Britain's insurers become test case for post-Brexit 'unshackling'

By Huw Jones and Carolyn Cohn

LONDON, Nov 16 (Reuters) - The British government and the Bank of England are reforming insurers' capital rules, seen as a post-Brexit test of UK willingness to "unshackle" the City of London after leaving the European Union.

Reform would potentially free up billions of pounds to invest in infrastructure to boost growth and help Britain to meet net zero climate targets.

Finance minister Jeremy Hunt could unveil changes on Thursday as part of his fiscal statement. But Hunt could be constrained by September's meltdown in UK government bond markets after his predecessor's mini-budget, which badly hit pension funds. This could curb Hunt's appetite for radical changes.


The EU's Solvency II rules were introduced for insurers in 2016, after years of debate, when Britain was still an EU member.

They are designed to ensure insurers hold enough capital to remain stable and can make payouts on policies.

Insurance companies and UK lawmakers see reforming the rules as a key "Brexit dividend" now the UK is free to write its own rules.

Insurers have already complained that the EU rules are too restrictive, drive them to move business offshore, and tie up billions of pounds in capital that is not needed.

"Today, we will be required to hold less regulatory capital for investing in a coal mine than in a wind farm, that to us does not seem right," said Mike Eakins, chief investment officer of life insurer Phoenix PHNX.L , referring to the EU's Solvency II regime.


There is a draft financial services and markets bill in parliament for approval that includes giving the Bank of England powers to change Solvency II.

The Bank has already consulted on potential changes it says would release 45-90 billion pounds ($53.65-$107.30 billion) of investment capital. Insurers say this does not go far enough, but the BoE has said that reform must not become a "free lunch" that puts pensioners' and policyholders' money at risk.

The finance ministry is seeking to broker a deal but it is unclear if it will override the BoE. After September's UK government bond turmoil, the government is seeking to reassure markets the UK financial system is stable and that its regulators are independent.


There are three main elements.

The first is the risk margin, which acts as a capital buffer when one insurer takes over policies from another insurer that has run into trouble. It was costly when interest rates - and investment returns - were at historical lows, because this meant insurers had to hold more capital to pay future policies. That burden has fallen with higher rates.

There is a consensus emerging on this plan, but it will have less impact due to the rise in interest rates since the reforms were proposed.

The second element involves easing reporting requirements, widening the range of assets insurers can invest in, and tweaks to how insurers' internal capital models are approved. There is general agreement on this.

The third and final element is to reform something called the matching adjustment (MA), where agreement has proved difficult.


The MA helps to ensure insurers' assets generate enough cash in future years to cover payouts on policies and pensions.

Investing in an asset that will generate cash at the right time allows an insurer to recognise upfront some of those returns and cut back on capital requirements.

But there is a "haircut" or discount - known under the rules as a "fundamental spread" - which limits how much capital can be knocked off.

The BoE favours a bigger haircut. It also wants the MA to regularly reflect changes in market prices for the assets.

Insurers want a much faster response from regulators when they seek approval on whether an investment should benefit from capital relief.


Funds offering liability-driven investments (LDI) are also used by pension funds to help match assets to payouts. The funds faced collapse in September when they could not stump up collateral fast enough to cope with the UK government bond meltdown.

Regulators argue that the painful lessons from LDI turmoil have a read across for MA, meaning that caution should be the byword for any reforms.

"The recent LDI crisis has undoubtedly surprised certain politicians and regulators around parts of the market," said Eakins.

He said it should not influence Solvency II reform, but that others might disagree.

"It should have zero impact as LDI is completely separate from matching adjustment - I think the reality is that people might say ‘do we not need to do a broader look at financial services regulation?'”


The EU is also updating its Solvency II rules but is further ahead than Britain. The European Parliament and member states are approving final changes. The BoE has said its own package would release more capital than changes proposed in the bloc. ($1 = 0.8388 pounds)
Reporting by Huw Jones. Editing by Jane Merriman

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