Solvency II 'working well' one year on, says PRA supervision head

Prudential Regulation Authority (PRA) director of insurance supervision David Rule said that the regulator's implementation of the Solvency II regime had been "robust but proportionate". In his speech, given at an Association of British Insurers (ABI) event, Rule indicated that the PRA was not seeking to reverse the regime as a result of the UK's vote to leave the EU, pointing out that some of the "most important parts" of the rules developed from the previous UK regime and UK experience.

Rule conceded, however, that the framework was "too long in the making and expensive to implement for both regulators and industry". He also agreed that some aspects of the new regime required revision at EU level, in particular "the excessive sensitivity of the risk margin to interest rates".

The House of Commons' Treasury Select Committee is currently reviewing EU insurance regulation against the backdrop of the Brexit vote. While the general view from the industry is that Brexit is unlikely to lead to a massive dilution of EU-imposed financial regulatory rules, leaving the trading bloc "provides an opportunity for the UK to assume greater control of insurance regulation", according to committee chair Andrew Tyrie.

In submissions to the committee, industry experts including ABI director general Huw Evans have called for changes to the rules to make them "more effective and competitive for a post-Brexit environment". Last month, Julian Adams of Prudential criticised the PRA for "excessively rigorous implementation" of some of the rules, particularly those around cash flow matching.

The Solvency II regime came into force across the EU on 1 January 2016, after various delays. The rules, which apply in the UK to more than 400 retail and wholesale insurance firms as well as to the Lloyd's insurance market, set out broader risk management requirements for European insurers and require firms to hold enough capital to cover all their expected future insurance or reinsurance liabilities.

The rules permit firms to develop 'internal' models in order to calculate their liabilities. These models must receive approval from the firm's own regulator, and cover "all material risks" to which firms are exposed. In the UK, 22 firms have developed either full or partial internal models, with "several more" in the pipeline, according to Rule.

In his speech, Rule pointed out that the nature of Solvency II as a 'maximum harmonising' regulation gave the PRA little scope to impose requirements on UK firms that went beyond those required by the EU rules. For example, it cannot impose additional capital requirements on Solvency II insurers in the way that it can on banks. Because of this, Rule said that the regulator's internal model approval process had to be "intrusive", to ensure that the complex proposals presented by firms were "up to scratch". The PRA "cannot simply require firms to top up capital if we think a model is too aggressive", he said.

Rule dismissed complaints from the industry about the PRA's implementation of the 'matching adjustment', which is designed to make it easier for insurers to invest in long-term assets such as infrastructure. The PRA has taken a more flexible approach to implementation than that provided for by the directive, which Rule said was "leading to a better market outcome" than if it had limited its use. He said that he was "open to suggestions" for improvement that fit within the existing legal structure.

Rule did, however, accept that the design of the 'risk margin' was currently "too sensitive" to interest rate movements, which had caused problems for life insurers with long-term liabilities such as annuities. Review of the risk margin at EU level was a "key priority" for the PRA ahead of the European Commission's planned review of Solvency II, he said.