This could occur as part of a reform package comprising three main components: first, a large cut to the “Risk Margin”, which is an extra liability that firms have to carry in order to make it more likely that another firm will agree to take on their insurance policies if the firm gets into trouble, to ensure policyholders are still protected in that scenario; second, a package of measures to remove unnecessary bureaucracy from the regime and enable insurers to invest in a wider set of assets; and third, measures to put one part of the regime (the “Matching Adjustment”) onto a more sustainable footing. While there are important issues to debate on the first two elements, it’s on the third of these that there is the main current difference of view between the PRA and parts of the life insurance sector and I will focus mainly on that element in my remarks today. What is the “Matching Adjustment” and why does it matter? The main point of contention in the review is what, if anything, to change about the calibration of a part of the regime called the “Matching Adjustment” (or “MA” for short). It’s usually at this point in any speech about insurance regulation that most people switch off, but bear with me while I try to bring the issue to life. First, what is this “MA” and what does it do?
What should we do about this? Based on the analysis and evidence we have reviewed, we think we need to take some steps now to guard against these problems with the MA leading to an insurer getting into trouble in the future. As part of the wider package of reforms under consideration, we think those steps should also support the government’s investment objectives. This should occur in one or both of two ways. First, our analysis indicates to us that the combined effect of the reforms – in particular loosening the risk margin while tightening the MA – should free up a significant amount of capital for insurance companies across the sector, which they could choose to re-deploy into investment if their boards support that course of action rather than returning it to shareholders. [11] We think that on recent economic conditions – specifically, those at both year-end 2020 and yearend 2021 – the amount of capital released would be equivalent to 10-15% of the current capital held by life insurers, which could support between £ and £ in additional investment in the economy. In higher interest-rate environments the figure would be a bit lower, simply because the risk margin in its current form shrinks as interest rates go up and therefore the large cut we propose releases less capital when rates are higher. But we think it is still a material release – for instance we estimate it would be 5-7% under one long-run 'rates up' scenario.