page-banner

What does Solvency II
reform mean for pension schemes’ de-risking plans?

Our viewpoint

In October 2020, the UK Government launched a review of Solvency II, the rules governing the capital requirements for insurers.

With the UK leaving the EU, the review provided an opportunity to diverge from the European-wide rules and for the UK to set its own course.

We consider the four key themes emerging from the latest Government proposals announced in April 2022 and the implications for pension schemes’ de-risking plans.

Key proposed changes

Risk margin and longevity reinsurance

The proposals will reduce the “risk margin” element of capital reserves by 60-70%. Currently insurers are achieving similar reductions in the risk margin by reinsuring longevity risk. This change means it will be less necessary for insurers to use longevity reinsurance. However, we expect many insurers to continue to do so given current reinsurer pricing offers good economic value, particularly for pensioners, and still reduces insurers’ risk capital requirements.

Wider asset eligibility

The proposals will relax some of the rules around which assets qualify for favourable capital treatment under the “matching adjustment”. This will make it easier for insurers to invest in assets such as callable bonds, commercial real estate lending, housing association bonds and loans, infrastructure assets and local authority loan portfolios.

Investment default reserves

The proposals will revise the way reserves are calculated for possible defaults on insurers’ assets. Currently the default allowance (the “fundamental spread”) is set centrally across Europe and updated only quarterly.

This will change the assets that are optimal for insurer pricing and, to an extent, “smooth” out the price opportunities that arise when a market shock pushes up credit spreads (such as occurred in April 2020 in the wake of Covid-19).

Overall capital levels

The UK Government suggests the proposals will reduce insurer risk capital by 10% - 15%. This would increase insurer capital coverage ratios from current levels of 150% - 200%. In practice, this reduction may not come through because the benefit from a lower risk margin is already largely reflected in insurers' capital. Indeed, the capital requirements could increase overall for some insurers as the changes to investment default reserves may lead to a net increase in capital requirements.

Implications for pension schemes

Policyholder security

Whilst the proposals could result in a reduction in overall capital requirements, the extent will be dependent on the final details and is likely to vary by insurer. Our current expectation is the implications for policyholder security will be modest but this is an area to monitor. The wider asset eligibility also potentially introduces new risks that the insurers will need to manage.

Longevity swaps

If insurers use less longevity reinsurance this should increase capacity from reinsurers for writing longevity swaps with pension schemes. But overall the proposals are less significant for longevity swaps than for buy-ins/outs.

Buy-in/out pricing

At this stage there is not sufficient detail confirmed to be definitive on what the proposals mean for pricing. We expect overall it is likely to be neutral to positive with the greatest potential benefits for the largest transactions where increased flexibility around reinsurance and asset eligibility should be helpful. For the majority of schemes the impact is likely to be small and we see no reason to amend current timelines or journey plans.

Buy-in/out capacity

We expect a number of the changes (lower capital, wider asset eligibility and less reliance on longevity reinsurance) will all be helpful for insurers’ capacity to write increased volumes at current pricing levels. It may also encourage new insurers to enter the market. The changes should help contain upward pressure on pricing as we project volumes to grow significantly over the next few years as scheme funding levels improve.

To see Solvency II reform timeline and find out the latest developments in the buy-ins and buy-outs market, click here to read our pensions de-risking update.