Insurance rules should prioritise policyholders over politics

That the arcane world of insurance regulation has made an appearance in the race for the next UK prime minister may come as a surprise. Yet as the contest increasingly turns on tax cuts versus public spending as a way to resolve Britain’s soaring cost of living crisis, the promise of releasing tens of billions of pounds from the shackles of Brussels red tape may be all too beguiling for the next leader of the ruling Conservative party: almost the proverbial magic money tree. Rishi Sunak, the former chancellor who championed overhauling EU insurance rules called Solvency II, is now a frontrunner to be the next prime minister. A rival, Tom Tugendhat, this week portrayed Solvency II reform as one of the biggest potential benefits of Brexit.

The battle for this niche of post-Brexit regulation is predictable. A well organised industry has lobbied hard to throw off what it sees as overly restrictive EU rules, so it can deploy more capital as it sees fit. Insurers’ pledges to invest in projects such as levelling up, infrastructure and green assets were music to the ears of Boris Johnson’s government — which duly launched a consultation on reform, which runs until the end of July — and are likely to appeal to his successor. Meanwhile, supervisors at the Bank of England are anxious not to erode policyholder protections for the benefit of shareholders. Cue government briefings that the BoE is being less a watchdog than a “dog in the manger”. 

Everyone agrees that Solvency II needs to change, even Brussels. The EU’s own reform efforts give insurers the opportunity to portray this as a race: the UK risks being left with clunky rules that the EU will have ditched. A Brexit penalty instead of a dividend.

After Brexit, Britain is free to write its own rules to regulate better a local market heavy in life insurers specialising in annuities. Elements of Solvency II disproportionately penalise this group. The current battlefield is part of the regime called the “matching adjustment”, which in effect determines what assets insurers can use to back their long-term liabilities.

The BoE’s Prudential Regulation Authority, which supervises insurers, has said it is willing substantially to cut bureaucracy and some capital requirements of Solvency II — to the tune of as much as £90bn that could be released for investment — but only if the matching adjustment is also recalibrated. Sam Woods, the head of the PRA, said on Friday that the regulator has concerns that the calculation of the EU’s matching adjustment is too centred around the historical performance of corporate and government bonds. This may not fully capture risks inherent in new, more diverse portfolios — where infrastructure, for instance, plays a heavier role. Insurers now fret that the bonanza unleashed by rolling back one requirement of Solvency II could be erased by a strict PRA approach around another.

The bigger risk is that the government overrules technical specialists on the altar of political expediency. The PRA’s effectiveness is already potentially compromised by government proposals that it ensure UK competitiveness, along with its existing statutory objectives such as protecting policyholders and ensuring firms’ soundness. Promoting the UK is the job of government and lobby groups, not watchdogs.

At stake are pensioners’ and policyholders’ life savings, which, if they are improperly invested, could lead to invidious choices between policyholder haircuts and taxpayer bailouts that a government may have to make long after this one, whoever leads it, has finished. Preventing such dilemmas is one reason Britain set up arm’s-length regulators in the first place; that the PRA may be cautious when it comes to lifetime savings is how it should be. Prudential by name, prudential by nature.