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Solvency II reforms could hinder investment

Author: ICAEW Insights

Published: 02 Sep 2022

Proposed reforms to the Solvency II regulatory regime would make it harder and less attractive for much of the insurance sector to invest in long-term infrastructure assets, despite a strong political will to make it easier, experts say.

Currently, the proposals put forward by the Prudential Regulation Authority (PRA) would grant the sector additional capital for investment by reducing the risk margin that governs the amount of extra capital that must be held above their liabilities. This reduction would reduce the risk margin by 60% for life insurers and 30% for general insurers.

However, while the insurance sector has welcomed this element of the reforms, it has warned that the addition of a credit risk premium (CRP) to the methodology of the matching adjustment (MA) measure would result in life insurers and annuity providers having less capital to invest than under the current arrangements.

“While illiquid assets would still offer a larger spread than bonds following the introduction of a credit risk premium in the fundamental spread adjustment, the proposal may disproportionately reduce the attractiveness of holding illiquid assets, such as real estate and infrastructure debt,” says Matthew Francis, Insurance Director at KPMG.

While the PRA has stated that the full package of measures, which has also pledged to broaden the range of assets that insurers can invest in, would increase the availability of capital by 10% to 15%, leading insurers and industry bodies have stated it would in fact lead to an overall reduction.

Responding to the proposals, the Association of British Insurers stated: “The current proposals would not achieve the suggested release of capital for re-investment. Life insurance firms would have to hold more capital than currently required, preventing them from being able to provide the funds that are needed for investment across the UK.”

Such an outcome from the reforms would appear to be in stark contrast to the wishes of both of the contenders to be the next Prime Minister. Speaking during a leadership debate in July, Liz Truss, the current frontrunner, stated that she wanted “turbo-charge” investment into towns and cities through the reform of Solvency II.

Similarly, her opponent and the former Chancellor, Rishi Sunak, has stated he wanted the reforms to unleash “tens of billions” of capital for investment in the country to support economic growth and infrastructure to combat climate change.

However, in a sign of clear tensions between the political objectives and those of the regulator itself, Sam Woods, CEO of the PRA has said that any package of reforms that did not change the matching adjustment would be “seriously unbalanced”.

You can read more from the Financial Services Faculty here: The realities of Solvency II reform for insurers

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