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The current design of the risk margin is too sensitive to the level of interest rates, and it is therefore too high at current low levels of interest rates. This is particularly true for long-dated insurance contracts such as annuities. Broadly speaking, transitional measures off-set the risk margin for business written before Solvency II, and for new annuity business firms have responded to the level of risk margin by reinsuring a substantial proportion of the longevity risk offshore.
This build-up of the stock of offshore reinsurance is an unintended consequence and, if left unconstrained, would become a significant prudential concern.
PRA‘s supervisory reviews of firms' reinsurance activities have not, however, brought to light significant immediate concerns about the way in which that reinsurance is being conducted.
Similarly, it does not appear that Solvency II is having a detrimental impact on policyholders via annuity prices, the dominant drivers of which continue to be risk-free interest rates and corporate bond spreads.
PRA has been considering its supervisory approach to the use of future risk mitigation and transfer mechanisms in a number of contexts, including the calculation of the risk margin. PRA has looked at this option very carefully, and think it 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 PRA does 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.
PRA will keep this position under review and will update the Committee as soon as it can see a clear way forward.