The Bank of England (BoE) said that UK insurers will need more time to comply fully with new European Union (EU) capital rules that come into force in January 2016.
BoE deputy governor for prudential regulation and chief executive officer (CEO) of the Bank’s supervisory arm, the Prudential Regulation Authority (PRA), cited implementing the Solvency II rules as his single biggest task this year.
The reform aims to ensure that UK insurers such as Prudential, Aviva and the Lloyd’s of London insurance market hold enough capital to meet policy commitments that stretch out for decades in some cases.
To determine the level of capital needed to cover liabilities, insurers use a complex mix of real and extrapolated interest rates as far forward as 60 years.
“The issue we have got is we have had quite a big shift down in the risk-free interest rate curves and that affects capital requirements under Solvency II,” Bailey told an audience at the Financial Regulation Summit held by Reuters.
The UK rate is based on sterling market rates – currently very low – as far forward as 50 years. Eurozone insurers in the only have reliable market rates up to 20 years ahead, relying thereafter on a rate calculated by regulators.
This latter rate tracks higher far sooner than the sterling rate, thus dampening the amount of capital needed to potentially give euro zone insurers an advantage. Straight comparisons between UK and eurozone insurers will be harder for investors.
“I would prefer it if everybody was done on the same basis, frankly,” said Bailey. “We can’t have one set of firms benefiting from one set of treatments and another set benefit from a slightly different set of treatments.”
The EU rules allow regulators to grant transitional relief to insurers for up to 16 years to fully comply with Solvency II. “As long the risk-free curves remain where they are then firms will be making greater use of the transitional capital structure in Solvency II than they thought they would,” said Bailey.
Some UK insurers will only meet Solvency II requirements in January with transitional relief factored in. By making such transitional periods transparent, the PRA hopes to prevent market pressure building up on firms to find more capital quickly.
“This is not a world where the capital regime is bust. We don’t regard our insurance companies in that position,” Bailey said.
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