The Financial Times this morning reported “growing tensions” between Downing Street and the Prudential Regulation Authority (PRA) over reforms to Solvency II.
In a nutshell: Boris Johnson wants the insurance industry to be liberated from EU shackles, launch an investment “big bang” and give him a Brexit win to crow about. But the PRA is being more cautious.
It’s not a new theme. At the end of last year I commented on the prospects for Solvency II reform, noting: “The PRA has a fine line to tread. Show too much caution, and the government will begin to wield its power.”
Tensions between government and regulator were already flaring up by February, ahead of the Treasury’s launch of its Solvency II reform plans.
But this latest skirmish perhaps points to the tension between Number 10 and Number 11 Downing Street, rather than any point-picking over a relatively obscure piece of financial legislation.
As one commentator so neatly put it: “I will eat EIOPA headquarters if Boris can explain a single provision in Solvency II”.
Let’s not forget that earlier in the week Rishi Sunak, Chancellor of the Exchequer and resident of Number 11, met with UK life insurers and promised them a speedy reform. Johnson thinks it could be done even quicker and better.
The Treasury position has been repeatedly illuminated by Economic Secretary John Glen, who reminded the TheCityUK's Annual Conference just yesterday that reforms to Solvency II aim to “spur a vibrant and competitive insurance sector without compromising our high standards and policyholder protections”.
The Treasury seems to see a balance is to be struck between “vibrant and competitive” and “policyholder protection”. Is Number 10 emphasising the former?
Governments should be wary about liberating insurers to invest in whatever they want. They should be even more careful about the matching adjustment mechanism that allows life insurers to take tens of billions of capital credit upfront for risks they assume will not materialise.
In the not too distant past, the PRA had to take action on life insurers that invested significant chunks of their portfolios in equity-release mortgages. It turned out some were using discredited models and bonkers assumptions about property price growth to value the mortgages.
Investment “big bangs” might be good news in the short term, but they can backfire, badly.