits a range of meanings, leaving scope for variation between national systems. THE BROADER PERSPECTIVE - BREXIT Once the UK leaves the EU, the design vs implementation debate arguably becomes redundant as the UK is no longer constrained by Solvency II. In practice, the position is more complex. For example: • For some firms, particularly general insurers, the ideal outcome for Brexit negotiations would be to secure a bespoke deal that preserves access to the single market; • Although this looks increasingly difficult, it would be likely to mean that the UK regime must remain very close to, if not the same as, Solvency II; • Achieving equivalence status is also likely to mean preserving a regime in the UK very similar to Solvency II; • Other firms, particularly in the life sector, favour reform of Solvency II over retaining the passport. They argue that, while the existing regime does not work in the UK, UK insurers are less competitive in non-EEA markets. A flawed regime is also driving activity off-shore and preventing innovation for the benefit of consumers. AREAS OF AGREEMENT Nonetheless, the PRA and industry agree that certain aspects of the Solvency II regime require reform. Risk margin - Top of most lists (at least for life companies) is concern that the risk margin is too sensitive to the level of risk-free rates, causing firms to hold significantly more capital than should be necessary . The PRA’s preferred approach is to fix this issue at source i.e. at an EU level. Mr Woods recognised industry’s preference for the PRA to take action locally but regarded this as sub-optimal because it would undermine the PRA’s ability to achieve change in Europe. Reporting - Several responses to the TC argue that Solvency II reporting requirements are disproportionate. This is a particular issue in the UK as the PRA has introduced its own templates in addition to those prescribed at an EU level. In response to questions from the TC, Mr Woods indicated that he has an “open mind” on this issue. The PRA will carry out a comprehensive review of current requirements to see whether there is scope for change. ABI proposed reforms - Of 23 Solvency II reforms proposed by the ABI, Mr Woods indicated to the TC that he saw some merit in five and disagreed on eight. His view on the remaining 10 sits somewhere in the middle. He has agreed to prepare a written response on each to share with the TC. Alison Matthews Consultant, Corporate T +44 20 7466 2765 alison.matthews@hsf.com Matthew Brewer Senior Associate, Corporate T +44 20 7466 2382 matthew.brewer@hsf.com ADDITIONAL BREXIT MATERIAL Additional information on the implications of Brexit for businesses can be found on our Brexit hub, including a recent update of our general client legal guide "The UK vote to leave the EU". Other information includes: • Brexit timeline • Brexit: "at a glance" key issues for lobbying by insurers • "Access to the single market" – an explanation for the (re)insurance sector • Brexit: impact on EEA insurers and non-EEA headquartered groups TREASURY COMMITTEE INQUIRY INTO SOLVENCY II SOURCES OF INFORMATION Sources referred to in this guide include: • TC inquiry into EU regulation of insurance • Insurers call on government to “refine not replace” Solvency II, ABI • Solvency II – one year in, David Rule, PRA • Treasury Committee, oral evidence, 25 January 2017 Geoffrey Maddock Partner, Corporate T +44 20 7466 2067 geoffrey.maddock@hsf.com Barnaby Hinnigan Partner, Corporate T +44 20 7466 2816 barnaby.hinnigan@hsf.com Solvency II does not discourage long term investment but “at the margin we could make it a bit better”. The risk margin is “fundamentally flawed and needs to be fixed ”. Sam Woods