Regulatory reform has the potential to release capital from insurers that could be invested in large green and infrastructure projects ... However, there are also risks that such reforms may drive up fees, with costs being passed on to policy holders and pension savers.
The government’s Benefits of Brexit policy paper, published
in January 2022, identifies financial services as a sector with clear
potential to deliver a post-Brexit economic dividend. It calls for this
aim to be realised by tailoring ‘the regulation of our financial
services sector to better suit our market, improve competitiveness and
deliver better outcomes for consumers’.
Financial services encompasses a range of activities, from asset management and banking to securities trading, green finance and fintech. Brexit
has always presented different challenges and opportunities for each of
these, but one area that has attracted attention as an early candidate
for regulatory divergence from the EU is insurance. Here, the UK’s
regulatory framework is largely based on the EU’s Solvency II directive.
As we’ve noted elsewhere, potential post-Brexit regulatory changes
bring opportunities, as well risks and costs. This is nicely evidenced
by the case of changes to the UK’s regulatory regime for insurance –
involving a shift away from Solvency II.
Here, regulatory reform has the potential to release capital from
insurers that could be invested in large green and infrastructure
projects, thereby contributing to the government’s wider ‘levelling up’
agenda. However, there are also risks that such reforms may drive up
fees, with costs being passed on to policy holders and pension savers.
And so we see the challenge for government: it hopes to both enhance the global competitiveness of the UK’s financial services sector, whilst also preventing increased costs for consumers.
A further aspect of this tension is the need to develop a clear
strategy for post-Brexit regulatory reform that doesn’t consider
financial services as separate from the rest of the UK’s economy – but
instead takes seriously the ways in which changes in financial
regulation have the potential to either help or hinder any wider
economic policy reset.
Solvency II
Solvency II came into effect in 2016 aiming to improve the robustness
of insurance firms. Importantly, it did this by issuing harmonised,
EU-wide policies increasing the buffers firms have to hold to guard
against insolvency, and standardising aspects of corporate governance
and regulatory oversight.
This is particularly relevant to the current discussion, as the UK –
and in particular several large British insurers – have always argued
that insurance markets across the EU are diverse, reflecting different
risks, population characteristics and the like. The strategy of imposing
a one-size-fits-all approach was thus misguided, and led to unfair
burdens for some firms or national sectors.
Given this, it is not surprising that Solvency II has been identified as the source of a potential ‘regulatory Big Bang’. At a speech to the trade organisation TheCityUK in February the Bank of England Governor said that the ‘case for reform is clear’.
The first specific area for potential reform to the UK’s regulatory
regime is the risk margin –an extra reserve insurers have to hold
against some long-term policies in order to cover the potential costs of
transferring them to another firm should they fail at some point in the
future. This was not in place in the UK prior to Solvency II, and it is
widely agreed that it is too large and not well suited to the low
interest rate environment that has prevailed since 2016.
Indeed, the European Commission
has indicated that it will also look to amend the risk margin following
proposals brought forward by the European Insurance and Occupational
Pensions Authority (EIOPA).
The second area for potential reform is the matching adjustment. This
is designed to allow firms to match liabilities on long-term policies
against predictable cash inflows from certain types of investment, and
thus reduce the buffers they have to hold against those long-term risks.
Solvency II specifies the investments which can be used in this way,
but the insurance sector has argued that this is too prescriptive and
prevents it from investing in areas that the government has prioritised
for growth, notably green energy and infrastructure.
The Association of British Insurers states
that £95 billion of capital could be freed up for investment in these
areas with changes to UK policy. Following a review of the regulatory
regime for UK insurance, HM Treasury echoed
this, stating that the government views Solvency II as ‘overly rigid
and rules-based’, and that ‘reforms to Solvency II are required’.
However, the government is clear that it wants to deliver a more
competitive financial services sector whilst also ensuring ‘better
outcomes for consumers’. It is here that regulatory changes to the UK’s
insurance regulations – moving away from Solvency II – may well prove
trickier.
A former member of the Board of the Financial Conduct Authority, Mick
McAteer (who now co directs the Financial Inclusion Centre) has
recently expressed
concerns that the changes on the table could lead to higher fees and
dividends for shareholders, but also that policy holders and those with
pensions based on insurance products could lose out. He also noted that
there was a need to full public scrutiny of proposed plans.
This also raises questions about the proposals to increase the power
of financial services regulators after Brexit. The government is keen to
pass more control to regulators to deliver a more flexible regime that
can be changed more rapidly, rather than having to be debated Parliament
– as required under the current approach based on EU law....
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