In a speech given at the Investment and Life Assurance Group Conference in May 2016, Andrew Bulley, director of life insurance at the UK’s Prudential Regulation Authority (PRA) reflected upon the implementation of Solvency II and gave an insight into what areas the PRA would examine closely.

Additional risk margin capital is a concept introduced in Solvency II that dictates insurers should be required to hold more capital for risks that are deemed non-hedgeable. The longevity risk inherent in annuities business is deemed to be one of these risks and is therefore is subject to these requirements.

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Sensitive

However, the risk margin measurement has been very sensitive to low interest rates – surprisingly so to some observers – and put a greater strain on insurers than was originally expected. A consequence of this is that a number of insurers have moved to reinsure significant books of the longevity risk associated with annuities.

Ina speech given in February this year, Bulley said the PRA will be: "Monitoring closely if firms become active in this market consistently and solely for reasons other than seeking genuine risk transfer."

Our interpretation of the PRA position on these transactions is that they are aware of the issues insurers face with the risk margin due to the way it is constructed, but nevertheless are firm on longevity risk reinsurance transactions not being used solely to reduce the effects of the risk margin on a company’s required capital levels.

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Bulley has also noted: "The prudential capital ratios for firms that in aggregate represent over 80% of the UK life sector balance sheet are determined by approved internal models."

Higher than most countries

This figure is higher than most countries in Europe and seems to be in large part due to the groundwork laid by the PRA in the preceding 2-3 years to implementation to ensure there were not any surprises sprung upon insurers when they approached the end of the approval process, whilst not in any way compromising on regulatory integrity.

There is an expectation the approvals process will be even smoother this year, but this is likely to be due to more awareness of the process as opposed to a relaxation of standards