The government has translated[1] this into three objectives: to spur a vibrant, innovative, and internationally competitive insurance sector; to protect policyholders and ensure the safety and soundness of firms; and to support insurance firms to provide long-term capital to support growth, including investment in infrastructure, venture capital and growth equity, and other long-term productive assets, as well as investment consistent with the government’s climate change objectives. These are consistent and mutually supportive objectives. Safety and soundness underpin the other two objectives: the sector can only be internationally competitive if it operates within a robust and reliable infrastructure, which includes the prudential regime as well as things like the legal system; and only a financially sound insurance sector  Goldilocks and the three pillars: how much capital is just right? ‐ speech by Anna Sweeney | Bank of England  Page 2  can make a sustainable contribution to long term investment. Conversely, an innovative sector, that supports the wider economy through long term investment, is ultimately a sounder one. Tailoring will mean reforms to specific aspects of the regime that are not well-designed or imperfectly calibrated for the UK, and are currently distorting incentives and behaviour. The risk margin is probably the best known example. The concept – a margin over best estimate of liabilities so that they are held on the regulatory balance sheet at an estimate of their transfer value – is sound.
But of course the existence of this safety net blunts the policyholder incentive to distinguish between a high risk and a low risk insurer at the point of taking out a policy. Paradoxically the stronger the safety net, the stronger the other two regulatory pillars need to be to hold it up. The less the market and policyholders discipline a firm, the more the regulator needs to do it for them, including by policing financial standards. Pillar 2: intervention and risk management Pillar 2 contains a range of qualitative measures, but broadly speaking they can be divided into the ladder of intervention, and requirements for good risk management, including the prudent person principle. These are both intimately connected to how we define capital adequacy. The ladder of intervention is critical to preventing gambling for resurrection: it formalizes and defines the power to intervene before the interests of shareholders and policyholders diverge, in the same way that debt covenants protect creditors by giving them the ability to intervene in clearly defined circumstances under which their interests will diverge from those of the providers of equity capital. The role of regulatory capital in relation to the ladder is to buy time for that intervention.