9.The UK insurance industry managed investments of over £1.9 trillion in 2016 and paid nearly £12 billion in taxes to the Government. It has a Gross Value Added (a measure of the contribution a sector makes to the UK economy) of £35 billion per annum. It employs around 305,000 individuals, of which around a third are employed directly by providers with the remainder in auxiliary services such as broking. Furthermore, the insurance and pensions sector is a significant exporter of services to the EU.
10.Insurance provides a useful social purpose in that it pools risk to provide protection against losses from risks that an individual or company would be unable to bear. Of the 26.7 million households in the UK in 2014, over 20 million had home contents insurance and/or motor insurance. It also facilitates long term saving by providing a vehicle for individuals to take advantage of investment in long term assets that would not ordinarily be available to them. Writing about the insurance industry as a whole, the Chief Executive of Axa UK said in 2015 that:
“Last year as protectors we paid £14.5 billion—that’s £40 million each day—in motor and property claims, £370 million was paid in claims to travellers who needed help, and £3.6 billion to provide access to private healthcare. For savers, we invested £1.9 trillion (equivalent to 25% of the UK’s total net worth)—providing enormous fuel to the economy, and crucial funding for its necessary infrastructure.”
11.The UK insurance industry also includes the London Market—both companies and Lloyd’s of London, which insures global risks through 84 syndicates. In 2015 the aggregate gross written premiums of the Lloyd’s market totalled £26.7 billion, out of a total of £260 billion for all firms supervised by the PRA.
12.There have been only two significant failures of UK insurers in the last 40 years, which have been summarised by the Institute and Faculty of Actuaries:
13.There have been several well-known incidents outside of the UK market. These include the failure of around a third of Japanese insurers in 2000, and the collapse and near-failing of American International Group (AIG) in 2008. In the latter case, AIG’s UK Insurance subsidiary failed—but this was a result of the Group’s non-insurance activities, rather than any intrinsic failing of the insurer. None of the various overseas failures has had a significant impact on the UK market or the UK financial system.
14.The UK insurance industry is a major contributor to both personal and national economic development; a major employer and tax payer; and a major investor and source of market liquidity. The scale of its contribution to the UK economy is often not recognised and it has historically produced few risks to UK Government finances, and far less of a solvency risk than the banking system.
15.This Report contains the conclusions and recommendations of the inquiry into the effect on the UK insurance industry of the introduction of Solvency II, the new EU-wide solvency regime for insurers.
16.Solvency II is a European Union Directive that entered into force on 1 January 2016, after a long period of development from 2001. While reflecting much of the UK’s ICAS regime that it replaced, the Solvency II regime takes a more rules-based, rather than principles-based, approach to regulation. Solvency II is seen by some as a ‘gold standard’ of international insurance regulation, with many countries “moving towards regimes that are more aligned to Solvency II,” reflecting the “clear direction of travel for insurance regulation.”
17.The Solvency II Directive is an example of ‘maximum harmonisation’, a term used in European law for legislation that puts in place a single regulatory framework aimed at creating a level playing field across the 28 EU member states and the three European Economic Area countries. Signatories of Solvency II cannot go beyond the legislation (preventing so-called ‘gold-plating’). In contrast, a ‘minimum harmonisation’ regime allows signatories to go beyond the prescribed minimum standards. The Solvency II regime allows firms to write business in other EU Member States under the supervision of their home state regulator, without any further approval.
18.In order to achieve maximum harmonisation, the legislation is grounded in rules rather than principles, curtailing the degree of regulatory discretion at a national level. This in theory prevents regulatory arbitrage, obviating any competitive disadvantage caused by prudential regulation at a national level. However, this loss of control by national regulators caused Andrew Bailey, the then Chief Executive of the PRA, to list it as one of three “major concerns” in 2013, commenting that it “will be a battleground of the future as the judgement approach of the PRA comes up against narrow interpretations of EU law”. Solvency II also constrains the ability of insurers to apply discretion of the rules: “there is a requirement for departures from standard protocols to be justified”.
19.However, there is a degree of optionality in the implementation of Solvency II. Examples include how a member state implements the Transitional Measure on Technical Provisions (see Chapter 8); whether the national regulator needs to approve a firm’s use of the Volatility Adjustment (see Chapter 8), and whether the national regulator allows the use of Dynamic Volatility (see Chapter 8).
20.The long gestation period, punctuated by the 2008 financial crisis, has not gone unnoticed by the industry or financial regulators. In 2013 Andrew Bailey stated that he found “the history of the EU process on SII shocking”, while also noting the “staggering” costs. In total, HM Treasury has estimated a one-off cost to UK business of “£2.6 billion…and ongoing costs at approximately £196 million each year”. These costs have been generated by the legislation, but also the implementation of Solvency II, although there have been benefits in terms of improved risk management and a level playing field across Europe (see paragraphs 57 to 59)
21.Opinion of the legislation and implementation of Solvency II ranged from “absolutely dreadful” to a view that, while there are “bits of it that don’t work well”, the “fundamental regime is pretty sensible”. For these reasons the Committee decided to undertake an inquiry into the introduction and operation of Solvency II, launching this inquiry on 13 September 2016 to:
“Consider the options for the UK insurance industry that are created by the decision to leave the EU;
Assess any impact of Solvency II on the competitiveness of the UK insurance industry;
Examine the impact of Solvency II on the role of insurance in meeting the needs of UK customers and the wider UK business economy; and
Assess any learning for both regulators and industry from the introduction of this major piece of insurance harmonising legislation.”
22.While Brexit has created both complications and opportunities, to be explored in Chapter 9, the primary focus of this Report has been on the effect of the legislation and implementation of Solvency II. The effects on competition, the PRA’s objectives and its implementation of the Directive are explored in Chapters 2 and 3. Macroeconomic issues are examined in Chapter 4, while specific technical elements are assessed in Chapters 5 to 8 as follows:
23.It is the purpose of this report to review Solvency II. However, in parallel with the development of EU insurance regulation, there have been developments in international solvency and accounting standards which may turn out to be almost as burdensome and costly as Solvency II, particularly coming so soon after the implementation of Solvency II. Solvency and financial reporting will normally differ, but there are significant differences between Solvency II and the recently agreed IFRS17 and there is a risk that the sheer number of initiatives could lead to a level of complexity which will be a barrier to understanding of an insurer’s business by its Board, investors and regulators. The ability of the PRA to address this problem may be limited but, where possible, opportunities to do so should be taken.
24.The previous Committee received, and published, 50 pieces of written evidence through the course of the inquiry. In addition, it took oral evidence on the EU Insurance Regulation from 3 panels of witnesses during three meetings as follows:
25.The current Committee has not taken any further evidence, but it has published one further piece of correspondence received by Committee staff during the last Parliament, one further letter from the PRA and a round of correspondence with the Chancellor.
13 While retail policyholders had recourse to the former Policyholder Protection Board (PPB) if their insurance was compulsory (e.g. motor insurance), voluntary policies were not covered, and neither were commercial consumers. As the PPB was funded by the insurance industry costs were spread across the industry.
17 Solvency II is a Directive as opposed to a Regulation. While Regulations are legal acts of the European Union that become immediately enforceable as law in all member states simultaneously, Directives need to be transposed into national law.
28 Lord Turnbull giving oral evidence to the Committee on the UK’s Future Economic Relationship with the European Union, 28 June 2016, HC483, Q21
29 Sam Woods giving oral evidence to the Committee on his appointment as Deputy Governor for Prudential Regulation and Chief Executive of the PRA, 19 July 2016, HC567, Q69
32 This term is used throughout this Report to refer to a UK exit or withdrawal from the EU
33 ICS—International Capital Standards for insurance—a detailed, risk-based capital requirement controlling the level of capital a firm must hold as a percentage of its risk-based assets, which will be applied to Internationally Active Insurance Groups (IAIGs) and Globally Systemically Important Insurers (G-SIIs) from 2019
34 IFRS 17—a new International Financial Reporting Standard, which was released in May 2017 to replace IFRS4 on accounting for insurance contracts from 1 January 2021
25 October 2017