Government does not appear to share the same concern about the increased risk of a life insurance firm collapsing due to its Solvency II reforms as the Bank of England does, according to deputy governor Sam Woods.
Addressing the Treasury Select Committee today, Woods (pictured) said he thought the key issue was around the risk of the default of a life insurance firm, adding that government’s rejection of the bank’s alternative proposal suggested the government was not as worried about this risk.
Earlier this week Bank of England governor Andrew Bailey wrote to the committee warning government Solvency II proposals cutting how much capital life insurers must carry to protect themselves against bankruptcy would increase the annual chance of these firms collapsing by around 20%.
Bailey highlighted the annual risk of a failure will rise from 0.5% to 0.6% if the changes are implemented, a “relative increase in the probability of failure of around 20%”.
The governor said government plans increased the risk by twice as much as the Bank’s preferred reforms which would improve the way the financial services sector captures risk.
Not worrying as much as the bank does
Speaking at today’s session in Parliament, Woods noted that on lots of other areas of the reforms government and BoE had been on exactly the same page throughout.
But in this instance, Woods said: “The government has been clear it’s not persuaded by that case. That is a combination of perhaps not being persuaded that the risk is one that it needs to worry about as much as we think we need to worry about it.
“But also there is balance that government has to strike with its growth and investment objectives. And I think that government took the view that to introduce the change that we were looking for would reduce the government’s assessment of the growth and investment benefits of the package.
“We can argue whether that’s right but I think that’s probably the judgement that was reached,” he added.
Writing to committee chairwoman Harriet Baldwin MP, Bailey said: “Using firms’ reported figures at end-June 2022 as a basis, the risk margin for the life insurance sector was £22bn.
“Post reform, we expect this to shrink to c.£8bn, i.e. a release of c.£14bn, once transitional measures on technical provisions have run off (by 2032).
“Had the PRA’s [Prudential Regulatory Authority] reforms of the FS [financial services] been taken forward, we expect that there would still have been a net capital reduction from the combination of these reforms, but that less than half of this capital would have been released in aggregate.”
PRA reforms half increased risk
Bailey noted it was challenging to translate an estimated capital release figure to an estimate of the increase in the probability of failure and a variety of approaches had been used.
The current Solvency II regime is calibrated to ensure insurers hold sufficient capital to withstand a stress level with 99.5% probability over a year, or an annual probability of failure of 0.5%.
Bailey added that over a one-year period “it is likely that the estimated capital release of £14bn (or 14% of the own funds at end-June 2022) could lead to an increase in the annual probability of failure for this sector of approximately 0.1 percentage points”.
This would mean that over a one-year period if a firm just met the minimum regulatory standard, “the probability that a life insurance firm would hold sufficient capital to withstand the solvency standard stress level will be 99.4% when compared to the current level – a relative increase in the probability of failure of around 20%,” Bailey continued.
“Had the PRA’s preferred FS reforms been taken forward, we estimate that less than half of this increase would have occurred.”
