However, the review does give an opportunity we are seizing, to deal with those areas of Solvency II that we know are not working as well as they could. Sam Woods and I have both previously discussed the PRA’s concerns relating to the current regime[2] [3]. Taken together, the improvements we want to make represent an important set of reforms and can achieve the objectives of the review. Page 3  Objectives for the Solvency II review The Government set three high level objectives for regulatory reforms, namely: 1. to spur a vibrant, innovative, and internationally competitive insurance sector; 2. to protect policyholders and ensure the safety and soundness of firms; and 3. to support insurance firms to provide long-term capital to underpin 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 objective. These Government objectives are aligned with the PRA’s two primary statutory objectives of safety and soundness of regulated firms, and protection of policyholders. The PRA’s statutory objectives are reflected directly in one of the Government’s review’s objectives, and they underpin the other two: only a financially sound insurance sector can provide sustainable contributions to long-term investment. Similarly, the sector’s competitiveness depends on its operating under a robust prudential regime.
The PRA agrees with longstanding and justified concerns raised by the industry on the sensitivity of the risk margin to interest rates, and its overall quantum when interest rates are low. The Government’s April Consultation Document[9] lays out reform proposals. The potential impact of these reforms can be significant. For general insurers, we believe that a roughly 30% cut in risk margin can be justified, similar to the impact on EU firms of reform proposals made by the European Commission. This outcome would therefore ensure no disadvantage on competitiveness grounds for GI firms. For life insurers, given the longer term nature of the insurance risks and the presence of closely matched assets, we believe that a greater reduction of around 60% is possible – but only if the FS is also reformed to better reflect credit risk retained by life insurers. Simultaneous reform of both risk margin and MA can also correct a potential distortion in the current framework that has become apparent over time. Namely that, broadly speaking, under the Solvency II regulatory regime, some long term insurance risks – in particular, longevity risk – appears to have been highly-capitalised, relative to credit risk. This has created an environment where life insurers have been retaining less and less insurance risk, but acquiring additional credit risk, including counterparty credit risk. This trend has become more evident since Solvency II came into force, and raises questions about the effectiveness of the regime, in terms of both competitiveness and in mitigating risks to our statutory objectives.