CP12/23 – Review of Solvency II: Adapting to the UK insurance market

The Prudential Regulation Authority (PRA) has published a consultation paper, CP12/23, outlining proposed reforms to Solvency II, the prudent regulatory framework for insurers in the UK which was „overtaken“ from the EU following the exit from the European Union. The paper is the first of three planned consultation papers as part of the Solvency II review. The aim is to establish a new regulatory framework called Solvency UK, which is expected to enhance competition and dynamics in the insurance sector while maintaining policyholder protection.
The PRA recommends reading the consultation paper in conjunction with the „Government’s response to its Solvency II review consultation“, reported by EventID#18882.
The proposed reforms primarily focus on simplification, flexibility, and proportionality, and they provide scope for judgment by firms and the PRA to ensure appropriate prudential outcomes. This particular consultation does not cover changes to the „Matching Adjustment and Investment rules“, which will be addressed in a separate second consultation paper which is scheduled to be launched in September. A third consultation paper in early 2024 will complete the review and focus on transferring remaining EU law into PRA rules. According to the PRA, it plans to implement most reform measures by the end of 2024.
##### The currently proposed measures concern the following key issues in connection with Solvency II and include the following:
(1) Transitional measures on technical provisions (TMTP) and the transitional measure on risk-free interest rate (TMIR): TMTP and TMIR are transitional measures that were introduced to help insurers transition from Solvency I to Solvency II. The PRA proposes changes primarily to simplify the TMTP calculation and so to reduce costs and burdens on affected firms. Specifically, the PRA seeks to remove the financial resource requirement (FRR) test, allow firms to „calculate TMTP at the final day of each reporting period, and remove the requirement for firms to seek the PRA’s permission for a recalculation“. Furthermore, the TMTP calculations would no longer have to be signed-off by an audit committee. Finally, the PRA would mandate that all insurance companies gradually reduce their TMTP over the transitional period and would limit the TMTP permissions to technical provisions related to business written before 2016.
(2) Internal Models (IM): The PRA seeks to establish a new internal model framework that may be used by firms to calculate regulatory capital requirements. The objective of the new framework is to streamline requirements on firms and increase operational flexibility. Specifically, the PRA proposes to significantly simplify the tests and standards required for new IMs and changes made to existing IMs while ensuring that appropriate internal modeling standards are maintained. At the same time, the Authority seeks to introduce greater flexibility in granting permissions for firms to utilize IMs in calculating their Solvency Capital Requirement (SCR). This flexibility would apply to granting new permissions and making variations to existing permissions and include flexibility with residual model limitations provided that certain safeguards are maintained. Also, the PRA proposes to introduce an ongoing review process for IM, the so-called internal model ongoing review (IMOR) framework, which would consist of four parts: an ongoing assessment of approved IMs, oversight over firms using IMs, oversight over firms that seek to change IMs, and responses to identified residual model limitations (RMLs).
(3) Flexibility in calculating the Group SCR: The PRA is putting forward a proposal to provide insurance groups with increased flexibility in calculating the group SCR. The aim is to address situations where the current calculation might result in a higher group SCR than necessary to adequately cover group risks. Specifically, the PRA proposes to temporary allow the use of two or more different calculation approaches when determining the consolidated group SCR. For example, a group could employ an internal model for certain entities and the standard formula for others, or it could utilize a combination of different IMs or partial IMs. This option would particularly assist groups that lack a single group IM due to recent inclusion within group supervision, restructuring, mergers, or acquisitions. A new Statement of Principles (SoP) would outline the factors considered by the PRA in deciding whether to permit the use of multiple calculation approaches. Permission for this approach would be granted for a maximum of two years.
(4) Third country branches: The PRA proposes to eliminate certain rules that currently apply to third-country branch undertakings in the UK. These rules pertain to the calculation of the branch solvency capital requirement (branch SCR) and branch minimum capital requirement (branch MCR). The PRA also proposes the removal of the obligation to establish and report a branch risk margin (branch RM) and the requirement to hold assets in the UK specifically to cover the branch SCR (SCR localization requirement).
(5) Reporting and disclosures: The PRA is suggesting multiple changes to the reporting requirements of Solvency II for insurance groups and third-country branches which aim to simplify reporting, reduce the burden on firms, and enhance the quality of data received by the PRA. For example, the Authority proposes to consolidate group Solvency Capital Requirement reporting which would only necessitate one template to be filed for the SCR of a group. Also, the PRA proposes to remove the requirement for insurance groups to report SCR by risk module which is already reported at the subsidiary level, thereby avoiding duplication at the group level. Furthermore, the PRA intends to introduce a new template for reporting SCR for ring-fenced funds and matching adjustment portfolios. This will offer the PRA a better understanding of the shareholder SCR and the policyholder SCR.
(6) Threshold for coming under the remit of Solvency II: The PRA proposes to increase and denominate in GBP the thresholds that apply to come under the scope of Solvency II, namely the gross written premium income of a firm and the firm and group technical provisions, from €5 million to £15 million and from €25 million to £50 million respectively.
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There are many other issues discussed in the consultation paper, ranging from the application of capital add-ons, to administrative changes throughout the PRA Rulebook. Please refer to the original legal document for more detailed, comprehensive information.