ANALYSIS OF SOLVENCY II RISK MARGIN AND HOW THIS DIFFERS BY LINE OF BUSINESS

Firms must hold a risk margin on their balance sheets under Solvency II regulations, which is intended to represent the additional amount that another entity would need to be paid to take on the liabilities, over and above the value of the net best estimate provisions.

On 23 June 2020, the UK Government announced it would review certain features of the Solvency II regulatory regime for insurance firms, which includes a review of the risk margin calculation. There has been widespread lobbying from the industry that the 6% pa cost-of-capital assumption in the risk margin unfairly penalises insurers with longer-term liabilities in the current low interest rate environment. To support this review, the Bank of England launched a quantitative impact study (QIS) on 20 July 2021. The QIS covers three main areas of Solvency II: the calculation of the matching adjustment, the risk margin, and the transitional measure on technical provisions.

EIOPA also published its opinion on the 2020 review of Solvency II in December 2020. EIOPA proposed changes to the risk margin calculations so that it allows for the time dependency of risks, therefore reducing the sensitivity of the margin to interest rate changes. The proposed change will reduce the amount of the risk margin, particularly for long-term liabilities.

It will be interesting to see if the UK, now post-Brexit, will mirror any future amendments EIOPA may make to Solvency II rules on the risk margin, or any other part of the regulations. Any deviations from the Solvency II approach would have wider ramifications on the UK regime’s Solvency II equivalence going forwards.