Clifford Chance

On Monday 21 February, City Minister John Glen delivered a speech to the Association of British Insurers' (ABI) Annual Dinner in which he revealed details of the Government’s Solvency II reforms, months before the formal consultation process (expected in April).  This was followed on Friday 25 February, by an article by John Glen, reiterating the Government's intention to seize the opportunity to reform Solvency II to create "Solvency UK". The proposed changes should help attract new entrants to the UK market and capital reforms will assist UK insurers, particularly in the life sector, to invest in the Government's post-Brexit vision of UK growth and innovation.

This note examines the key reforms for in-house counsel and compliance so that, subject to the proposed consultation, firms can start to prepare for changes.

Background

The PRA is working with HM Treasury to develop potential reforms to Solvency II to achieve three objectives set by the Government: (i) to spur a vibrant, innovative and internationally competitive insurance sector; (ii) to protect policyholders and ensure the safety and soundness of firms; and (iii) to support insurers to provide long-term capital to underpin growth, in particular in infrastructure and other long-term assets, as well as investment consistent with the Government's climate change objectives. 

There has been a lot of activity in the last 18 months, including the Government's Call for Evidence, a Quantitative Impact Study (QIS) and a Qualitative Questionnaire published in Autumn 2021. The PRA has been tasked with modelling different options and the preparatory work have informed the package of reforms that will be part of the formal consultation, we believe, in April this year.  

Reforms to Solvency II go hand in hand with the proposals on the Future Regulatory Framework for financial services, for example, the responsibility that is delegated to the PRA will be based on core elements determined by the Government, making the PRA directly accountable to HM Treasury.

In addition, to mark the second anniversary of Brexit, the Brexit Freedoms Bill is being brought forward by the Government. The Bill will make it easier to amend or remove legacy EU law that was brought onto/kept on the statute book after Brexit as a bridging measure. It will also end the special status of EU law made before 1 January 2020 over domestic laws. 

"Solvency UK"

The speech by John Glen includes a full list of proposed Solvency II reforms, which include: 

• a substantial reduction in the risk margin, including a proposed cut of around 60-70% for long-term life insurers. The PRA has for some years expressed a desire for less longevity risk to be reinsured offshore and proposed changes to the risk margin are hoped to incentivise the retention of longevity risk; 
• a reassessment of the fundamental spread, to improve treatment of credit risk while avoiding introducing material volatility on to balance sheets;
• broadening the range of assets eligible for the matching adjustment portfolio;
• encouraging innovation, by supporting new market entrants through a mobilisation regime and other changes, such as changes to the threshold for when Solvency II applies, but with an option to opt-in for small firms;  
• "from Bonds to wind farms" - It is clear from the various statements on the reform of Solvency II from HM Treasury and the speech and article by John Glen, that enabling UK insurers to invest in long-term infrastructure projects is an important goal of creating "Solvency UK". The reforms are hoped to release billions in capital that can be redeployed into long-term assets that assist with the Government's economic agenda. 

Preparatory steps for legal and compliance

• Consider how your firm can engage in the consultation process that is expected in April. This may be the last significant opportunity to influence key policy changes. Evaluating the impact of the proposed changes now will put you in a good position to respond effectively to the consultation when it is published.  
• Consider how your team can prepare to identify the differences between the current 'onshored' retained UK Solvency II legislation and the new "Solvency UK" requirements. This could include technology solutions.   If you have EU (re)insurers in the group as well, this should extend to how to compare "Solvency UK" and EU Solvency II requirements and how to efficiently keep abreast of future amendments to both regimes. 
• Identify policies that need to be updated and ensure the governance process for updating is complied with (e.g. Investment policies, risk management policies).
• Changes are expected to reporting forms, ensure revised forms (when available) are on GABRIEL system and can be completed, for portfolio reporting outsourced, check whether any changes are needed to outsourcing policies/terms & conditions.
• Understand the extent of legal change and assess the impact on internal model/capital/investments/risk transfer, for example:
  • Review legal terms of assets to see if reforms mean that previously undesirable terms are no longer prohibitive, and the asset will now be eligible.
  • Consider if proposed new approaches to calculating consolidated group capital will be beneficial to your group.
  • Life insurers should review the impact of proposed changes to risk margin and matching adjustment.  This includes considering the impact on offshore reinsurance strategies if proposed changes result in tangible incentives for retaining longevity exposure.
  • Review current terms of reinsurance arrangements, to see if any opportunity to capitalise on any change in law/regulation clauses and consider future-proofing reinsurance arrangements that are currently being negotiated. 
• Potential new market entrants should keep abreast of proposed changes that assist with mobilisation for new insurers, e.g. doubling the threshold for Solvency II firms. 
• As part of the Future Regulatory Framework Review process, consider engaging in PRA and FCA stakeholder panels and keep abreast of opportunities to make industry nominations to relevant panels.  
• Determine the impact of removing the requirement that UK third-country branches hold local assets and calculate local capital requirements if applicable to your group.

Please contact any member of the Clifford Chance insurance team for further information and for how we can assist you with your preparations for "Solvency UK".