Solvency II one year on: Bank of England is cautiously optimistic
Regulations to ensure UK insurers hold sufficient capital have been a success despite being too costly and taking too long to put into practice, the Bank of England said today, one year after the rules first came into force.
Insurance companies will report their first annual results including disclosures on Solvency II in the coming weeks.
And David Rule, the Bank of England's executive director on insurance supervision, took the anniversary as an opportunity to reflect on how the process had played out. He said:
Solvency II was too long in the making and expensive to implement for both regulators and industry. But that is the past. Broadly, it is now working well.
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Rule did highlight some areas where he felt Solvency II had "shortcomings". The most notable was in connection with the life insurance sector, which has long legacy annuity payouts to meet in the future, and firms' sensitivity to risk margin.
The regulations attempt to define risk margin as the amount an insurer would have to pay a third party to take future liabilities off its hands.
The risk margin calculation increases as interest rates fall. Rule said: "With the fall in sterling interest rates between January and September 2016, the overall risk margin of major UK life firms rose from around £30bn to nearly £44bn."
However, Rule added: "Bank analysis has found that that margin at which insurance liabilities have transferred between firms in the past is not nearly so strongly correlated with interest rates."
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The Bank of England went on to explain why there was such a level of scrutiny over insurer's Solvency II models. Unlike banking regulations, which following stress tests can dictate lenders set aside increased capital to cover increased risk, financial models are signed-off at by regulators at the start of the process.
"Allowing firms to use internal models to calculate their solvency requirements is an example of how Solvency II meets the needs of the UK insurance sector," said Rule.