Ten things you need to know about Solvency UK

1. Onshoring and adapting Solvency II as Solvency UK

The amended Solvency II regime, referred to as Solvency UK, has been transmuted from the Solvency II Directive, the Solvency II Delegated Regulation and other assimilated law primarily into the PRA Rulebook and other PRA policy materials (such as supervisory statements or statements of policy), as well as several UK statutory instruments.

The PRA’s final statement of policy of the Solvency UK reform process (PS15/24 – Review of Solvency II: Restatement of assimilated law) updated references to Solvency II assimilated law and EU Directives in the PRA rules and policy material to refer to the final rules published in PS15/24, and not to the assimilated law equivalents. The statement also updated references to EU Directives in policy material to the relevant parts of the UK’s regulatory framework where appropriate and includes a full set of mapping tables (Appendix 8) setting out where all relevant Solvency II assimilated law and other materials have been restated into PRA rules and policy material.

2. Reducing the Risk Margin

A core element of the Solvency II regulatory capital regime is that insurers have to hold assets to cover their expected insurance liabilities, known as technical provisions. This includes a best estimate of liabilities and a risk margin.  

The risk margin is required so that the technical provisions are set at a level equivalent to the amount that would be required by a notional third-party insurer to assume the liabilities; in other words, the market value of the liabilities. 

The risk margin is calculated on a cost of capital basis: the cost of the regulatory capital that would be required to support the liabilities until they run-off. The cost of capital rate was set at 6% under Solvency II. When consulting on Solvency UK, the PRA acknowledged concerns that the risk margin was too sensitive to movements in interest rates and too high when interest rates are low, which particularly impacted the life sector given the long-term duration of its assumed liabilities. As a result, the PRA has reduced the cost of capital rate to 4%, with a risk tapering factor with a parameter of 0.9 for life business (subject to a floor of 0.25). 

The changes are expected to result in a c. 60-65% reduction of the risk margin for life insurers and 30% for non-life insurers. The PRA’s expectation is that this may allow additional capital to be released to be put to work in writing new business.  

3. The (not quite) Matching Adjustment

The Matching Adjustment (MA) is an important mechanism under Solvency II for life insurers. The MA allows them to take credit upfront for part of the expected investment returns of the cash flows of investment assets that are used to closely match the cash flows of certain long-term liabilities of insurers. The MA is calculated by reference to a Fundamental Spread (FS), which reflects risks retained by the insurer, such as credit risk on the issuer of the assets and losses arising from a downgrade of the matched assets. The MA allows the insurer to benefit from that part of the asset’s valuation which reflects the illiquid or long-term nature of the asset.

The PRA has amended the MA as part of the Solvency UK reforms to increase the investment flexibility of insurers who utilise the regime. 

The key MA reforms are: (1) expanding asset eligibility beyond assets with fixed cash flows; now up to 10% of the aggregate MA benefit for which credit can be taken can derive from assets with highly predictable (but not fixed) cash flows; (2) expanding the types of long-term insurance business that can benefit from the MA (e.g. in-payment income protection liabilities, the guaranteed element of with-profits annuities and in-payment group death in service dependants annuities); (3) removing the limit on the amount of the MA that may be credited from sub-investment grade assets; (4) expediting the PRA’s review process for MA applications, with triaging of applications and a six month target deadline for determining applications; and (5) requiring a senior manager to attest that the FS used by the firm in calculating the MA reflects all retained risks (i.e. not just credit risk) and that the MA can be earned with a high degree of confidence from the assets held in the relevant portfolio of assets.

4. Simplification of the Transitional Measure on Technical Provisions

Solvency II permitted the PRA to grant approval for firms to apply for transitional arrangements to apply for the calculation of their technical provisions (TMTP) in respect of liabilities in force prior to the commencement of Solvency II for a period of up to 16 years. 

As part of Solvency UK, the PRA has introduced a simplified default method for calculating the TMTP based solely on the Solvency II risk margin and best estimate of liabilities, as opposed to the Solvency II method which requires calculation of regulatory figures on a Solvency I and Solvency II basis. This is to address resource costs and improve consistency, although firms could apply prior to 31 December 2024 to apply a modified version of the legacy approach. 

The new rules require all firms applying the TMTP to amortise the TMTP in a consistent manner to zero by the end of the transitional period on 1 January 2032 to avoid a cliff-edge effect.  

The PRA has confirmed that it will not generally consider any further new applications for TMTP permissions, except in cases where a firm without an existing TMTP permission is acquiring business (via a transfer under Part VII of the Financial Services and Markets Act 2000 or through a 100% reinsurance arrangement) that already benefits from TMTP. Firms are also required to review and adjust their calculation approaches where necessary within two months of any transfer event (being a Part VII transfer or the entry into, amendment, cancellation or expiry of a 100% reinsurance contract) to account for the change in their liabilities. 

Third country branches of overseas (re)insurers will not be able to use the TMTP going forwards.

5. Relaxation of third country branch capital requirements

The PRA has removed the requirement for overseas (re)insurers operating through UK branches to calculate and report branch capital requirements and consequently the requirement to establish and report a branch risk margin and to hold assets in the UK to cover the branch solvency capital requirement (SCR). 

The PRA considers that these changes represent a proportionate approach to policyholder protection given that a branch cannot fail independently of the insurance undertaking and that appropriate safeguards are in place to mitigate the risk of regulatory arbitrage. For example, the PRA has indicated that it will only authorise third country branches where the home jurisdiction’s supervisory regime is deemed to be broadly equivalent (which includes assessing whether UK policyholders of the firm will be given an appropriate priority upon an insolvency event), where the firm has sufficient worldwide resources and where the branch’s business plan in the short to medium term indicates it will assume less than £500 million of liabilities protected by the Financial Services Compensation Scheme, thus creating an indicative threshold limit for operating in the UK via a branch. 

Notwithstanding these changes, a third country branch must still calculate and hold assets to cover the branch best estimate of liabilities. This can include holdings of assets held at the legal entity level, but such assets must only be notionally allocated to the branch where they would be “available” to pay the claims of branch policyholders in the event of a winding-up. 

Third country branches (other than pure reinsurance third country branches) will continue, however, to be required to hold a security deposit in the UK of a quarter of the minimum capital requirement (MCR).

6. Mobilisation regime and change to application thresholds

The PRA has increased the thresholds at which Solvency UK would apply. The requirements now capture firms with gross written premium (GWP) income of £25 million or more (increased from €5 million) and firm and group technical provisions of £50 million or more (increased from €25 million). The threshold with respect to reinsurance operations has also increased, to £2.5 million GWP income (increased from £530,000) or £5 million gross technical provisions (increased from £2.4 million), to retain the calibration as 10% of overall business as under Solvency II. 

Firms are only exempted from the regime if they have not exceeded any of the revised thresholds for three consecutive years, and do not expect to exceed any in the following five years but can apply to operate within Solvency UK on a voluntary basis. The PRA considers this to be a more proportionate approach and has noted that it may consider further measures to increase the proportionality of the Solvency UK regime for smaller insurers. 

In this context, Solvency UK introduces a mobilisation regime for new insurers while they complete the final stages of their development with the aim of facilitating and encouraging new entrants to the UK insurance market. Mobilisation is an optional stage for up to 12 months (beginning at the point of authorisation) during which time the firm has a lower MCR floor of £1 million (rather than £2.4 million). In return, the business it can write is subject to certain restrictions to limit the risks to policyholders. The PRA note that they will take a case-by-case approach, but a firm may generally only take on short term liabilities on a claims made basis and will have a maximum limit on its exposure (both in terms of net exposure, class of business (i.e. no liability insurance) and term).

7. Reporting

The PRA has sought, through the Solvency UK reforms, to reduce the reporting burden on firms, whilst still enabling it to collect sufficient data to meet its statutory objectives.

A first phase of reforms, which streamlined insurance reporting requirements by removing certain reporting templates (including summary assets and own funds variation reporting for all firms and financial stability reporting for larger firms) and expanding the quarterly reporting waiver to the PRA’s “Category 3” firms, was implemented by the PRA on 31 December 2021.

The core PRA changes made in 2023 and 2024 were to: (1) implement a general simplification of the reporting and disclosure templates (such as deletion of a number of Solvency II Quantitative Reporting Templates, the directly associated disclosure templates and relevant PRA National Specific Templates (NSTs)), reduce the reporting frequency of certain templates and consolidate reporting templates covering the same topics; (2) remove the requirement to provide the Regular Supervisory Report in the UK, which took effect on 31 December 2023; (3) with respect to third country branches, transfer the expectation to submit information on their home state resolution arrangements to a standalone narrative report and create new reporting requirements regarding the solvency and financial position of the legal entity and  create certain NSTs; (4) amend SCR reporting by groups to harmonise the reporting format of the different SCR calculation methods and provide detail on internal model components; (5) introduce new reporting requirements on the changes in internally modelled SCR through the year; (6) simplify reporting requirements in respect of the TMTP and (7) amend the quarterly model change reporting requirements. 

8. Changes to Internal Model approvals

Under Solvency II, insurers could seek approval for a bespoke method of calculating its SCR known as an internal model. 

As part of Solvency UK, the PRA has moved towards a more principles-based approach to its assessment, approval and ongoing monitoring of internal models. In particular, the PRA has streamlined the tests and standards for new internal models to be approved and reduced the number of prescriptive requirements that insurers must meet for approval of their internal model and any subsequent variations. 

The PRA has also implemented safeguards that can be used to bring an internal model that is not wholly compliant into compliance with the PRA’s calibration standards (being, in summary, the requirement to ensure that the SCR calibration reflects all quantifiable risks at a 1-in-200 standard over one year) and/or mitigate the risks arising from such non-compliance (e.g. capital add-ons (CAOs) or qualitative requirements). The PRA will also permit the use of model limitation adjustments by firms to address weaknesses in their internal model (which would increase the SCR). 

The PRA has also implemented an internal model ongoing review framework, which builds upon the PRA’s existing supervisory review processes. This process has four key strands: (1) engaging with firms in respect of issues identified through PRA thematic reviews; (2) a requirement to report the results of the firm’s analysis of change exercise in respect of movements in the firm’s SCR; (3) annual attestation of compliance with the calibration standards and internal model requirements by a senior manager (expected to be the Chief Risk Officer); and (4) ongoing monitoring of the use and effectiveness of the safeguards adopted to address model limitations. 

9. Capital add-ons

Linked to the PRA’s reform of the internal model framework is an adjustment to the Solvency II approach to setting CAOs. 

The PRA is introducing a new residual model limitation CAO as a safeguard to support granting permission to an internal model or a variation of an existing permission. The PRA’s view is that this will make the regime more flexible and allow a wider set of internal models to be approved, although there was some industry concern in response to the consultations that this could lead to a more widespread imposition of CAOs and further, that this could impact on investor confidence. 

The PRA has also introduced a new approach for calculating a CAO for a significant deviation in a risk profile, where the PRA has concerns that part or all of a firm’s internal model is inadequate or the SCR that the internal model generates no longer appropriately reflects the firm’s risk profile. The new approach involves setting a CAO as a proportion of the difference between the firm’s SCR and the SCR that would be calculated if it reverted to calculating part or all of its SCR using the standard formula. 

The PRA has also opened the door for firms to apply a CAO which moves dynamically in line with certain outputs calculated by an insurer to reflect how the underlying risk deviation varies over time, rather than the prior fixed CAO approach. 

The PRA will publish a regular summary report setting out its use of model safeguards on an aggregated basis. The PRA will not require the residual model limitation CAO to be separately disclosed in the Solvency and Financial Condition Report but rather included as an amount of the SCR.

10. Group SCR flexibility

The PRA has introduced a temporary ability, for a period of up to two years, for groups to add the results of two or more calculation approaches when calculating the consolidated group SCR (e.g. two or more sets of internal model approaches; or two or more internal model and standard formula approaches). The PRA considers that this will reduce the regulatory burden and frictional costs for groups looking to grow through M&A activity. 

Groups will have up to six months after an acquisition to create a clear and realistic plan to integrate multiple calculation approaches. The PRA considers that this will create additional flexibility by better recognising the differences in nature between firms and ensuring a firm has sufficient time to assess the most appropriate approach to model integration. Within this period, firms are required to submit their plan and, upon satisfactory review by the PRA, will be granted a two-year temporary permission to use two or more calculation approaches.  

In addition, where a UK group’s overseas sub-group is subject to equivalent group supervision, such group will also be allowed to include the overseas sub-group’s SCR under the consolidated group SCR under method 2 set out in the Group Supervision Part of the PRA Rulebook (e.g. aggregation and deduction rather than consolidation) to allow diversification benefits between the method 2 entities within that sub-group.