‘Fundamental change’ coming from Solvency II: PRA

‘Fundamental change’ coming from Solvency II: PRA

The Prudential Regulation Authority has today (20 March) published final rules setting out how it will implement the European Solvency II directive in the UK, with chief executive Andrew Bailey stating it represents “a fundamental change in the way that insurers are regulated”.

Solvency II puts in place a consistent solvency and capital adequacy framework for insurers across Europe and aims to provide greater protection to policyholders by reducing the probability of an insurance firm failure.

It is designed to align capital requirements to firms’ asset and liability profiles, while also providing incentives to strengthen risk management, reporting and disclosure across the industry.

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From the start of April, firms will be able to submit applications for Solvency II approvals.

Bank of England’s governor Mark Carney commented “it is difficult to appreciate just how revolutionary Solvency II is for the prudential framework in Europe”, adding that “our task now is to ensure a robust implementation of the new regime”.

The PRA set out how it will implement the ‘long-term guarantees package’ whereby insurers reduce the level of risk on some types of long-term liabilities, such as annuities, if they hold closely-matched, long-term assets to back them.

In addition to the final rules, the PRA also published a consultation paper on the application process for the ‘volatility adjustment’ to the risk-free discount rate which will be used to value insurance liabilities.

It is designed to mitigate the effect of short-term volatility in financial markets on valuation of insurers’ long-term liabilities under Solvency II.

Firms wishing to use the volatility adjustment can submit a formal application after 1 April and the PRA will assess applications on a case-by-case basis, saying it will adopt a ‘proportionate’ approach to reviews.

The consultation closes on 20 April and follows the Treasury deciding to exercise supervisory approval for the volatility adjustment in the UK. The regulator is aiming to make decisions on standalone applications within a six week timeline.

Mr Bailey, the deputy governor for prudential regulation at the Bank of England, stated that the papers should provide clarity for UK firms on how the PRA will implement the new regime.

“These publications will allow firms to finalise their preparations for Solvency II in order to be ready for the start of the regime on 1 January 2016.”