On 16 March 2021 the PRA published a speech given by Sam Woods, Deputy Governor of the Bank of England and CEO of the PRA, with some important updates on the regulatory and legislative framework of the UK insurance market.
Mr Woods highlighted that regulation of the insurance sector in the UK is about to change – including a shift from legislation towards more rulemaking by the PRA as regulator. He also largely dispelled any expectations that, following Brexit, the PRA would start reducing the amount of regulatory capital that firms must hold; he stated that the PRA had not seen any “persuasive evidence” that the amount of capital in the insurance sector was either too low or too high and highlighted his doubts about a reform package which “materially decapitalises the insurance sector”.
Mr Woods covered a number of areas in his speech and much of what the PRA is proposing will not come as a shock to the insurance sector. Potential amendments to the PRA rules relating to Solvency II capital requirements have formed a fundamental part of the Treasury’s Solvency II review which commenced last year.
Mr Woods made it clear that the review will “stay true to the basic principles of Solvency II” and that the regulator sees “no appetite to tear those up and start again from a blank sheet of paper”. The review into the UK’s post-Brexit rules will not lead to any “radical departure” or a reduction in capital requirements.
Whilst there appears to be some good news on reforming the risk margin – the extra layer of capital that insurers must hold against certain kinds of long-term business, such as annuities – the PRA’s willingness to amend these provisions comes as no surprise. The PRA and the Treasury have long acknowledged that the rule has been contentious within the UK insurance industry, and the PRA has previously noted that the risk margin has been larger than anticipated for life insurance firms.
Mr Woods however expressed caution about calls for the matching adjustment – an upward adjustment to the risk-free rate where insurers hold certain long-term assets with cash-flows matching the liabilities – to be made more generous. This caution follows the long-standing PRA view that the matching adjustment has functioned as intended thus far – although last year the PRA recognised that, within what the legal framework permitted, firms may wish to change their approach to managing the matching adjustment portfolio in light of the financial turbulence caused by Covid-19. For now though, it appears that the PRA will only consider breadth of eligibility and process improvements for the matching adjustment to remove barriers to investment.
Mr Woods also discussed the “shift towards more rule-making by the regulator.” This has been considered by the PRA for some time now, and in recent months the Treasury has proposed taking greater control over financial services policymaking post-Brexit as the government wants more say over the UK’s financial regulatory system.
Last year, the Treasury proposed changes to the Financial Services and Markets Act (FSMA) which would mean the government would set “core elements of the regulatory approach” as well as the “specific purpose of the regime”. The Treasury stated at the time, that “much of our regulatory approach to financial services has been prescribed by EU legislation. Leaving the EU means the UK has the opportunity to take back control of the decisions governing our financial services sector”.
To this end, the regulator has proposed a shift in the future of rulemaking – that ultimately the PRA take much closer control of this function. The PRA’s proposed approach would involve putting the detail relating to the regulatory framework for insurers in the PRA Rulebook rather than in statute. The Solvency II rules are laid down in legislation, which makes it difficult for regulators to adjust them, something that Mr Woods noted that he wanted to change, arguing that this approach would make it easier to update rules as and when required.
Whilst insurers will welcome the flexibility afforded by a regime that can be amended to reflect the specific features of the UK insurance market and be updated more readily if it appears a rule is not working, this news will only be welcome to the extent that it doesn’t mean more rules and an increased burden on firms. The question however remains as to the PRA’s accountability, and whilst Mr Woods has set out to reassure firms that the PRA will not “go rogue”, there remains work to be done to set out in detail how the PRA will be held to account and the extent to which Parliament will oversee and fully engage in the PRA’s rulemaking activities.
Mr Woods has made it clear that we can now expect to find more of the rules that insurers need to follow in the PRA Rulebook rather than in law. In some ways though, this will be a relief for those of us who have long hoped to find everything in one place. The fundamental question is whether the PRA can be trusted with more power and how much of an active role Parliament will play going forward. The PRA believes this new model will work well, but for everyone else in the sector it’s very much a case of let’s wait and see.
