UK will slash solvency risk margin by end-2023 on 1/3 cut to cost of capital

The UK will trim the risk margin for insurer solvency calculations, including a slashing of the cost of capital underpinning the measure and adding a small perk for life insurance, in a new regulatory calculation that ought be in place starting year-end, the UK Treasury said in launching a public review of a regulatory proposal.

“The Government is determined to implement reforms as soon as possible,” authors of the long-expected draft regulations wrote.

Reform of the risk margin should be in force in legislation by year-end 2023 and the government is further "considering options" to enable reforms to the matching adjustment to come into force by the end of June 2024. The remainder of the new regime should come into force by year-end 2024, authors claimed.

But further changes and amendments remain possible in a system where numerous parts have been set in motion by a multi-faceted shift out of the EU regulatory regime.

“These regulations will also need to work effectively with related [regulatory oversight office] PRA rules,” authors warned. “Adjustments to the regulations may be necessary as the PRA completes the development of their rules.”

The risk margin applied by UK-domiciled insurers should come down quickly just on the force of a cut in the standard cost of capital used in the measurement from the EU's 6% to a proposed 4%. The UK additionally will discount the risk margin with a 'risk tapering factor' including a flat 10% benefit for life insurers. Life insurers will benefit well beyond that headline 10% as benefits compound over the much-longer duration of life liabilities, although the upside is eventually capped.

For the matching adjustment, the mechanism that allows insurers to discount long-term liabilities at more favourable rates if balanced against a bundle of long-term assets, a new list of qualifying asset criteria was expected to make the adjustment more broadly accessible. New UK wording speaks to "similar cash flow characteristics" of the bundled assets, seemingly a tone down from the EU standard where cash flows are "expected to replicate" the insurance liability.

Both moves have been previously flagged in round terms, if not so fully defined. Regulators had spoken to a roughly 30% cut to risk margins for non-life and 65% for life.

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