PRA-Treasury continue Solvency II reform discussions
Solvency II reform in the UK moved from political signalling to detailed rule design in 2022, as HM Treasury and the Prudential Regulation Authority (PRA) began to translate high‑level objectives into concrete changes to the regime's core mechanics. The evolving package centres on reshaping the risk margin, recalibrating and widening the matching adjustment, and cutting reporting and administrative requirements, with HM Treasury and the PRA now working through how far each element should sit in statute versus supervisory rules.
The reforms apply to all UK Solvency II firms, but the most material quantitative changes are directed at long‑term life business using the matching adjustment, where both HM Treasury and the PRA are now openly discussing risk margin cuts of around 60% or more.
Monetary policy and macro‑prudential context
Solvency II has formed the backbone of the UK's prudential framework for insurers since it came into force on 1 January, and the current reform process is the first comprehensive re‑opening of that framework since implementation. HM Treasury's consultation, published on 28 April 2022, sets out the government's preferred direction for reshaping that framework now that the UK can diverge from the EU rulebook, while still operating within the same overarching Solvency II architecture. The consultation confirms that these reforms have been developed by HM Treasury alongside the PRA, making clear that the prudential authority is not a passive recipient but a co‑designer of the new regime.
The government has stated that it will consider feedback from the consultation. This feedback will inform the government's decision on which aspects of the reforms should be embedded directly in primary or secondary legislation and which should instead be implemented through the PRA's rulebook. This creates an explicit split between politically anchored parameters, such as the overall structure of the regime, and more technical calibrations that the PRA may be expected to adjust over time within its prudential mandate. Aon's summary of the proposals notes a substantial reduction in the risk margin, in particular a cut of around 60–70% for long‑term life insurers, indicating a materially lower capital add‑on for these books relative to the current Solvency II design.
HM Treasury's consultation records that the PRA considers a reduction in the risk margin of 60% or just over for long‑term life business could be consistent with its prudential objectives. This aligns the regulator's technical view with the government's political ambition on the scale of relief. Both HM Treasury and the PRA are now publicly anchoring around similar magnitudes for the reduction. This marks a shift from earlier, more cautious discussions and moves the debate onto the precise calibration and implementation mechanics rather than the principle of a large cut.
The focus on long‑term life business reflects where the risk margin has been most contentious under the current regime, given its sensitivity to interest rates and its impact on the economics of annuity and other long‑dated guarantees.
Matching adjustment: fundamental spread and eligibility
The matching adjustment is the second major prudential lever under review, with reforms aimed both at its calibration and at the scope of assets and liabilities that can benefit from it. HM Treasury's consultation sets out a proposed reassessment of the fundamental spread used in the calculation of the matching adjustment, opening the door to changes in how much of the credit spread is treated as compensation for expected losses and other risks versus illiquidity premium.
Alongside this recalibration, the proposals include broadening the assets and liabilities that may be eligible for the matching adjustment, for example to include assets with the option to change the redemption date and morbidity risk liabilities. This represents a functional expansion of the matching adjustment toolkit beyond the current focus on fixed cash‑flow assets backing predictable annuity‑type liabilities, subject to whatever eligibility conditions the PRA ultimately sets in its rules.
The combination of a revised fundamental spread and wider eligibility means the matching adjustment is being re‑opened both vertically (through its quantitative parameters) and horizontally (through the range of instruments and liabilities that can be brought into scope). The PRA's subsequent technical consultation, scheduled for later in 2022, is expected to focus on these detailed aspects, including how any broadened eligibility interacts with the authority's expectations on asset quality, structural features and risk management. According to Aon's summary, the Treasury consultation on the proposals was expected in April 2022, with a subsequent technical consultation by the PRA later in 2022, creating a two‑step process from political design to supervisory detail.
The government will use feedback from the consultation to decide which aspects of the reforms are best located in legislation. The government will also determine which aspects should be placed in the PRA's rules. This effectively draws a boundary between elements that are politically fixed and those that remain under prudential control. This division is particularly relevant for parameters such as the risk margin methodology, the matching adjustment fundamental spread and eligibility criteria, and the scope of reporting simplifications, where the PRA may seek flexibility to adjust calibrations over time.
The PRA's role as co‑developer of the reforms, as recorded in government communications, means that its subsequent technical consultation is not expected to reopen the high‑level direction but rather to operationalise it within the existing Solvency II structure. That structure, in place since 1 January 2016, provides the overall three‑pillar framework and capital standard, while the UK‑specific reforms now focus on how far to modify key inputs such as the risk margin and matching adjustment within that architecture. Macfarlanes notes that the proposals focus "more generally" on the reporting and administrative burden of Solvency II, placing this alongside the risk margin and matching adjustment as one of the three main pillars of change.
Policyholder protection and political framing
Throughout the reform process, HM Treasury has repeatedly stated that policyholder protection remains a central constraint on the design of the new regime. In his February 2022 speech, John Glen said he made clear that policyholder protection is a top priority and will be safeguarded through the proposals, framing the risk margin and matching adjustment changes within that commitment. This dual framing sets up the current consultation phase as a negotiation not only over technical calibrations but also over how to codify the balance between competitiveness, investment flexibility and prudential resilience in the post‑2016 Solvency II market. The timing of any subsequent legislative changes will depend on how quickly the government can assess consultation feedback and decide which elements to embed in law versus the PRA rulebook, a decision it has said will follow the close of the current consultation process.
--- Sources: https://www.bankofengland.co.uk/prudential-regulation/key-initiatives/solvency-ii https://assets.publishing.service.gov.uk/media/62697a6ce90e0746c5113428/20220328_Review_of_Solvency_II_Consultation.pdf https://www.macfarlanes.com/what-we-think/2022/solvency-ii-reform-an-overview/
