Gulf between PRA and insurance industry over Solvency II – but there could be less paperwork | Wolters Kluwer Financial Services
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  • Gulf between U.K.'s PRA and insurance industry over Solvency II – but there could be less paperwork

    By Selwyn Parker

    Published January 11, 2018

    The shadow of Brexit looms large over U.K.’s giant insurance industry as it continues to labour with the complexities – some of them unnecessary, according to critics -- of the massive exercise known as Solvency II.

    As the powerful Treasury Committee points out in a revealing report in September 2017 on the implementation of Solvency II, which is very much an EU initiative, there is too wide a difference between the Prudential Regulation Authority and the insurance industry on some of its most fundamental elements. A particular bugbear for firms is the much bigger reporting requirements dumped on them.

    In what is very much a Brexit-linked issue, the committee has made a strong plea for the industry and the PRA to figure out between them exactly what parts of Solvency II can be changed right now while the UK remains a member of the E.U. That is, without first seeking the approval of Brussels.

    And, just as importantly, the committee want to know how Solvency II should be redesigned for the benefit of British firms after U.K. finally walks away from Brussels, whenever that may be.

    To complicate things further, there is an ongoing review of Solvency II on the other side of the Channel even though the directive has only been in operation since 2016. Launched by the European Insurance and Occupational Pensions Authority (EIOPA), this review is a highly technical one about infrastructure investment risk categories and is of interest to specialist insurers. But EIOPA is also working on formulae for capital requirements, reporting of measures of long-term guarantees and of equity risks among other issues that are unlikely to simplify the way Solvency II is applied in the real world.

    Pivotal

    Although the banking industry hogs most of the headlines, Britain’s insurance industry is of pivotal importance to the economy. In 2016 it managed over £1.9 trillion in investments, paid nearly £12bn in taxes, and has a gross value added (a useful measure of its contribution to the economy) of £35bn a year. And then of course there’s the London Market, which includes Lloyds of London and insures global risks through 84 syndicates that perform a worldwide role centred in the City.

    Insurance companies perform a fundamental social service – one large firm estimates its pays out more than £40m a day in various claims. And the industry does all this with remarkably little fuss. In the last 40 years, there have been only two significant failures – Equitable Life whose guaranteed annuity products fell foul of hostile interest rates in the 1990s and Independent Insurance Company which went bankrupt in 2001, a victim of fraudulent activity at senior level.

    The cost of managing these failures was modest compared to those in Britain’s banking sector that cost the taxpayer dearly.

    Unlike the post-financial crisis regulations introduced to prevent banks from collapsing without causing long-term economic damage, the Solvency II directive was not therefore designed as a response to failures by British insurance firms. Quite the contrary, given the industry’s history of responsible self-management.

    Yet Solvency II has been something of a monster to develop and implement. It took 15 years from its conception to put into practice, an indefensibly long time. In fact, the former chief executive of the PRA, Andrew Bailey, famously said that “the history of the EU process on Solvency II is shocking.”

    According to studies by Treasury, the cost to UK business of implementing the directive is about £196m a year. And that’s on top of a one-off cost of £2.6bn.

    Usefulness 

    Even now, after nearly two years in operation, there’s a divergence of opinion about the usefulness of Solvency II. While some -- regulators in particular -- see it as the pre-eminent system that firms must by default implement in their own interests even if they are not located within the EU, others see it as a typically Brussels-designed product that has adopted a rigid, rules-based rather than a principles- based approach in the ultimate aim of ensuring the stability of the sector.

    The technical term for this kind of directive is “maximum harmonization” – that is, a regulation that is enforced equally across the 28 member states. The ability of national regulators to fine-tune it for local markets has been deliberately designed out.

    And it’s in the narrow rules-based principle where tension has arisen between the British industry and the PRA. To put it simply, there are important technical areas where the PRA seems to prefer to stick to the letter of the law while the industry would prefer some more latitude.

    Reporting burden

    Of direct interest to the compliance function, one of the most burdensome requirements of Solvency II is the amount of reports that firms must hand to the regulator. Many respondents to the Treasury Committee hearings complained that the PRA has added a whole raft of U.K.-specific reporting obligations on top of the already immensely detailed, obligatory annual and quarterly returns required by the original directive. In short, gold-plated reporting.

    The committee’s report is sceptical about this – “it is unclear what value much of the reporting adds.”

    Lloyds of London, one of the most influential respondents, appears to agree. In its submission it wondered: “Solvency II’s requirements are very detailed and it is not clear what use supervisors can make of all the information they receive.”

    Putting it purely in terms of volume of paper, the Association of British Insurers estimates the volume of obligatory reporting has increased by four to eight times compared with the former ICAS regulations.

    The PRA is not giving up much ground though. The regulator’s head, Sam Woods, argues that all this extra data will come in useful if there’s a future crisis of some sort and the PRA must act quickly. Better to have vital intelligence in hand rather than to go looking for it in a hurry. As a small concession, the PRA has however agreed a dispensation for smaller firms that, it estimates, will remove about 70 per cent of their quarterly reporting burden.

    After Brexit

    After investing so much time and money in Solvency II, nobody in the insurance industry appears to want to dump it. The looming issue now – and it’s one the Treasury Committee wants dealt with – is how the PRA should interpret Solvency II for the post-Brexit era in a way that reinforces the standing of Britain’s insurance industry on a global rather than just an E.U. basis.

    Without going into all the technicalities such as proportionality and internal models, the gulf between the PRA and the industry appears to come down to the degree to which the rules-based philosophy of Solvency II conflicts with the judgement-based approach, which so many seem to prefer. This is because it allows national regulators a degree of interpretation in response to what the real-world throws at their country’s firms.

    With an industry that’s worth about £35bn a year to Britain, this is clearly worth getting right.

    About the author: Selwyn Parker is an author of books on finance and business topics, a specialist in financial history, and regular contributor to newspapers and magazines. Based in Spain, France and the UK, he focuses mainly on European developments. His latest book, The Great Crash, is a new history of the Great Depression that among other things explains the rise of regulation in the form of the SEC and related authorities. Selwyn is a regular contributor to Wolters Kluwer Compliance Resource Network.

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