Solvency 2 and Insurance (Amendment, etc.) (EU Exit) Regulations 2019

Earl of Kinnoull Excerpts

Monday 11th February 2019 Lords Chamber

In summary, this Government believe that the proposed legislation is necessary to ensure that insurance and reinsurance firms, insurance distributors and financial conglomerates continue to operate effectively in the UK and that the legislation will continue to function appropriately if the UK leaves the EU without a deal or an implementation period. I hope noble Lords will find that explanation helpful. I commend these regulations to the House.

[The Earl of Kinnoull (CB)]

My Lords, I declare my interests as set out in the register, especially those in respect of the insurance and reinsurance industries. I will speak briefly to two of the three statutory instruments: the Solvency II and insurance regulations and the insurance distribution regulations.

Turning to the Solvency II and insurance regulations, and thinking about the near term, I congratulate the drafters of the statutory instrument; I know the ABI has been sitting with Treasury and PRA officials. First, it gives great comfort to the board of an insurer or reinsurer in the near term—I was thinking about how I would analyse it. It gives certainty on capital required, rollover for capital models and the ability to use reinsurance as temporary capital, and the asset values in an insurer’s balance sheet are unaffected. Secondly, I think the mutual equivalence regime is clever. It would have been possible to put equivalence for EU countries in the statutory instrument, but instead it is left to the Treasury to decide what to do. I think that is important because otherwise it would be possible for us to grant equivalence and then find that our Lloyd’s market had no equivalence granted back to it in the EU, which would be quite wrong. Mutuality of interest is preserved by that. Finally, I think the selection of measures designed to reduce that horror for all insurers, multiple regulation of the same action, is as good as can be done in the circumstances, so I congratulate the drafters on that.

However, thinking about the longer term, I put a question to the Minister. Solvency II—which came into force on 1 January 2016, for those who did not know, and is a regulation dating from 2009—is very much a one-size-fits-all solution to the problem of having the right amount of capital in your insurance market. Accordingly, it was not designed for the British situation. If you look at equivalent regimes in other jurisdictions—I am particularly familiar with the Bermuda jurisdiction, which is equivalent to the EU, but there are others such as Japan, Australia, Canada and the US, which is of course 50 jurisdictions in insurance terms—it seems that some changes could be made.

Your Lordships might well ask for some examples and I can think of two. There is a lot of gold plate around; that can go away. But one dynamic that has always surprised me is that over the last 15 years or so a large number of insurers and reinsurers have been set up, notably in Bermuda, while I do not think any have been set up here in the UK, the home of insurance. A review could properly investigate that dynamic. There are many reasons for it but I hope a review could address them because, to be competitive, I hope that new insurers and reinsurers will be born here, and soon. I would like to hear the Minister’s views on whether a review is warranted and can be expected.

I turn to the insurance distribution regulations. The directive on insurance distribution came in during 2016 and was the update to the 2002 insurance mediation directive. Insurance brokers were then hit by a regulation in 2017, which expanded on the directive, and in 2018 were hit by GDPR. A substantial series of changes have thus been made to how they need to operate, and a period of stability for them would be quite important. I come from the insurance underwriting world but I know the absolute necessity of having a healthy insurance intermediary world to feed our insurance underwriters.

One statistic that is a little worrying is that when the FSA, as it then was, took over the regulation of brokers there were 8,000 insurance brokers in Britain. Britain now has a bigger economy and we are down to under 5,000 of them, which does not feel right to me. I know that it is extremely difficult to found new insurance businesses. Does the Minister feel that, in the longer term, a review would be warranted here? It could seek out gold plate—insurance brokers are sure, and I am convinced, that the cost of regulation in this country is far greater than in other EU countries—but also look at why we have a shrinking number of brokers and why it is so difficult to start up a new broking business. A good review there would certainly give us a fitter and healthier insurance industry.

[Baroness Bowles of Berkhamsted (LD)]

My Lords, I too thank the Minister for his introduction. When I was involved in legislation in Europe, Solvency II was perhaps the first time that I discovered that I could be right while the Treasury was wrong. When I chaired the committee that gave me the confidence to trust my own judgment and to have few, if any, disagreements with the Treasury.

As it was originally done, Solvency II did not manage to cater for everything that the UK needed. In particular, we forgot about annuities; so did the ABI and the Treasury. I have to tell your Lordships that Parliament did not forget about annuities, but we were not strong enough to work out what to do about that because there was a big row going on, particularly between the UK and France, on equities and volatility. When I came back and discovered that I was to chair the committee, one of the first things on my agenda was Omnibus II, which aimed to sort things these out. We had the volatility adjustment for France; we had extrapolation for bonds in the eurozone, which were desperately needed by Germany; we also had the so-called matching adjustment, which we needed because otherwise the fact that insurance companies naturally tried to match the term of the assets that they collected to their liabilities would have been forbidden. They were supposed to account for their assets separately from assessing their liabilities, which in the business of annuities is a pretty stupid thing to do. Because we were having to box and cox with three other things, that meant that the solutions were probably less than perfect in the end, so in the fullness of time it might perhaps be made a little more perfect.

--- Later in debate ---

[Lord Tunnicliffe (Lab)]

My Lords, I thank the Minister for introducing these three SIs. However, once again, it gives me no pleasure to be here; these various SIs have ruined yet another weekend and are in pursuit of an outcome which all sane people believe is stupid and potentially catastrophic. It need not have been this way. Even with the excuse of taking responsible action in case of a no-deal scenario, had we started the whole process earlier we could have been considering these SIs at a more modest rate and perhaps giving them more scrutiny than they are inevitably able to receive—certainly, from me.

Before turning to my own concerns, I want to comment on what other noble Lords have referred to. The noble Baroness, Lady Drake, and the noble Lord, Lord Deben, spoke of responsibilities presently held by EU bodies being transferred to UK bodies. There are two problems here. One is that the sheer complexity necessarily involved in doing that leaves the possibility of unintended mistakes having been made in the transfer. Secondly, the noble Lord mentioned costs. I am not too worried about costs; I am much more worried about resources. Do the FCA and the PRA have the resources to take on this burden? It has been explained to me that they will get their money from the industry and so on, but will the people involved be good enough, given the complexity of the situation that we are addressing?

The noble Baroness, Lady Bowles, talked about the generality of Solvency II. From my standing-start understanding of this area, which began on Friday night, I accept that there is some debate about Solvency II. On the solution suggested by the noble Earl, Lord Kinnoull, that the changes be introduced through this instrument, the Minister knows that I would be the first person to jump down his throat if he tried to do that.

[The Earl of Kinnoull]

I am sorry for having confused the noble Lord, but I certainly did not suggest that changes be introduced in the instrument. I suggested that Solvency II was a one-size-fits-all regulation with a number of things in it. The noble Baroness, Lady Bowles, must have known how difficult were the negotiations, taking place over such a long period and spanning a large part of the world, because of the interaction between the global insurance markets. I suggested merely that it might be wise to have a review and asked the Minister for his view on that. I apologise for any confusion.

[Lord Tunnicliffe]

I thank the noble Earl for that explanation and apologise for misunderstanding him.

The task we have is under Section 8 of the European Union (Withdrawal) Act, which is a very narrow task. My concerns are perhaps quite small and detailed, but I think that there is a fundamental concern about the process. There is a generality in political activity whereby what politicians do should be understood by a reasonably intelligent amateur—I am at least an amateur—and there is disquiet about the complexity of these three SIs. They are remarkably difficult to understand if one is not part of the industry. It is impossible to read the raw instruments. Much of them relates to FSMA 2000, which has been amended so many times that the original document is indistinguishable. Trying to understand the measure from the Explanatory Memorandum, in which I must trust because I have no other way of examining it, was difficult.

The Opposition will not oppose these instruments. As I read through them, they seem in general to do similar things, so I have no points to raise. However, paragraph 7.12 of the Explanatory Memorandum states:

“The European Commission’s responsibility for developing legislation will be transferred to HM Treasury which will be given power to make regulations for certain matters previously dealt with under Solvency II, e.g. the system of governance and risk management, methods and assumptions used in valuations and risk modules”.


That seems to be a pretty sweeping power which has been transferred. Does the Minister believe that is compatible with the withdrawal Act, particularly Section 8? What scrutiny, if any, will Parliament have of the exercise of these powers by HM Treasury? As set out here, they seem to be unrestricted.

Paragraph 7.13 says:

“EU assets and exposures held by UK insurers will no longer be subject to preferential risk charges when setting capital requirements for insurers that use the Standard Formula”.


At first sight, that sounds as though we are taking something away from the EU, that we are being beastly to them. It was only when I did further research that I realised that it has the opposite effect. As I understand it—I hope the Minister will be able to confirm this—the effect will be to increase the capital requirements for UK insurers, which will certainly reduce their profitability. As we know from previous debates, the objective of the withdrawal Act was to not introduce new policy. In his introduction, the Minister said that these instruments aligned with previous SIs. I do not think they do because, in order to stop cliff-edge changes in value, previous SIs have always had some sort of transition regime. If the effect is higher capital requirements, does that mean that UK insurers have been operating unsafely, with insufficient capital? If not, we will be introducing an increased burden on them. If my interpretation is right, why is there not a transition regime in order to make sure there is no cliff-edge change to that requirement?

Further on, in the section on impact, paragraph 12.3 states:

“UK insurers which use the Standard Formula for calculating capital requirements will be impacted by the removal of preferential treatment for EEA risk-weighted assets and exposures. Such insurers could face higher capital requirements unless they divest themselves of such assets and exposures. However, the government intends to legislate to provide regulators with powers to introduce transitional measures to phase in on-shoring changes to reduce the immediate impact on exit.


That hints that the Government are going to introduce a transitional regime through the regulators. Is that a proper interpretation of the paragraph? If so, when will the legislation alluded to, giving these powers to the regulators, come before the House? Why has this not been part of the SI?

Paragraph 7.15 of the insurance distribution instrument says:

“Regulations 6 and 12 of this instrument also transfer relevant legislative functions of the European Commission contained within Articles 25(2), 28(4), 29(4) and 30(6) of the IDD to HM Treasury. This includes the powers to make regulations about conflicts of interest, regulations about inducements, and regulations on assessments of suitability, appropriateness and reporting to customers, and specifying principles for product oversight”.


That seems to be a big bunch of powers. Will they be subject to any parliamentary scrutiny?

Finally, I was somewhat exhausted by the time I came to look at the conglomerates SI—we amateurs do have to work hard—but reassured by paragraph 7.12 of the Explanatory Memorandum which says:

“In practice this change will not have a material effect on financial conglomerates already operating in the UK”.


With that assurance, I have no questions on that SI.