EU freezes out UK bid to change life insurers' capital rules before Brexit
3 August 2017. By Hugo Coelho
A UK bid to ease controversial capital rules for insurers is being sidelined by EU regulators, MLex has learned.
British authorities are seeking a revamp of capital calculations for life insurers that they blame for disrupting annuity markets and threatening financial stability.
But EU authorities have disregarded Bank of England proposals to achieve this in initial plans to review implementing regulations in the bloc's insurance law, known as Solvency II, ahead of Brexit.
At issue is the formula to determine the "risk margin," an additional layer of capital that insurers must hold in excess of reserves.
The required buffer has more than doubled the capital that some UK annuity providers have to set aside against policies they sell, and has proven highly volatile.
Industry leaders have blamed it for pushing insurance companies out of the annuity market or forcing them to offload risks to reinsurers abroad. Regulators also fear that it could make any future financial crisis worse.
The Prudential Regulation Authority, the BOE's supervisory arm, called the formula to calculate the margin "fundamentally flawed" in February.
PRA Chief Executive Sam Woods told lawmakers on the Parliament's Treasury Committee that amending it was the authority's priority in EU discussions on the review of the rules, due by the end of 2018.
Too big a change
But the EU's insurance and pensions regulator has largely ignored UK proposals in the initial stages of its work, a document seen by MLex reveals.
The European Insurance and Occupational Pensions Authority is tasked with advising the European Commission, which holds the power to make changes to regulations that implement the Solvency II law.
EU officials have little appetite to change tack and widen the scope of the research while Brexit negotiations are unfolding, it is understood.
Officials also think that a substantive revamp of the risk margin formula would require changing the Solvency II law, not just amending its implementing regulations.
But a review of the law isn't planned until 2021, presumably after the UK has left the EU, meaning it would probably be excluded from the negotiations involving member states and the European Parliament.
Regulators describe the risk margin as the compensation an investor would require to take on assets and liabilities from an insurer that runs into trouble.
It is reached by multiplying the value of future capital requirements by the cost of capital, which represents the opportunity cost for investors in insurance companies.
The COC was set at 6 percent in the implementing regulations, and it is this figure that the UK wants to change, arguing it is too high in the current low interest-rate environment for investors.
BOE officials have also argued that because insurers' capital requirements are affected by changes in interest rates, the COC must also be pegged to interest rates to reduce volatility.
For the average UK insurer, the risk margin swings by 10 percent to 15 percent every quarter, industry figures show. Falling interest rates saw annuity providers having to cope with a 40 percent increase in the nine months to September 2016.
Research by the British central bank shows that the margin could balloon in times of market stress, pressuring insurers to sell off assets in a pattern that would jeopardize the financial system.
Because of this risk, insurers are ploughing into short-term and safe assets, a strategy that depresses their investment returns, the BOE has found.
EU regulators agree that the COC should be updated and most likely reduced. But they plan to stick to the old methodology. "The focus of work is currently to provide advice on revising the COC rate as a fixed amount," Eiopa wrote in document shared with key stakeholders in late May.
MLex understands that a cut to about 3 percent is being considered. This would halve the buffer, but do little to reduce volatility for British insurers.
A UK issue
The impact of the margin in the UK is more severe than for most other member states because British insurers sell more annuities, the product most affected by the rules. Regulators from across Europe often call it a "UK issue."
Failure to secure a change in the risk-margin methodology would be a blow to the BOE and raise questions about the likelihood of the UK following EU rules after Brexit.
Earlier this year, the central bank rejected proposals from annuity companies to help them by unilaterally making its own "quick fix". The BOE stuck to a path of amending EU implementing regulations, saying moving alone would undercut its negotiating strategy.
In his February appearance in Parliament, Woods had said the PRA was "making good progress" in EU discussions on the margin, responding to lawmakers who doubted the BOE's influence following the Brexit referendum in June 2016.
Political pressure on the BOE will likely increase if its risk-margin requests are ignored. The issue could become a flashpoint for discussions on mutual recognition of financial-industry rules after Brexit.
If it acts on its own, the UK could find it harder to win access to European markets, and insurers could face obstacles to moving capital between their British and EU operations.
Eiopa plans to publish draft advice for consultation in October and send the final proposals to the commission by February. The implementing regulations would change at the end of 2018.