UK Solvency II reform raises potential of investment portfolio restructuring: AM Best

According to AM Best analysts, plans to reform the Solvency II framework for UK insurers will allow the country’s life insurers to invest in a wider array of assets, and likely lead to a higher proportion of UK-based assets underpinning the UK annuity portfolio.

On 17 November 2022, the UK Treasury published its response to an earlier consultation exercise on Solvency II reform. The government’s plans regarding these reforms are part of a wider reform program to make the UK the world’s “most innovative, dynamic and competitive global financial center”, and have been welcomed by the insurance industry.

In a recent Best commentary, analysts stated that a key feature of this reform is the intended change in asset eligibility rules for the matching adjustment to allow the inclusion of assets with highly predictable, rather than only fixed, cashflows.

The rating agency said: “Asset eligibility changes do not directly affect capital ratios. The likely impact of the changes will be focused on the restructuring of investment portfolios backing policyholder liabilities, as the range of eligible assets is widened.

It added: “Expansion of asset options for UK annuity writers should assist the industry in sourcing assets to meet expected high demand for pension risk transfer (PRT) solutions over the coming years.”

Stratumn, by SIA Partners

According to analysts, broadening the assets eligible for the matching adjustment moves the prudential system incrementally away from cliff-edge product classifications towards a more economic approach.

The Association of British Insurers (ABI), has suggested that the reform could allow the industry to invest more than £100 billion over the next ten years across a more diverse range of assets.

AM Best highlighted that the overall expectation is that the changes will lead to a higher proportion of UK-based assets available to back UK annuity portfolios, compared with today.

Regarding the proposed risk margin reduction – 65% for long-term life insurers -, AM Best analysts believe that it is unlikely that it will change UK annuity writers’ longevity reinsurance purchasing decisions in the near term.

However, AM Best also believes the lower risk margin should enhance annuity writers’ options and negotiating position with reinsurers.

Additionally, the rating agency noted its support regarding stress-testing and believes it should be mandatory.

It said: “A requirement for insurers to participate in stress-testing exercises prescribed by the PRA (Prudential Regulatory Authority) means these exercises will no longer be voluntary for UK insurers.

“It will place greater emphasis on scenario-based solvency testing over time, in addition to model-based work. AM Best would welcome this evolution of the UK regulatory framework on transparency grounds and to the extent that stress testing results are disclosed.”

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