PRA pauses work on risk margin reform - UPDATED

Published in: Regulation, Solvency II, UK, Rest of Europe, Brexit

Companies: Prudential Regulation Authority, PRA, Association of British Insurers, ABI, European Insurance and Occupational Pensions Authority, Eiopa

Editor's note: This story was updated on 7 June, adding paragraph 9 with quote from David Rule and final paragraph with comment from Treasury Committee

The UK’s Prudential Regulation Authority (PRA) has paused work on reforming the Solvency II risk margin, blaming the “ongoing uncertainty” about the UK’s future relationship with the EU.

In a letter to Treasury Committee chair Nicky Morgan MP, PRA chief executive Sam Woods wrote that its work to date – focusing on the use of future risk mitigation and transfer mechanisms – “has some merit as a solution to the problem the risk margin is causing”. 

“However, in the context of the ongoing uncertainty about our future relationship with the EU in relation to financial services we do not yet see a durable way to implement a change with sufficient certainty for firms to be able to rely on it for pricing, capital planning and use of reinsurance.

“We will keep this position under review and will update the Committee as soon as we can see a clear way forward.”

Reforming the risk margin has been a major preoccupation for the industry and the PRA.

Annuity writers, in particular, are forced to hold significant extra capital against risks that according to the rules of Solvency II cannot be hedged.

Insurers have responded by reinsuring longevity risk offshore, usually, in the US and Bermuda – a situation that the PRA considers a significant prudential concern if left unchecked.

InsuranceERM understands the PRA remains committed to reforming the risk margin, but it is unclear what exactly led to the decision to pause the work at this stage and under what circumstances the PRA would resume work.

Speaking at a conference in London on 7 June, David Rule, PRA executive director for insurance supervision, said: "Brexit negotiations at the moment are too uncertain to proceed with risk margin reform. It will all boil down to the UK relationship with the European Commission. We need clarity as to whether we will have the ability to have a regulation different from Solvency II or not to do something about risk margin."

Huw Evans, director general at the Association of British Insurers told InsuranceERM: “It is very disappointing that the Prudential Regulation Authority has chosen not to take action to address an issue which they themselves have said is having a highly damaging impact on the UK insurance industry and its customers.

"While it is a step forward for them to confirm a technical solution to the problem exists within the current Solvency II framework, that only makes it more frustrating to hear that uncertainty about Brexit has prevented the regulator acting in a way that makes sense for UK plc.”

The European Insurance and Occupational Pensions Authority (Eiopa) told InsuranceERM that the risk margin would be discussed in the 2021 Solvency II review.

"In the advice on the standard formula submitted to the European Commission end of February this year, Eiopa analysed cost-of-capital rate, one the key parameters of the calculation. Other elements of the risk margin should be assessed in the upcoming overall review of the Solvency II regime due in 2021," an Eiopa spokesperson said. 

The European Commission declined to comment.

Morgan declined to comment on the letter at the time of writing, but the Treasury Committee told InsuranceERM it may choose to look at the issue in more detail in the future. 

Christopher Cundy, Cintia Cheong, Aggelos Andreou