‘Increased volatility’ likely to arise from proposed SII reforms

Written by Adam Cadle

14/02/2022

Increased volatility and a material reduction in the funds held by insurers to withstand shocks are a likely outcome of any reforms to Solvency II that resemble those explored in the PRA’s Quantitative Impact Study (QIS), Willis Towers Watson (WTW) has argued in its latest report commissioned by the ABI.

Following HM Treasury’s call for evidence on re-shaping the UK insurance regulatory regime in light of the UK’s withdrawal from the EU, the PRA undertook a QIS to explore variations in several technical aspects of particular importance to writers of long-term insurance.

WTW stated that the QIS framework “does not satisfy the collective objectives of the HM Treasury review of Solvency II, as it would lead, if implemented, to material reductions in, and increasing volatility of, insurers’ funds available to withstand shocks, prioritising increased prudence to the detriment of competition and growth”.

Furthermore, it argued that the framework will hinder, rather than stimulate, growth and investment in the UK, especially for infrastructure and long-term productive assets that the UK government is keen for insurers to invest in. WTW said the framework “could lead to higher and more volatile annuity prices with resulting lower demand for such products and impact the broader pensions sector, ultimately leading to reduced income security for pensioners”.

The WTW report includes an analysis of life insurer data submitted in the QIS, representing approximately three-quarters of the life insurance industry by technical provisions. It has been prepared by the UK insurance practice of WTW for the ABI.

The findings from the WTW analysis of the two scenarios explored in the QIS (Scenario A and Scenario B) using this sample of data are:
• The Matching Adjustment (MA) would reduce by 44% in Scenario A and by 13% under Scenario B, equating to an increase in annuity liabilities of £14.1bn and £4.3bn, respectively.
• The Risk Margin (RM) for annuity business would reduce by 56% under Scenario A, while Scenario B would lead to a 21% reduction. The RM for non-annuity life business would reduce by 42% and 18% for Scenario A and Scenario B respectively.
• In aggregate, insurers’ funds available to withstand shocks would reduce by 4.2% under Scenario A and by 1.0% under Scenario B.
• For firms with MA portfolios, the average reduction in solvency ratio is 8% and 2% for Scenario A and Scenario B, respectively, based on holding the SCR constant across the scenarios. For firms that specialise in annuities, the average solvency ratio drops by 31% and 11% under Scenario A and Scenario B, respectively.
• Under an “extreme spread” stress, as specified by the PRA, the MA under the QIS scenarios offset the spread movement by approximately 30% less than the current approach.

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